Last updated on April 24th, 2024 at 04:32 am
Title 26—Internal Revenue–Volume 1
CHAPTER I—INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
SUBCHAPTER A—INCOME TAX
PART 1—INCOME TAXES
Section 1.21-1 also issued under 26 U.S.C. 21(f); Section 1.21-2 also issued under 26 U.S.C. 21(f); Section 1.21-3 also issued under 26 U.S.C. 21(f); Section 1.21-4 also issued under 26 U.S.C. 21(f); Section 1.25-1T also issued under 26 U.S.C. 25; Section 1.25-2T also issued under 26 U.S.C. 25; Section 1.25-3 also issued under 26 U.S.C. 25; Section 1.25-3T also issued under 26 U.S.C. 25; Section 1.25-4T also issued under 26 U.S.C. 25; Section 1.25-5T also issued under 26 U.S.C. 25; Section 1.25-6T also issued under 26 U.S.C. 25; Section 1.25-7T also issued under 26 U.S.C. 25; Section 1.25-8T also issued under 26 U.S.C. 25; Section 1.25A-1 also issued under section 26 U.S.C. 25A(i); Section 1.25A-2 also issued under section 26 U.S.C. 25A(i); Section 1.25A-3 also issued under section 26 U.S.C. 25A(i); Section 1.25A-4 also issued under section 26 U.S.C. 25A(i); Section 1.25A-5 also issued under section 26 U.S.C. 25A(i); Section 1.28-0 also issued under 26 U.S.C. 28(d)(5); Section 1.28-1 also issued under 26 U.S.C. 28(d)(5); Section 1.30-1 also issued under 26 U.S.C. 30(d)(2); Section 1.36B-0 also issued under 26 U.S.C. 36B(g); Section 1.36B-4 also issued under 26 U.S.C. 36B(g); Section 1.36B-5 also issued under 26 U.S.C. 36B(g); Section 1.41-4 also issued under 26 U.S.C. 41(d)(4)(E). Section 1.41-6 also issued under 26 U.S.C. 41(f)(1) and 1502; Section 1.41-8 also issued under 26 U.S.C. 41(c)(4)(B); Section 1.41-8T also issued under 26 U.S.C. 41(c)(4)(B); Section 1.41-9 also issued under 26 U.S.C. 41(c)(5)(C); Section 1.41-9T also issued under 26 U.S.C. 41(c)(5)(C); Section 1.42-1 also issued under 26 U.S.C. 42(n); Section 1.42-1T also issued under 26 U.S.C. 42(n); Section 1.42-3 also issued under 26 U.S.C. 42(n); Section 1.42-4 also issued under 26 U.S.C. 42(n); Section 1.42-5 also issued under 26 U.S.C. 42(n); Sections 1.42-6, 1.42-8, 1.42-9, 1.42-10, 1.42-11, and 1.42-12, also issued under 26 U.S.C. 42(n); Section 1.42-13 also issued under 26 U.S.C. 42(n); Section 1.42-14 also issued under 26 U.S.C. 42(n); Section 1.42-15 also issued under 26 U.S.C. 42(n); Section 1.42-16 also issued under 26 U.S.C. 42(n); Section 1.42-17 also issued under 26 U.S.C. 42(n); Section 1.42-18 also issued under 26 U.S.C. 42(h)(6)(F) and 42(h)(6)(K); Section 1.42-19 also issued under 26 U.S.C. 42(n); Section 1.42-19T also issued under 26 U.S.C. 42(n); Sections 1.43-0—1.43-7 also issued under section 26 U.S.C. 43; Section 1.45D-1 also issued under 26 U.S.C. 45D(e)(2) and (i); Section 1.45G-1 also issued under 26 U.S.C. 45G(e)(2); Sections 1.45Q-1, 1.45Q-2, 1.45Q-3, 1.45Q-4, and 1.45Q-5 also issued under 26 U.S.C. 45Q(h). Section 1.45Q-3 also issued under 26 U.S.C. 45Q(f)(2). Section 1.45Q-4 also issued under 26 U.S.C. 45Q(f)(5). Section 1.45Q-5 also issued under 26 U.S.C. 45Q(f)(4). Section 1.46-5 also issued under 26 U.S.C. 46(d)(6) and 26 U.S.C. 47(a)(3)(C); Section 1.46-6 also issued under 26 U.S.C. 46(f)(7); Section 1.47-1 also issued under 26 U.S.C. 47(a); Section 1.48-9 also issued under 26 U.S.C. 38(b) (as in effect before the amendments made by subtitle F of the Tax Reform Act of 1984); Section 1.48D-6T also issued under 26 U.S.C. 48D(d)(2)(E) and (6). Section 1.48(e)-1 issued under 26 U.S.C. 48. Sections 1.50A—1.50B also issued under 85 Stat. 553 (26 U.S.C. 40(b)); Section 1.52-1 also issued under 26 U.S.C. 52(b); Section 1.56(g)-1 also issued under section 7611(g)(3) of the Omnibus Budget Reconciliation Act of 1989 (Pub. L. 101-239, 103 Stat. 2373). Section 1.59A-0 also issued under 26 U.S.C. 59A(i). Section 1.59A-1 also issued under 26 U.S.C. 59A(i). Section 1.59A-2 also issued under 26 U.S.C. 59A(i). Section 1.59A-3 also issued under 26 U.S.C. 59A(i). Section 1.59A-4 also issued under 26 U.S.C. 59A(i). Section 1.59A-5 also issued under 26 U.S.C. 59A(i). Section 1.59A-6 also issued under 26 U.S.C. 59A(i). Section 1.59A-7 also issued under 26 U.S.C. 59A(i). Section 1.59A-8 also issued under 26 U.S.C. 59A(i). Section 1.59A-9 also issued under 26 U.S.C. 59A(i). Section 1.59A-10 also issued under 26 U.S.C. 59A(i).
§ 1.0-1 Internal Revenue Code of 1954 and regulations.
(a) Enactment of law. The Internal Revenue Code of 1954 which became law upon enactment of Public Law 591, 83d Congress, approved August 16, 1954, provides in part as follows:
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That
(a) Citation. (1) The provisions of this Act set forth under the heading “Internal Revenue Title” may be cited as the “Internal Revenue Code of 1954”
(2) The Internal Revenue Code enacted on February 10, 1939, as amended, may be cited as the “Internal Revenue Code of 1939”.
(b) Publication. This Act shall be published as volume 68A of the United States Statutes at Large, with a comprehensive table of contents and an appendix; but without an index or marginal references. The date of enactment, bill number, public law number, and chapter number, shall be printed as a headnote.
(c) Cross reference. For saving provisions, effective date provisions, and other related provisions, see chapter 80 (sec. 7801 and following) of the Internal Revenue Code of 1954.
(d) Enactment of Internal Revenue Title into law. The Internal Revenue Title referred to in subsection (a)(1) is as follows:
(b) Scope of regulations. The regulations in this part deal with (1) the income taxes imposed under subtitle A of the Internal Revenue Code of 1954, and (2) certain administrative provisions contained in subtitle F of such Code relating to such taxes. In general, the applicability of such regulations is commensurate with the applicability of the respective provisions of the Internal Revenue Code of 1954 except that with respect to the provisions of the Internal Revenue Code of 1954 which are deemed to be included in the Internal Revenue Code of 1939, the regulations relating to such provisions are applicable to certain fiscal years and short taxable years which are subject to the Internal Revenue Code of 1939. Those provisions of the regulations which are applicable to taxable years subject to the Internal Revenue Code of 1939 and the specific taxable years to which such provisions are so applicable are identified in each instance. The regulations in 26 CFR (1939) part 39 (Regulations 118) are continued in effect until superseded by the regulations in this part. See Treasury Decision 6091, approved August 16, 1954 (19 FR 5167, C.B. 1954-2, 47).
Normal Taxes and Surtaxes
§ 1.1-1 Income tax on individuals.
(a) General rule. (1) Section 1 of the Code imposes an income tax on the income of every individual who is a citizen or resident of the United States and, to the extent provided by section 871(b) or 877(b), on the income of a nonresident alien individual. For optional tax in the case of taxpayers with adjusted gross income of less than $10,000 (less than $5,000 for taxable years beginning before January 1, 1970) see section 3. The tax imposed is upon taxable income (determined by subtracting the allowable deductions from gross income). The tax is determined in accordance with the table contained in section 1. See subparagraph (2) of this paragraph for reference guides to the appropriate table for taxable years beginning on or after January 1, 1964, and before January 1, 1965, taxable years beginning after December 31, 1964, and before January 1, 1971, and taxable years beginning after December 31, 1970. In certain cases credits are allowed against the amount of the tax. See part IV (section 31 and following), subchapter A, chapter 1 of the Code. In general, the tax is payable upon the basis of returns rendered by persons liable therefor (subchapter A (sections 6001 and following), chapter 61 of the Code) or at the source of the income by withholding. For the computation of tax in the case of a joint return of a husband and wife, or a return of a surviving spouse, for taxable years beginning before January 1, 1971, see section 2. The computation of tax in such a case for taxable years beginning after December 31, 1970, is determined in accordance with the table contained in section 1(a) as amended by the Tax Reform Act of 1969. For other rates of tax on individuals, see section 5(a). For the imposition of an additional tax for the calendar years 1968, 1969, and 1970, see section 51(a).
(2)(i) For taxable years beginning on or after January 1, 1964, the tax imposed upon a single individual, a head of a household, a married individual filing a separate return, and estates and trusts is the tax imposed by section 1 determined in accordance with the appropriate table contained in the following subsection of section 1:
Taxable years beginning in 1964 | Taxable years beginning after 1964 but before 1971 | Taxable years beginning after Dec. 31, 1970 (references in this column are to the Code as amended by the Tax Reform Act of 1969) | |
---|---|---|---|
Single individual | Sec. 1(a)(1) | Sec. 1(a)(2) | Sec. 1(c). |
Head of a household | Sec. 1(b)(1) | Sec. 1(b)(2) | Sec. 1(b). |
Married individual filing a separate return | Sec. 1(a)(1) | Sec. 1(a)(2) | Sec. 1(d). |
Estates and trusts | Sec. 1(a)(1) | Sec. 1(a)(2) | Sec. 1(d). |
(ii) For taxable years beginning after December 31, 1970, the tax imposed by section 1(d), as amended by the Tax Reform Act of 1969, shall apply to the income effectively connected with the conduct of a trade or business in the United States by a married alien individual who is a nonresident of the United States for all or part of the taxable year or by a foreign estate or trust. For such years the tax imposed by section 1(c), as amended by such Act, shall apply to the income effectively connected with the conduct of a trade or business in the United States by an unmarried alien individual (other than a surviving spouse) who is a nonresident of the United States for all or part of the taxable year. See paragraph (b)(2) of § 1.871-8.
(3) The income tax imposed by section 1 upon any amount of taxable income is computed by adding to the income tax for the bracket in which that amount falls in the appropriate table in section 1 the income tax upon the excess of that amount over the bottom of the bracket at the rate indicated in such table.
(4) The provisions of section 1 of the Code, as amended by the Tax Reform Act of 1969, and of this paragraph may be illustrated by the following examples:
Tax on $14,000 (from table) | $3,790.00 |
Tax on $1,750 (at 41 percent as determined from the table) | 717.50 |
Total tax on $15,750 | 4,507.50 |
Tax on $14,000 (from table) | $3,550.00 |
Tax on $1,750 (at 39 percent as determined from the table) | 682.50 |
Total tax on $15,750 | 4,232.50 |
Tax on $14,000 (from table) | $3,210.00 |
Tax on $1,750 (at 31 percent as determined from the table) | 542.50 |
Total tax on $15,750 | 3,752.50 |
(b) Citizens or residents of the United States liable to tax. In general, all citizens of the United States, wherever resident, and all resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States. Pursuant to section 876, a nonresident alien individual who is a bona fide resident of a section 931 possession (as defined in § 1.931-1(c)(1) of this chapter) or Puerto Rico during the entire taxable year is, except as provided in section 931 or 933 with respect to income from sources within such possessions, subject to taxation in the same manner as a resident alien individual. As to tax on nonresident alien individuals, see sections 871 and 877.
(c) Who is a citizen. Every person born or naturalized in the United States and subject to its jurisdiction is a citizen. For other rules governing the acquisition of citizenship, see chapters 1 and 2 of title III of the Immigration and Nationality Act (8 U.S.C. 1401-1459). For rules governing loss of citizenship, see sections 349 to 357, inclusive, of such Act (8 U.S.C. 1481-1489), Schneider v. Rusk, (1964) 377 U.S. 163, and Rev. Rul. 70-506, C.B. 1970-2, 1. For rules pertaining to persons who are nationals but not citizens at birth, e.g., a person born in American Samoa, see section 308 of such Act (8 U.S.C. 1408). For special rules applicable to certain expatriates who have lost citizenship with a principal purpose of avoiding certain taxes, see section 877. A foreigner who has filed his declaration of intention of becoming a citizen but who has not yet been admitted to citizenship by a final order of a naturalization court is an alien.
(d) Effective/applicability date. The second sentence of paragraph (b) of this section applies to taxable years ending after April 9, 2008.
§ 1.1-2 Limitation on tax.
(a) Taxable years ending before January 1, 1971. For taxable years ending before January 1, 1971, the tax imposed by section 1 (whether by subsection (a) or subsection (b) thereof) shall not exceed 87 percent of the taxable income for the taxable year. For purposes of determining this limitation the tax under section 1 (a) or (b) and the tax at the 87-percent rate shall each be computed before the allowance of any credits against the tax. Where the alternative tax on capital gains is imposed under section 1201(b), the 87-percent limitation shall apply only to the partial tax computed on the taxable income reduced by 50 percent of the excess of net long-term capital gains over net short-term capital losses. Where, for purposes of computations under the income averaging provisions, section 1201(b) is treated as imposing the alternative tax on capital gains computed under section 1304(e)(2), the 87-percent limitation shall apply only to the tax equal to the tax imposed by section 1, reduced by the amount of the tax imposed by section 1 which is attributable to capital gain net income for the computation year.
(b) Taxable years beginning after December 31, 1970. If, for any taxable year beginning after December 31, 1970, an individual has earned taxable income which exceeds his taxable income as defined by section 1348, the tax imposed by section 1, as amended by the Tax Reform Act of 1969, shall not exceed the sum computed under the provisions of section 1348. For imposition of minimum tax for tax preferences see sections 56 through 58.
§ 1.1-3 Change in rates applicable to taxable year.
For computation of the tax for a taxable year during which a change in the tax rates occurs, see section 21 and the regulations thereunder.
§ 1.1(h)-1 Capital gains look-through rule for sales or exchanges of interests in a partnership, S corporation, or trust.
(a) In general. When an interest in a partnership held for more than one year is sold or exchanged, the transferor may recognize ordinary income (e.g., under section 751(a)), collectibles gain, section 1250 capital gain, and residual long-term capital gain or loss. When stock in an S corporation held for more than one year is sold or exchanged, the transferor may recognize ordinary income (e.g., under sections 304, 306, 341, 1254), collectibles gain, and residual long-term capital gain or loss. When an interest in a trust held for more than one year is sold or exchanged, a transferor who is not treated as the owner of the portion of the trust attributable to the interest sold or exchanged (sections 673 through 679) (a non-grantor transferor) may recognize collectibles gain and residual long-term capital gain or loss.
(b) Look-through capital gain—(1) In general. Look-through capital gain is the share of collectibles gain allocable to an interest in a partnership, S corporation, or trust, plus the share of section 1250 capital gain allocable to an interest in a partnership, determined under paragraphs (b)(2) and (3) of this section.
(2) Collectibles gain—(i) Definition. For purposes of this section, collectibles gain shall be treated as gain from the sale or exchange of a collectible (as defined in section 408(m) without regard to section 408(m)(3)) that is a capital asset held for more than 1 year.
(ii) Share of collectibles gain allocable to an interest in a partnership, S corporation, or a trust. When an interest in a partnership, S corporation, or trust held for more than one year is sold or exchanged in a transaction in which all realized gain is recognized, the transferor shall recognize as collectibles gain the amount of net gain (but not net loss) that would be allocated to that partner (taking into account any remedial allocation under § 1.704-3(d)), shareholder, or beneficiary (to the extent attributable to the portion of the partnership interest, S corporation stock, or trust interest transferred that was held for more than one year) if the partnership, S corporation, or trust transferred all of its collectibles for cash equal to the fair market value of the assets in a fully taxable transaction immediately before the transfer of the interest in the partnership, S corporation, or trust. If less than all of the realized gain is recognized upon the sale or exchange of an interest in a partnership, S corporation, or trust, the same methodology shall apply to determine the collectibles gain recognized by the transferor, except that the partnership, S corporation, or trust shall be treated as transferring only a proportionate amount of each of its collectibles determined as a fraction that is the amount of gain recognized in the sale or exchange over the amount of gain realized in the sale or exchange. With respect to the transfer of an interest in a trust, this paragraph (b)(2) applies only to transfers by non-grantor transferors (as defined in paragraph (a) of this section). This paragraph (b)(2) does not apply to a transaction that is treated, for Federal income tax purposes, as a redemption of an interest in a partnership, S corporation, or trust.
(3) Section 1250 capital gain—(i) Definition. For purposes of this section, section 1250 capital gain means the capital gain (not otherwise treated as ordinary income) that would be treated as ordinary income if section 1250(b)(1) included all depreciation and the applicable percentage under section 1250(a) were 100 percent.
(ii) Share of section 1250 capital gain allocable to interest in partnership. When an interest in a partnership held for more than one year is sold or exchanged in a transaction in which all realized gain is recognized, there shall be taken into account under section 1(h)(7)(A)(i) in determining the partner’s unrecaptured section 1250 gain the amount of section 1250 capital gain that would be allocated (taking into account any remedial allocation under § 1.704-3(d)) to that partner (to the extent attributable to the portion of the partnership interest transferred that was held for more than one year) if the partnership transferred all of its section 1250 property in a fully taxable transaction for cash equal to the fair market value of the assets immediately before the transfer of the interest in the partnership. If less than all of the realized gain is recognized upon the sale or exchange of an interest in a partnership, the same methodology shall apply to determine the section 1250 capital gain recognized by the transferor, except that the partnership shall be treated as transferring only a proportionate amount of each section 1250 property determined as a fraction that is the amount of gain recognized in the sale or exchange over the amount of gain realized in the sale or exchange. This paragraph (b)(3) does not apply to a transaction that is treated, for Federal income tax purposes, as a redemption of a partnership interest.
(iii) Limitation with respect to net section 1231 gain. In determining a transferor partner’s net section 1231 gain (as defined in section 1231(c)(3)) for purposes of section 1(h)(7)(B), the transferor partner’s allocable share of section 1250 capital gain in partnership property shall not be treated as section 1231 gain, regardless of whether the partnership property is used in the trade or business (as defined in section 1231(b)).
(c) Residual long-term capital gain or loss. The amount of residual long-term capital gain or loss recognized by a partner, shareholder of an S corporation, or beneficiary of a trust on account of the sale or exchange of an interest in a partnership, S corporation, or trust shall equal the amount of long-term capital gain or loss that the partner would recognize under section 741, that the shareholder would recognize upon the sale or exchange of stock of an S corporation, or that the beneficiary would recognize upon the sale or exchange of an interest in a trust (pre-look-through long-term capital gain or loss) minus the amount of look-through capital gain determined under paragraph (b) of this section.
(d) Special rule for tiered entities. In determining whether a partnership, S corporation, or trust has gain from collectibles, such partnership, S corporation, or trust shall be treated as owning its proportionate share of the collectibles of any partnership, S corporation, or trust in which it owns an interest either directly or indirectly through a chain of such entities. In determining whether a partnership has section 1250 capital gain, such partnership shall be treated as owning its proportionate share of the section 1250 property of any partnership in which it owns an interest, either directly or indirectly through a chain of partnerships.
(e) Notification requirements. Reporting rules similar to those that apply to the partners and the partnership under section 751(a) shall apply in the case of sales or exchanges of interests in a partnership, S corporation, or trust that cause holders of such interests to recognize collectibles gain and in the case of sales or exchanges of interests in a partnership that cause holders of such interests to recognize section 1250 capital gain. See § 1.751-1(a)(3).
(f) Examples. The following examples illustrate the requirements of this section:
ASSETS | ||
---|---|---|
Adjusted basis | Market value | |
Cash | $3,000 | $3,000 |
Loans Owed to Partnership | 10,000 | 10,000 |
Collectibles | 1,000 | 3,000 |
Other Capital Assets | 6,000 | 2,000 |
Capital Assets | 7,000 | 5,000 |
Unrealized Receivables | 0 | 14,000 |
Total | 20,000 | 32,000 |
LIABILITIES AND CAPITAL | ||
---|---|---|
Adjusted basis | Market value | |
Liabilities | 2,000 | 2,000 |
Capital: | ||
A | 9,000 | 15,000 |
B | 9,000 | 15,000 |
Total | 20,000 | 32,000 |
(iii) If PRS were to sell all of its section 751 property in a fully taxable transaction for cash equal to the fair market value of the assets immediately prior to the transfer of B’s partnership interest to T, B would be allocated $7,000 of ordinary income from the sale of PRS‘s unrealized receivables. Therefore, B will recognize $7,000 of ordinary income with respect to the unrealized receivables. The difference between the amount of capital gain or loss that the partner would realize in the absence of section 751 ($6,000) and the amount of ordinary income or loss determined under § 1.751-1(a)(2) ($7,000) is the partner’s capital gain or loss on the sale of the partnership interest under section 741. In this case, the transferor has a $1,000 pre-look-through long-term capital loss.
(iv) If PRS were to sell all of its collectibles in a fully taxable transaction for cash equal to the fair market value of the assets immediately prior to the transfer of B’s partnership interest to T, B would be allocated $1,000 of gain from the sale of the collectibles. Therefore, B will recognize $1,000 of collectibles gain on account of the collectibles held by PRS.
(v) The difference between the transferor’s pre-look-through long-term capital gain or loss (−$1,000) and the look-through capital gain determined under this section ($1,000) is the transferor’s residual long-term capital gain or loss on the sale of the partnership interest. Under these facts, B will recognize a $2,000 residual long-term capital loss on account of the sale or exchange of the interest in PRS.
(ii) If X were to sell its antiques in a fully taxable transaction for cash equal to the fair market value of the assets immediately before the transfer to T, A would be allocated $100 of gain on account of the sale. Therefore, A will recognize $100 of collectibles gain (look-through capital gain) on account of the collectibles held by X.
(iii) The difference between the transferor’s pre-look-through long-term capital gain or loss ($50) and the look-through capital gain determined under this section ($100) is the transferor’s residual long-term capital gain or loss on the sale of the S corporation stock. Under these facts, A will recognize $100 of collectibles gain and a $50 residual long-term capital loss on account of the sale of A‘s interest in X.
ASSETS | ||
---|---|---|
Adjusted basis | Market value | |
Cash | $22,000 | $22,000 |
Unrealized Receivables | 0 | 6,000 |
Capital Asset | 2,000 | 5,000 |
Collectible | 3,000 | 9,000 |
Capital Assets | 5,000 | 14,000 |
Total | 27,000 | 42,000 |
(iii) If PRS were to sell all of its section 751 property in a fully taxable transaction immediately before A‘s transfer of the partnership interest, A would be allocated $2,000 of ordinary income. Accordingly, A will recognize $2,000 ordinary income and $5,000 ($7,000-$2,000) of capital gain on account of the transfer to T of A‘s interest in PRS. Fifty percent ($2,500) of that gain is long-term capital gain and 50 percent ($2,500) is short-term capital gain. See § 1.1223-3(c)(1).
(iv) If the collectible were sold or exchanged in a fully taxable transaction immediately before A‘s transfer of the partnership interest, A would be allocated $2,000 of gain attributable to the collectible. The gain attributable to the collectible that is allocable to the portion of the transferred interest in PRS with a long-term holding period is $1,000 (50 percent of $2,000). Accordingly, A will recognize $1,000 of collectibles gain on account of the transfer of A‘s interest in PRS.
(v) The difference between the amount of pre-look-through long-term capital gain or loss ($2,500) and the look-through capital gain ($1,000) is the amount of residual long-term capital gain or loss that A will recognize on account of the transfer of A‘s interest in PRS. Under these facts, A will recognize a residual long-term capital gain of $1,500 and a short-term capital gain of $2,500.
(g) Effective date. This section applies to transfers of interests in partnerships, S corporations, and trusts that occur on or after September 21, 2000.
§ 1.1(i)-1T Questions and answers relating to the tax on unearned income certain minor children (Temporary).
Q-1. To whom does section 1(i) apply?
A-1. Section 1(i) applies to any child who is under 14 years of age at the close of the taxable year, who has at least one living parent at the close of the taxable year, and who recognizes over $1,000 of unearned income during the taxable year.
Q-2. What is the effective date of section 1(i)?
A-2. Section 1(i) applies to taxable years of the child beginning after December 31, 1986.
Q-3. What is the amount of tax imposed by section 1 on a child to whom section 1(i) applies?
A-3. In the case of a child to whom section 1(i) applies, the amount of tax imposed by section 1 equals the greater of (A) the tax imposed by section 1 without regard to section 1(i) or (B) the sum of the tax that would be imposed by section 1 if the child’s taxable income was reduced by the child’s net unearned income, plus the child’s share of the allocable parental tax.
Q-4. What is the allocable parental tax?
A-4. The allocable parental tax is the excess of (A) the tax that would be imposed by section 1 on the sum of the parent’s taxable income plus the net unearned income of all children of such parent to whom section 1(i) applies, over (B) the tax imposed by section 1 on the parent’s taxable income. Thus, the allocable parental tax is not computed with reference to unearned income of a child over 14 or a child under 14 with less than $1,000 of unearned income. See A-10 through A-13 for rules regarding the determination of the parent(s) whose taxable income is taken into account under section 1(i). See A-14 for rules regarding the determination of children of the parent whose net unearned income is taken into account under section 1(i).
Q-5. What is the child’s share of the allocable parental tax?
A-5. The child’s share of the allocable parental tax is an amount that bears the same ratio to the total allocable parental tax as the child’s net unearned income bears to the total net unearned income of all children of such parent to whom section 1(i) applies. See A-14.
Q-6. What is net unearned income?
A-6. Net unearned income is the excess of the portion of adjusted gross income for the taxable year that is not “earned income” as defined in section 911(d)(2) (income that is not attributable to wages, salaries, or other amounts received as compensation for personal services), over the sum of the standard deduction amount provided for under section 63 (c)(5)(A) ($500 for 1987 and 1988; adjusted for inflation thereafter), plus the greater of (A) $500 (adjusted for inflation after 1988) or (B) the amount of allowable itemized deductions that are directly connected with the production of unearned income. A child’s net unearned income for any taxable year shall not exceed the child’s taxable income for such year.
Q-7. Will a child be subject to tax under section 1(i) on net unearned income (as defined in section 1(i) (4) and A-6 of this section) that is attributable to property transferred to the child prior to 1987?
A-7. Yes. The tax imposed by section 1(i) on a child’s net unearned income applies to any net unearned income of the child for taxable years beginning after December 31, 1986, regardless of when the underlying assets were transferred to the child.
Q-8. Will a child be subject to tax under section 1(i) on net unearned income that is attributable to gifts from persons other than the child’s parents or attributable to assets resulting from the child’s earned income?
A-8. Yes. The tax imposed by section 1(i) applies to all net unearned income of the child, regardless of the source of the assets that produced such income. Thus, the rules of section 1(i) apply to income attributable to gifts not only from the parents but also from any other source, such as the child’s grandparents. Section 1(i) also applies to unearned income derived with respect to assets resulting from earned income of the child, such as interest earned on bank deposits.
Q-9. For purposes of section 1(i), does income which is not earned income (as defined in section 911(d)(2)) include social security benefits or pension benefits that are paid to the child?
A-9. Yes. For purposes of section 1(i), earned income (as defined in section 911(d)(2)) does not include any social security or pension benefits paid to the child. Thus, such amounts are included in unearned income to the extent they are includible in the child’s gross income.
Q-10. If a child’s parents file a joint return, what is the taxable income that must be taken into account by the child in determining tax liability under section 1(i)?
A-10. In the case of parents who file a joint return, the parental taxable income to be taken into account in determining the tax liability of a child is the total taxable income shown on the joint return.
Q-11. If a child’s parents are married and file separate tax returns, which parent’s taxable income must be taken into account by the child in determining tax liability under section 1(i)?
A-11. For purposes of determining the tax liability of a child under section 1(i), where such child’s parents are married and file separate tax returns, the parent whose taxable income is the greater of the two for the taxable year shall be taken into account.
Q-12. If the parents of a child are divorced, legally separated, or treated as not married under section 7703(b), which parent’s taxable income is taken into account in computing the child’s tax liability?
A-12. If the child’s parents are divorced, legally separated, or treated as not married under section 7703(b), the taxable income of the custodial parent (within the meaning of section 152(e)) of the child is taken into account under section 1(i) in determining the child’s tax liability.
Q-13. If a parent whose taxable income must be taken into account in determining a child’s tax liability under section 1(i) files a joint return with a spouse who is not a parent of the child, what taxable income must the child take into account?
A-13. The amount of a parent’s taxable income that a child must take into account for purposes of section 1(i) where the parent files a joint return with a spouse who is not a parent of the child is the total taxable income shown on such joint return.
Q-14. In determining a child’s share of the allocable parental tax, is the net unearned income of legally adopted children, children related to such child by half-blood, or children from a prior marriage of the spouse of such child’s parent taken into account in addition to the natural children of such child’s parent?
A-14. Yes. In determining a child’s share of the allocable parental tax, the net unearned income of all children subject to tax under section 1(i) and who use the same parent’s taxable income as such child to determine their tax liability under section 1(i) must be taken into account. Such children are taken into account regardless of whether they are adopted by the parent, related to such child by half-blood, or are children from a prior marriage of the spouse of such child’s parent.
Q-15. Will the unearned income of a child who is subject to section 1(i) that is attributable to gifts given to the child under the Uniform Gift to Minors Act (UGMA) be subject to tax under section 1(i)?
A-15. Yes. A gift under the UGMA vests legal title to the property in the child although an adult custodian is given certain rights to deal with the property until the child attains majority. Any unearned income attributable to such a gift is the child’s unearned income and is subject to tax under section 1(i), whether distributed to the child or not.
Q-16. Will a child who is a beneficiary of a trust be required to take into account the income of a trust in determining the child’s tax liability under section 1(i)?
A-16. The income of a trust must be taken into account for purposes of determining the tax liability of a beneficiary who is subject to section 1(i) only to the extent it is included in the child’s gross income for the taxable year under sections 652(a) or 662(a). Thus, income from a trust for the fiscal taxable year of a trust ending during 1987, that is included in the gross income of a child who is subject to section 1(i) and who has a calendar taxable year, will be subject to tax under section 1(i) for the child’s 1987 taxable year.
Q-17. What effect will a subsequent adjustment to a parent’s taxable income have on the child’s tax liability if such parent’s taxable income was used to determine the child’s tax liability under section 1(i) for the same taxable year?
A-17. If the parent’s taxable income is adjusted and if, for the same taxable year as the adjustment, the child paid tax determined under section 1(i) with reference to that parent’s taxable income, then the child’s tax liability under section 1(i) must be recomputed using the parent’s taxable income as adjusted.
Q-18. In the case where more than one child who is subject to section 1(i) uses the same parent’s taxable income to determine their allocable parental tax, what effect will a subsequent adjustment to the net unearned income of one child have on the other child’s share of the allocable parental tax?
A-18. If, for the same taxable year, more than one child uses the same parent’s taxable income to determine their share of the allocable parental tax and a subsequent adjustment is made to one or more of such children’s net unearned income, each child’s share of the allocable parental tax must be recomputed using the combined net unearned income of all such children as adjusted.
Q-19. If a recomputation of a child’s tax under section 1(i), as a result of an adjustment to the taxable income of the child’s parents or another child’s net unearned income, results in additional tax being imposed by section 1(i) on the child, is the child subject to interest and penalties on such additional tax?
A-19. Any additional tax resulting from an adjustment to the taxable income of the child’s parents or the net unearned income of another child shall be treated as an underpayment of tax and interest shall be imposed on such underpayment as provided in section 6601. However, the child shall not be liable for any penalties on the underpayment resulting from additional tax being imposed under section 1(i) due to such an adjustment.
Q-20. Does the phase-out of the parent’s 15 percent rate bracket and personal exemptions under section 1(g), if applicable, have any effect on the calculation of the allocable parental tax imposed on a child’s net unearned income under section 1(i)?
A-20. Yes. Any phase-out of the parent’s 15 percent rate bracket or personal exemptions under section 1(g) is given full effect in determining the tax that would be imposed on the sum of the parent’s taxable income and the total net unearned income of all children of the parent. Thus, any additional tax on a child’s net unearned income resulting from the phase-out of the 15 percent rate bracket and the personal exemptions is reflected in the tax liability of the child.
Q-21. For purposes of calculating a parent’s tax liability or the allocable parental tax imposed on a child, are other phase-outs, limitations, or floors on deductions or credits, such as the phase-out of the $25,000 passive loss allowance for rental real estate activities under section 469(i)(3) or the 2 percent of AGI floor on miscellaneous itemized deductions under section 67, affected by the addition of a child’s net unearned income to the parent’s taxable income?
A-21. No. A child’s net unearned income is not taken into account in computing any deduction or credit for purposes of determining the parent’s tax liability or the child’s allocable parental tax. Thus, for example, although the amounts allowable to the parent as a charitable contribution deduction, medical expense deduction, section 212 deduction, or a miscellaneous itemized deduction are affected by the amount of the parent’s adjusted gross income, the amount of these deductions that is allowed does not change as a result of the application of section 1(i) because the amount of the parent’s adjusted gross income does not include the child’s net unearned income. Similarly, the amount of itemized deductions that is allowed to a child does not change as a result of section 1(i) because section 1(i) only affects the amount of tax liability and not the child’s adjusted gross income.
Q-22. If a child is unable to obtain information concerning the tax return of the child’s parents directly from such parents, how may the child obtain information from the parent’s tax return which is necessary to determine the child’s tax liability under section 1(i)?
A-22. Under section 6103(e)(1)(A)(iv), a return of a parent shall, upon written request, be open to inspection or disclosure to a child of that individual (or the child’s legal representative) to the extent necessary to comply with section 1(i). Thus, a child may request the Internal Revenue Service to disclose sufficient tax information about the parent to the child so that the child can properly file his or her return.
§ 1.2-1 Tax in case of joint return of husband and wife or the return of a surviving spouse.
(a) Taxable year ending before January 1, 1971. (1) For taxable years ending before January 1, 1971, in the case of a joint return of husband and wife, or the return of a surviving spouse as defined in section 2(b), the tax imposed by section 1 shall be twice the tax that would be imposed if the taxable income were reduced by one-half. For rules relating to the filing of joint returns of husband and wife, see section 6013 and the regulations thereunder.
(2) The method of computing, under section 2(a), the tax of husband and wife in the case of a joint return, or the tax of a surviving spouse, is as follows:
(i) First, the taxable income is reduced by one-half. Second, the tax is determined as provided by section 1 by using the taxable income so reduced. Third, the tax so determined, which is the tax that would be determined if the taxable income were reduced by one-half, is then multiplied by two to produce the tax imposed in the case of the joint return or the return of a surviving spouse, subject, however, to the allowance of any credits against the tax under the provisions of sections 31 through 38 and the regulations thereunder.
(ii) The limitation under section 1(c) of the tax to an amount not in excess of a specified percent of the taxable income for the taxable year is to be applied before the third step above, that is, the limitation to be applied upon the tax is determined as the applicable specified percent of one-half of the taxable income for the taxable year (such one-half of the taxable income being the actual aggregate taxable income of the spouses, or the total taxable income of the surviving spouse, as the case may be, reduced by one-half). For the percent applicable in determining the limitation of the tax under section 1(c), see § 1.1-2(a). After such limitation is applied, then the tax so limited is multiplied by two as provided in section 2(a) (the third step above).
(iii) The following computation illustrates the method of application of section 2(a) in the determination of the tax of a husband and wife filing a joint return for the calendar year 1965. If the combined gross income is $8,200, and the only deductions are the two exemptions of the taxpayers under section 151(b) and the standard deduction under section 141, the tax on the joint return for 1965, without regard to any credits against the tax, is $1,034.20 determined as follows:
1. Gross income | $8,200.00 | |
2. Less: | ||
Standard deduction, section 141 | $820 | |
Deduction for personal exemption, section 151 | 1,200 | 2,020.00 |
3. Taxable income | 6,180.00 | |
4. Taxable income reduced by one-half | 3,090.00 | |
5. Tax computed by the tax table provided under section 1(a)(2) ($310 plus 19 percent of excess over $2,000) | 517.10 | |
6. Twice the tax in item 5 | 1,034.20 |
(b) Taxable years beginning after December 31, 1970. (1) For taxable years beginning after December 31, 1970, in the case of a joint return of husband and wife, or the return of a surviving spouse as defined in section 2(a) of the Code as amended by the Tax Reform Act of 1969, the tax shall be determined in accordance with the table contained in section 1(a) of the Code as so amended. For rules relating to the filing of joint returns of husband and wife see section 6013 as amended and the regulations thereunder.
(2) The following computation illustrates the method of computing the tax of a husband and wife filing a joint return for calendar year 1971. If the combined gross income is $8,200, and the only deductions are the two exemptions of the taxpayers under section 151(b), as amended, and the standard deduction under section 141, as amended, the tax on the joint return for 1971, without regard to any credits against the tax, is $968.46, determined as follows:
1. Gross income | $8,200.00 | |
2. Less: | ||
Standard deduction, section 141 | $1,066.00 | |
Deduction for personal exemption, section 151 | 1,300.00 | 2,366.00 |
3. Taxable income | 5,834.00 | |
4. Tax computed by the tax table provided under section 1(a) ($620 plus 19 percent of excess over $4,000) | 968.46 |
(3) The limitation under section 1348 with respect to the maximum rate of tax on earned income shall apply to a married individual only if such individual and his spouse file a joint return for the taxable year.
(c) Death of a spouse. If a joint return of a husband and wife is filed under the provisions of section 6013 and if the husband and wife have different taxable years solely because of the death of either spouse, the taxable year of the deceased spouse covered by the joint return shall, for the purpose of the computation of the tax in respect of such joint return, be deemed to have ended on the date of the closing of the surviving spouse’s taxable year.
(d) Computation of optional tax. For computation of optional tax in the case of a joint return or the return of a surviving spouse, see section 3 and the regulations thereunder.
(e) Change in rates. For treatment of taxable years during which a change in the tax rates occurs see section 21 and the regulations thereunder.
§ 1.2-2 Definitions and special rules.
(a) Surviving spouse. (1) If a taxpayer is eligible to file a joint return under the Internal Revenue Code of 1954 without regard to section 6013(a) (3) thereof for the taxable year in which his spouse dies, his return for each of the next 2 taxable years following the year of the death of the spouse shall be treated as a joint return for all purposes if all three of the following requirements are satisfied:
(i) He has not remarried before the close of the taxable year the return for which is sought to be treated as a joint return, and
(ii) He maintains as his home a household which constitutes for the taxable year the principal place of abode as a member of such household of a person who is (whether by blood or adoption) a son, stepson, daughter, or stepdaughter of the taxpayer, and
(iii) He is entitled for the taxable year to a deduction under section 151 (relating to deductions for dependents) with respect to such son, stepson, daughter, or stepdaughter.
(2) See paragraphs (c)(1) and (d) of this section for rules for the determination of when the taxpayer maintains as his home a household which constitutes for the taxable year the principal place of abode, as a member of such household, of another person.
(3) If the taxpayer does not qualify as a surviving spouse he may nevertheless qualify as a head of a household if he meets the requirements of § 1.2-2(b).
(4) The following example illustrates the provisions relating to a surviving spouse:
(b) Head of household. (1) A taxpayer shall be considered the head of a household if, and only if, he is not married at the close of his taxable year, is not a surviving spouse (as defined in paragraph (a) of this section, and (i) maintains as his home a household which constitutes for such taxable year the principal place of abode, as a member of such household, of at least one of the individuals described in subparagraph (3), or (ii) maintains (whether or not as his home) a household which constitutes for such taxable year the principal place of abode of one of the individuals described in subparagraph (4).
(2) Under no circumstances shall the same person be used to qualify more than one taxpayer as the head of a household for the same taxable year.
(3) Any of the following persons may qualify the taxpayer as a head of a household:
(i) A son, stepson, daughter, or stepdaughter of the taxpayer, or a descendant of a son or daughter of the taxpayer. For the purpose of determining whether any of the stated relationships exist, a legally adopted child of a person is considered a child of such person by blood. If any such person is not married at the close of the taxable year of the taxpayer, the taxpayer may qualify as the head of a household by reason of such person even though the taxpayer may not claim a deduction for such person under section 151, for example, because the taxpayer does not furnish more than half of the support of such person. However, if any such person is married at the close of the taxable year of the taxpayer, the taxpayer may qualify as the head of a household by reason of such person only if the taxpayer is entitled to a deduction for such person under section 151 and the regulations thereunder. In applying the preceding sentence there shall be disregarded any such person for whom a deduction is allowed under section 151 only by reason of section 152(c) (relating to persons covered by a multiple support agreement).
(ii) Any other person who is a dependent of the taxpayer, if the taxpayer is entitled to a deduction for the taxable year for such person under section 151 and paragraphs (3) through (8) of section 152(a) and the regulations thereunder. Under section 151 the taxpayer may be entitled to a deduction for any of the following persons:
(a) His brother, sister, stepbrother, or stepsister;
(b) His father or mother, or an ancestor of either;
(c) His stepfather or stepmother;
(d) A son or a daughter of his brother or sister;
(e) A brother or sister of his father or mother; or
(f) His son-in-law, daughter-in-law, father-in-law, mother-in-law, brother- in-law, or sister-in-law;
(4) The father or mother of the taxpayer may qualify the taxpayer as a head of a household, but only if the taxpayer is entitled to a deduction for the taxable year for such father or mother under section 151 (determined without regard to section 152(c)). For example, an unmarried taxpayer who maintains a home for his widowed mother may not qualify as the head of a household by reason of his maintenance of a home for his mother if his mother has gross income equal to or in excess of the amount determined pursuant to § 1.151-2 applicable to the calendar year in which the taxable year of the taxpayer begins, or if he does not furnish more than one-half of the support of his mother for such calendar year. For this purpose, a person who legally adopted the taxpayer is considered the father or mother of the taxpayer.
(5) For the purpose of this paragraph, the status of the taxpayer shall be determined as of the close of the taxpayer’s taxable year. A taxpayer shall be considered as not married if at the close of his taxable year he is legally separated from his spouse under a decree of divorce or separate maintenance, or if at any time during the taxable year the spouse to whom the taxpayer is married at the close of his taxable year was a nonresident alien. A taxpayer shall be considered married at the close of his taxable year if his spouse (other than a spouse who is a nonresident alien) dies during such year.
(6) If the taxpayer is a nonresident alien during any part of the taxable year he may not qualify as a head of a household even though he may comply with the other provisions of this paragraph. See the regulations prescribed under section 871 for a definition of nonresident alien.
(c) Household. (1) In order for a taxpayer to be considered as maintaining a household by reason of any individual described in paragraph (a)(1) or (b)(3) of this section, the household must actually constitute the home of the taxpayer for his taxable year. A physical change in the location of such home will not prevent a taxpayer from qualifying as a head of a household. Such home must also constitute the principal place of abode of at least one of the persons specified in such paragraph (a)(1) or (b)(3) of this section. It is not sufficient that the taxpayer maintain the household without being its occupant. The taxpayer and such other person must occupy the household for the entire taxable year of the taxpayer. However, the fact that such other person is born or dies within the taxable year will not prevent the taxpayer from qualifying as a head of household if the household constitutes the principal place of abode of such other person for the remaining or preceding part of such taxable year. The taxpayer and such other person will be considered as occupying the household for such entire taxable year notwithstanding temporary absences from the household due to special circumstances. A nonpermanent failure to occupy the common abode by reason of illness, education, business, vacation, military service, or a custody agreement under which a child or stepchild is absent for less than 6 months in the taxable year of the taxpayer, shall be considered temporary absence due to special circumstances. Such absence will not prevent the taxpayer from being considered as maintaining a household if (i) it is reasonable to assume that the taxpayer or such other person will return to the household, and (ii) the taxpayer continues to maintain such household or a substantially equivalent household in anticipation of such return.
(2) In order for a taxpayer to be considered as maintaining a household by reason of any individual described in paragraph (b)(4) of this section, the household must actually constitute the principal place of abode of the taxpayer’s dependent father or mother, or both of them. It is not, however, necessary for the purposes of such subparagraph for the taxpayer also to reside in such place of abode. A physical change in the location of such home will not prevent a taxpayer from qualifying as a head of a household. The father or mother of the taxpayer, however, must occupy the household for the entire taxable year of the taxpayer. They will be considered as occupying the household for such entire year notwithstanding temporary absences from the household due to special circumstances. For example, a nonpermanent failure to occupy the household by reason of illness or vacation shall be considered temporary absence due to special circumstances. Such absence will not prevent the taxpayer from qualifying as the head of a household if (i) it is reasonable to assume that such person will return to the household, and (ii) the taxpayer continues to maintain such household or a substantially equivalent household in anticipation of such return. However, the fact that the father or mother of the taxpayer dies within the year will not prevent the taxpayer from qualifying as a head of a household if the household constitutes the principal place of abode of the father or mother for the preceding part of such taxable year.
(d) Cost of maintaining a household. A taxpayer shall be considered as maintaining a household only if he pays more than one-half the cost thereof for his taxable year. The cost of maintaining a household shall be the expenses incurred for the mutual benefit of the occupants thereof by reason of its operation as the principal place of abode of such occupants for such taxable year. The cost of maintaining a household shall not include expenses otherwise incurred. The expenses of maintaining a household include property taxes, mortgage interest, rent, utility charges, upkeep and repairs, property insurance, and food consumed on the premises. Such expenses do not include the cost of clothing, education, medical treatment, vacations, life insurance, and transportation. In addition, the cost of maintaining a household shall not include any amount which represents the value of services rendered in the household by the taxpayer or by a person qualifying the taxpayer as a head of a household or as a surviving spouse.
(e) Certain married individuals living apart. For taxable years beginning after December 31, 1969, an individual who is considered as not married under section 143(b) shall be considered as not married for purposes of determining whether he or she qualifies as a single individual, a married individual, a head of household or a surviving spouse under sections 1 and 2 of the Code.
§ 1.3-1 Application of optional tax.
(a) General rules. (1) For taxable years ending before January 1, 1970, an individual whose adjusted gross income is less than $5,000 (or a husband and wife filing a joint return whose combined adjusted gross income is less than $5,000) may elect to pay the tax imposed by section 3 in place of the tax imposed by section 1 (a) or (b). For taxable years beginning after December 31, 1969 and before January 1, 1971 an individual whose adjusted gross income is less than $10,000 (or a husband and wife filing a joint return whose combined adjusted gross income is less than $10,000) may elect to pay the tax imposed by section 3 as amended by the Tax Reform Act of 1969 in place of the tax imposed by section 1 (a) or (b). For taxable years beginning after December 31, 1970 an individual whose adjusted gross income is less than $10,000 (or a husband and wife filing a joint return whose combined adjusted gross income is less than $10,000) may elect to pay the tax imposed by section 3 as amended in place of the tax imposed by section 1 as amended. See § 1.4-2 for the manner of making such election. A taxpayer may make such election regardless of the sources from which his income is derived and regardless of whether his income is computed by the cash method or the accrual method. See section 62 and the regulations thereunder for the determination of adjusted gross income. For the purpose of determining whether a taxpayer may elect to pay the tax under section 3, the amount of the adjusted gross income is controlling, without reference to the number of exemptions to which the taxpayer may be entitled. See section 4 and the regulations thereunder for additional rules applicable to section 3.
(2) The following examples illustrate the rule that section 3 applies only if the adjusted gross income is less than $10,000 ($5,000 for taxable years ending before January 1, 1970).
(b) Surviving spouse. The return of a surviving spouse is treated as a joint return for purposes of section 3. See section 2, and the regulations thereunder, with respect to the qualifications of a taxpayer as a surviving spouse. Accordingly, if the taxpayer qualifies as a surviving spouse and elects to pay the optional tax, he shall use the column in the tax table, appropriate to his number of exemptions, provided for cases in which a joint return is filed.
(c) Use of tax table. (1) To determine the amount of the tax, the individual ascertains the amount of his adjusted gross income, refers to the appropriate table set forth in section 3 or the regulations thereunder, ascertains the income bracket into which such income falls, and, using the number of exemptions applicable to his case, finds the tax in the vertical column having at the top thereof a number corresponding to the number of exemptions to which the taxpayer is entitled.
(2) Section 3(b) (relating to taxable years beginning after Dec. 31, 1964 and ending before Jan. 1, 1970) contains 5 tables for use in computing the tax. Table I is to be used by a single person who is not a head of household. Table II is to be used by a head of household. Table III is to be used by married persons filing joint returns and by a surviving spouse. Table IV is to be used by married persons filing separate returns using the 10 percent standard deduction. Table V is to be used by married persons filing separate returns using the minimum standard deduction. For an explanation of the standard deduction see section 141 and the regulations thereunder.
(3) 30 tables are provided for use in computing the tax under the Tax Reform Act of 1969. Tables I through XV apply for taxable years beginning after December 31, 1969 and ending before January 1, 1971. Tables XVI through XXX apply for taxable years beginning after December 31, 1970. The standard deduction for Tables I through XV, applicable to taxable years beginning in 1970, is 10 percent. The standard deduction for Tables XVI through XXX, applicable to taxable years beginning in 1971, is 13 percent. For an explanation of the standard deduction and the low income allowance see section 141 as amended by the Tax Reform Act of 1969.
(4) In the case of married persons filing separate returns who qualify to use the optional tax imposed by section 3, such persons shall use the tax imposed by the table for the applicable year in accordance with the rules prescribed by sections 4(c) and 141 and the regulations thereunder governing the use and application of the standard deduction and the low income allowance.
(5) The tax shown in the tax tables set forth in section 3 or the regulations thereunder reflects full income splitting in the case of a joint return (including the return of a surviving spouse) and lesser income splitting in the case of a head of household. Therefore, it is possible for the tax shown in the tables relating to joint returns, or relating to a return of a head of a household, to be lower than that shown in the table for separate returns even though the amounts of adjusted gross income and the number of exemptions are the same.
§ 1.4-1 Number of exemptions.
(a) For the purpose of determining the optional tax imposed under section 3, the taxpayer shall use the number of exemptions allowable to him as deductions under section 151. See sections 151, 152, and 153, and the regulations thereunder. In general, one exemption is allowed for the taxpayer; one exemption for his spouse if a joint return is made, or if a separate return is made by the taxpayer and his spouse has no gross income for the calendar year in which the taxable year of the taxpayer begins and is not the dependent of another taxpayer for such calendar year; and one exemption for each dependent whose gross income for the calendar year in which the taxable year of the taxpayer begins is less than the applicable amount determined pursuant to § 1.151-2. No exemption is allowed for any dependent who has made a joint return with his spouse for the taxable year beginning in the calendar year in which the taxable year of the taxpayer begins. The taxpayer may, in certain cases, be allowed an exemption for a dependent child of the taxpayer notwithstanding the fact that such child has gross income equal to or in excess of the amount determined pursuant to § 1.151-2 applicable to the calendar year in which the taxable year of the taxpayer begins. The requirements for the allowance of such an exemption are set forth in paragraph (c) of § 1.152-1. See paragraphs (c) and (d) of § 1.151-1 with respect to additional exemptions for a taxpayer or spouse who has attained the age 65 years and for a blind taxpayer or blind spouse
(b) The application of this section may be illustrated by the following examples:
§ 1.4-2 Elections.
(a) Making of election. The election to pay the optional tax imposed under section 3 shall be made by (1) filing a return on Form 1040A, or (2) filing a return on Form 1040 and electing in such return, in accordance with the provisions of section 144 and the regulations thereunder, to take the standard deduction provided by section 141.
(b) Election under section 3 and election of standard deduction. Section 144 (a) and the regulations thereunder provide rules for treating an election to pay the tax under section 3 as an election to take the standard deduction, and for treating an election to take the standard deduction as an election to pay the tax under section 3. For example, if the taxpayer’s return shows $5,000 or more of adjusted gross income and he elects to take the standard deduction, he will be deemed to have elected to pay the tax under section 3 if it is subsequently determined that his correct adjusted gross income is less than $5,000.
(c) [Reserved]
(d) Change of election. For rules relating to a change of election to pay, or not to pay, the optional tax imposed under section 3, see section 144 (b) and the regulations thereunder.
§ 1.4-3 Husband and wife filing separate returns.
(a) In general. If the separate adjusted gross income of a husband is less than $5,000 and the separate adjusted gross income of his wife is less than $5,000, and if each is required to file a return, the husband and the wife must each elect to pay the optional tax imposed under section 3 or neither may so elect. If the separate adjusted gross income of each spouse is $5,000 or more, then neither spouse can elect to pay the optional tax imposed under section 3. If the adjusted gross income of one spouse is $5,000 or more and that of the other spouse is less than $5,000, the election to pay the optional tax imposed under section 3 may be exercised by the spouse having adjusted gross income of less than $5,000 only if the spouse having adjusted gross income of $5,000 or more, in computing taxable income, uses the standard deduction provided by section 141. If the spouse having adjusted gross income of $5,000 or more does not use the standard deduction, then the spouse having adjusted gross income of less than $5,000 may not elect to pay the optional tax and must compute taxable income without regard to the standard deduction. Accordingly, if the spouse having adjusted gross income of $5,000 or more itemizes the deductions allowed by sections 161 and 211 in computing taxable income, the spouse having adjusted gross income of less than $5,000 must also compute taxable income by itemizing the deductions allowed by sections 161 and 211, and must pay the tax imposed by section 1. For rules relative to the election to take the standard deduction by husband and wife, see part IV (section 141 and following), subchapter B, chapter 1 of the Code, and the regulations thereunder.
(b) Taxable years beginning after December 31, 1963, and before January 1, 1970. (1) In the case of a husband and wife filing a separate return for a taxable year beginning after December 31, 1963, and before January 1, 1970, the optional tax imposed by section 3 shall be—
(i) For taxable years beginning in 1964, the lesser of the tax shown in Table IV (relating to the 10-percent standard deduction for married persons filing separate returns) or Table V (relating to the minimum standard deduction for married persons filing separate returns) of section 3(a), and
(ii) For a taxable year beginning after December 31, 1964, and before January 1, 1970, the lesser of the tax shown in Table IV (relating to the 10-percent standard deduction for married persons filing separate returns) or Table V (relating to minimum standard deduction for married persons filing separate returns) of section 3(b).
(2) If the tax of one spouse is determined with regard to the 10-percent standard deduction provided for in Table IV of section 3(a) or 3(b) or if such spouse in computing taxable income uses the 10-percent standard deduction provided for in section 141(b), then the minimum standard deduction provided for in Table V of section 3(a) or 3(b) shall not apply in the case of the other spouse, if such spouse elects to pay the optional tax imposed under section (3). Thus, if a husband and wife compute their tax with reference to the standard deduction, one cannot elect to use the 10-percent standard deduction and the other elect to use the minimum standard deduction. However, an individual described in section 141(d)(2) may elect pursuant to such section and the regulations thereunder to pay the tax shown in Table V of section 3(a) or 3(b) in lieu of the tax shown in Table IV of section 3(a) or 3(b). See section 141(d) and the regulations thereunder for rules relating to the standard deduction in the case of married individuals filing separate returns.
(c) Taxable years beginning after December 31, 1969. (1) In the case of a husband and wife filing a separate return for a taxable year beginning after December 31, 1969, the optional tax imposed by section 3 shall be the lesser of the tax shown in—
(i) The table prescribed under section 3 applicable to such taxable year in the case of married persons filing separate returns which applies the percentage standard deduction, or
(ii) The table prescribed under section 3 applicable to such taxable year in the case of married persons filing separate returns which applies the low income allowance.
(2) If the tax of one spouse is determined by the table described in subparagraph (1)(i) of this paragraph or if such spouse in computing taxable income uses the percentage standard deduction provided for in section 141(b), then the table described in subparagraph (1)(ii) of this paragraph shall not apply in the case of the other spouse, if such other spouse elects to pay the optional tax imposed under section 3. Thus, if a husband and wife compute the tax with reference to the standard deduction, one cannot elect to use the percentage standard deduction and the other elect to use the low income allowance. A married individual described in section 141(d)(2) may elect pursuant to such section and the regulations thereunder to pay the tax shown in the table described by subparagraph (1)(ii) of this paragraph in lieu of the tax shown in the table described by subparagraph (1)(i) of this paragraph. See section 141(d) and the regulations thereunder for rules relating to the standard deduction in the case of married individuals filing separate returns.
(d) Determination of marital status. For the purpose of applying the restrictions upon the right of a married person to elect to pay the tax under section 3, (1) the determination of marital status is made as of the close of the taxpayer’s taxable year or, if his spouse died during such year, as of the date of death; (2) a person legally separated from his spouse under a decree of divorce or separate maintenance on the last day of his taxable year (or the date of death of his spouse, whichever is applicable) is not considered as married; and (3) with respect to taxable years beginning after December 31, 1969, a person, although considered as married within the meaning of section 143(a), is considered as not married if he lives apart from his spouse and satisfies the requirements set forth in section 143(b). See section 143 and the regulations thereunder.
§ 1.4-4 Short taxable year caused by death.
An individual making a return for a period of less than 12 months on account of a change in his accounting period may not elect to pay the optional tax under section 3. However, the fact that the taxable year is less than 12 months does not prevent the determination of the tax for the taxable year under section 3 if the short taxable year results from the death of the taxpayer.
Tax on Corporations
§ 1.11-1 Tax on corporations.
(a) Every corporation, foreign or domestic, is liable to the tax imposed under section 11 except (1) corporations specifically excepted under such section from such tax; (2) corporations expressly exempt from all taxation under subtitle A of the Code (see section 501); and (3) corporations subject to tax under section 511(a). For taxable years beginning after December 31, 1966, foreign corporations engaged in trade or business in the United States shall be taxable under section 11 only on their taxable income which is effectively connected with the conduct of a trade or business in the United States (see section 882(a)(1)). For definition of the terms “corporations,” “domestic,” and “foreign,” see section 7701(a) (3), (4), and (5), respectively. It is immaterial that a domestic corporation, and for taxable years beginning after December 31, 1966, a foreign corporation engaged in trade or business in the United States, which is subject to the tax imposed by section 11 may derive no income from sources within the United States. The tax imposed by section 11 is payable upon the basis of the returns rendered by the corporations liable thereto, except that in some cases a tax is to be paid at the source of the income. See subchapter A (sections 6001 and following), chapter 61 of the Code, and section 1442.
(b) The tax imposed by section 11 consists of a normal tax and a surtax. The normal tax and the surtax are both computed upon the taxable income of the corporation for the taxable year, that is, upon the gross income of the corporation minus the deductions allowed by chapter 1 of the Code. However, the deduction provided in section 242 for partially tax-exempt interest is not allowed in computing the taxable income subject to the surtax.
(c) The normal tax is at the rate of 22 percent and is applied to the taxable income for the taxable year. However, in the case of a taxable year ending after December 31, 1974, and before January 1, 1976, the normal tax is at the rate of 20 percent of so much of the taxable income as does not exceed $25,000 and at the rate of 22 percent of so much of the taxable income as does exceed $25,000 and is applied to the taxable income for the taxable year.
(d) The surtax is at the rate of 26 percent and is upon the taxable income (computed without regard to the deduction, if any, provided in section 242 for partially tax-exempt interest) in excess of $25,000. However, in the case of a taxable year ending after December 31, 1974, and before January 1, 1976, the surtax is upon the taxable income (computed as provided in the preceding sentence) in excess of $50,000. In certain circumstances the exemption from surtax may be disallowed in whole or in part. See sections 269, 1551, 1561, and 1564 and the regulations thereunder. For purposes of sections 244, 247, 804, 907, 922 and §§ 1.51-1 and 1.815-4, when the phrase “the sum of the normal tax rate and the surtax rate for the taxable year” is used in any such section, the normal tax rate for all taxable years beginning after December 31, 1963, and ending before January 1, 1976, shall be considered to be 22 percent.
(e) The computation of the tax on corporations imposed under section 11 may be illustrated by the following example:
Gross income | $86,000 | |
Deductions: | ||
Partially tax-exempt interest | $5,000 | |
Other | 11,000 | 16,000 |
Taxable income | 70,000 | |
Normal tax (22 percent of $70,000) | 15,400 | |
Taxable income | 70,000 | |
Add: Amount of partially tax-exempt interest deducted in computing taxable income | 5,000 | |
Taxable income subject to surtax | 75,000 | |
Less: Exemption from surtax | 25,000 | |
Excess of taxable income subject to surtax over exemption | 50,000 | |
Surtax (26 percent of $50,000) | 13,000 |
(f) For special rules applicable to foreign corporations engaged in trade or business within the United States, see section 882 and the regulations thereunder. For additional tax on personal holding companies, see part II (section 541 and following), subchapter G, chapter 1 of the Code, and the regulations thereunder. For additional tax on corporations improperly accumulating surplus, see part I (section 531 and following), subchapter G, chapter 1 of the Code, and the regulations thereunder. For treatment of China Trade Act corporations, see sections 941 and 942 and the regulations thereunder. For treatment of Western Hemisphere trade corporations, see sections 921 and 922 and the regulations thereunder. For treatment of capital gains and losses, see subchapter P (section 1201 and following), chapter 1 of the Code. For computation of the tax for a taxable year during which a change in the tax rates occurs, see section 21 and the regulations thereunder.
Changes in Rates During a Taxable Year
§ 1.15-1 Changes in rate during a taxable year.
(a) Section 21 applies to all taxpayers, including individuals and corporations. It provides a general rule applicable in any case where (1) any rate of tax imposed by chapter 1 of the Code upon the taxpayer is increased or decreased, or any such tax is repealed, and (2) the taxable year includes the effective date of the change, except where that date is the first day of the taxable year. For example, the normal tax on corporations under section 11(b) was decreased from 30 percent to 22 percent in the case of a taxable year beginning after December 31, 1963. Accordingly, the tax for a taxable year of a corporation beginning on January 1, 1964, would be computed under section 11(b) at the new rate without regard to section 21. However, for any taxable year beginning before January 1, 1964, and ending on or after that date, the tax would be computed under section 21. For additional circumstances under which section 21 is not applicable, see paragraph (k) of this section.
(b) In any case in which section 21 is applicable, a tentative tax shall be computed by applying to the taxable income for the entire taxable year the rate for the period within the taxable year before the effective date of change, and another tentative tax shall be computed by applying to the taxable income for the entire taxable year the rate for the period within the taxable year on or after such effective date. The tax imposed on the taxpayer is the sum of—
(1) An amount which bears the same ratio to the tentative tax computed at the rate applicable to the period within the taxable year before the effective date of the change that the number of days in such period bears to the number of days in the taxable year, and
(2) An amount which bears the same ratio to the tentative tax computed at the rate applicable to the period within the taxable year on and after the effective date of the change that the number of days in such period bears to the number of days in the taxable year.
(c) If the rate of tax is changed for taxable years “beginning after” or “ending after” a certain date, the following day is considered the effective date of the change for purposes of section 21. If the rate is changed for taxable years “beginning on or after” a certain date, that date is considered the effective date of the change for purposes of section 21. This rule may be illustrated by the following examples:
(d) If a tax is repealed, the repeal will be treated as a change of rate for purposes of section 21, and the rate for the period after the repeal (for purposes of computing the tentative tax with respect to that period) will be considered zero. For example, the Tax Reform Act of 1969 repealed section 1562, which imposed a 6 percent additional tax on controlled corporations electing multiple surtax exemptions, effective for taxable years beginning after December 31, 1974. For such controlled corporations having taxable years beginning in 1974 and ending in 1975, the rate for the period ending before January 1, 1975, would be 6 percent; the rate for the period beginning after December 31, 1974, would be zero. However, subject to the rules stated in this section, section 21 does not apply to the imposition of a new tax. For example, if a new tax is imposed for taxable years beginning on or after July 1, 1972, a computation under section 21 would not be required with respect to such new tax in the case of taxable years beginning before July 1, 1972, and ending on or after that date. If the effective date of the imposition of a new tax and the effective date of a change in rate of such tax fall in the same taxable year, section 21 is not applicable in computing the taxpayer’s liability for such tax for such year unless the new tax is expressly imposed upon the taxpayer for a portion of his taxable year prior to the change in rate.
(e) If a husband and wife have different taxable years because of the death of either spouse, and if a joint return is filed with respect to the taxable year of each, then, for purposes of section 21, the joint return shall be treated as if the taxable years of both spouses ended on the date of the closing of the surviving spouse’s taxable year. See section 6013 (c), relating to treatment of joint return after death of either spouse. Accordingly, if a change in the rate of tax is effective during the taxable year of the surviving spouse, the tentative taxes with respect to the joint return shall be computed on the basis of the number of days during which each rate of tax was in effect for the taxable year of the surviving spouse.
(f) Section 21 applies whether or not the taxpayer has a taxable year of less than 12 months. Moreover, section 21 applies whether or not the taxable income for a taxable year of less than 12 months is required to be placed on an annual basis under section 443. If the taxable income is required to be computed under section 443(b) then the tentative taxes under section 21 are computed as provided in paragraph (1) or (2) of section 443(b) and are reduced as provided in those paragraphs. The tentative taxes so computed and reduced are then apportioned as provided in section 21(a)(2) to determine the tax for such taxable year as computed under section 21.
(g) If a taxpayer has made the election under section 441(f) (relating to computation of taxable income on the basis of an annual accounting period varying from 52 to 53 weeks), the rules provided in section 441(f)(2) shall be applicable for purposes of determining whether section 21 applies to the taxable year of the taxpayer. Where a taxpayer has made the election under section 441(f) and where section 21 applies to the taxable year of the taxpayer the computation under section 21(a)(2) shall be made upon the basis of the actual number of days in the taxable year and in each period thereof.
(h)(1) Section 21 is applicable only if the rate of tax imposed by chapter 1 changes. Sections in which rates of tax are specified or incorporated by reference include the following: 1, 2, 3, 11, 511, 531, 541, 821, 831, 871, 881, 1201, and 1348 (for taxable years beginning after December 31, 1970). Except as provided in subparagraph (3) of this paragraph, section 21 is not applicable with respect to changes in the law relating to deductions from gross income, exclusions from or inclusions in gross income, or other items taken into account in determining the amount or character of income subject to tax. Moreover, section 21 is not applicable with respect to changes in the law relating to credits against the tax or with respect to changes in the law relating to limitations on the amount of tax. Section 21 is applicable, however, to all those computations specified in the section providing the rate of tax which are implicit in determining the rate. For example, if one of the tax brackets in the tax tables under section 3 were to be changed, section 21 would be applicable to that change. Thus, if the bracket relating to “at least $4,200 but not less than $4,250” for heads of households should be changed to increase or decrease the last sum specified, with corresponding changes being made in subsequent brackets, section 21 would be applicable. The enactment of sections 1561 and 1562 is considered a change in section 11(d) which constitutes a change in rate for the period ending after December 31, 1963. The amendment of section 1561 and the repeal of section 1562 by the Tax Reform Act of 1969 is considered a change in section 11(d) which constitutes a change in rate for the period ending after December 31, 1974. The repeal of the 2 percent additional tax imposed under section 1503 on corporations filing consolidated returns constitutes a change in rate for the period ending after December 31, 1963. The addition to the Code of section 1348 (relating to 50 percent maximum rate on earned income) is a change in rate to which section 21(a) is applicable. The amendment of section 11(d) by the Tax Reduction Act of 1975 which increases to $50,000 the surtax exemption for a taxable year ending during 1975 constitutes a change in rate for such portion of the taxable year (if less than the entire taxable year) as follows December 31, 1974. Similarly, the return of the surtax exemption to $25,000 for a taxable year ending during 1976 constitutes a change in rate for such portion of the taxable year (if less than the entire taxable year) as follows December 31, 1975.
(2) Ordinarily, both the old and the new rates are applied to the same amount of taxable income. However, where the rate of tax is itself taken into account in determining taxable income (for example, the special deduction for Western Hemisphere trade corporations under section 922), the taxable income used in determining the tentative tax employing the rate before the effective date of change shall be determined by reference to that rate of tax, and the taxable income for the purpose of determining the tentative tax employing the rate for the period on and after the effective date of the change shall be determined by reference to the new tax rate.
(3) Section 21 is applicable with respect to changes in the law relating to the standard deduction for individuals provided in part IV of subchapter B and to the deduction for personal exemptions for individuals provided in part V of subchapter B.
(i) If the rate of tax changes more than once during the taxable year, section 21 is applicable to each change in rate. For example, if the rate of normal tax changed for taxable years beginning on or after March 1, 1954, and changed again for taxable years beginning on or after June 1, 1954, section 21 requires computation of 3 tentative taxes for any taxable year which began before March 1, 1954, and ended on or after June 1, 1954: One tentative tax at the rate in effect before the March 1 change; another tentative tax at the rate in effect from March 1 to May 31; and a third tentative tax at the rate in effect from June 1 to the end of the taxable year. The proportion of each such tentative tax taken into account in determining the tax imposed on the taxpayer is computed by reference to the portion of the taxable year before March 1, 1954, by reference to the portion of the taxable year from March 1, 1954, through May 31, 1954, and by reference to the portion of the taxable year from June 1, 1954, to the end of the taxable year, respectively.
(j)(1) If a change in the rate of one tax imposed by chapter 1 of the Code does not affect the amount of other taxes imposed by chapter 1 of the Code the other taxes may be determined without regard to section 21 and section 21 will be applied only to the tax for which a change in rate is made. However, if the change of rate of one tax does affect the amount of other taxes imposed under chapter 1 of the Code, then the computation of the taxes under chapter 1 of the Code so affected shall be made by applying section 21. For example, if section 1201 applies to an individual taxpayer for a taxable year containing the effective date of a change in a rate of tax provided in section 1, then under section 21 the taxpayer must compute a tentative tax for each period for which a different rate of tax is effective under section 1. The tentative tax for each such period as computed under section 1201 will reflect the rate of tax provided by section 1 for such period.
(2) In certain cases chapter 1 of the Code provides that the particular tax to be imposed upon the taxpayer shall be one of several taxes, the basis of selection being the tax that is greater or lesser. See, for example, sections 821 and 1201. If in any such case the rate of any one of these taxes changes, then the tentative taxes computed as provided by section 21 for each period shall be computed employing the tax selected in accordance with the general rule of selection for such a case, at the rate of tax in effect for such period. Thus, if a change in the rate of the alternative tax under section 1201 is such that the alternative tax under section 1201 is applicable if the old rate is used and is not applicable if the new rate is used, one tentative tax will consist of the alternative tax under section 1201 and the other tentative tax will consist of the tax imposed by the other applicable sections of chapter 1 of the Code. The two tentative taxes so computed are then prorated in accordance with section 21(a)(2) and the sum of the proportionate amounts is the tax imposed for the taxable year under chapter 1 of the Code. See the examples in paragraph (n) of this section.
(k) Section 21 does not apply in the following situations:
(1) The provisions of section 21 do not apply to the imposition of the tax surcharge by section 51. The proration rules of section 51(a) apply in the case of a taxable year ending on or after the effective date of the surcharge and beginning before July 1, 1970.
(2) The provisions of section 21 do not apply to the imposition of the minimum tax for tax preferences by section 56. The proration rules of section 301(c) of the Tax Reform Act of 1969 (83 Stat. 586) apply in the case of a taxable year beginning in 1969 and ending in 1970.
(l) In computing the number of days each rate of tax is in effect during the taxable year for purposes of section 21(a)(2), the effective date of the change in rate shall be counted in the period for which the new rate is in effect.
(m) Any credits against tax, and any limitation in any credit against tax, shall be based upon the tax computed under section 21. For credits against tax, see part IV (section 31 and following), subchapter A, chapter 1 of the Code.
(n) The application of section 21 may be illustrated by the following examples: (See also the examples in § 1.1561-2A(a)(3).)
Taxable income exclusive of capital gains and losses | $50,000 | ||
Long-term capital gain | 75,000 | ||
125,000 | |||
Deduct 50% of long-term capital gain | 37,500 | ||
Taxable income | 87,500 | ||
Tax under section 1 (1969 and 1970 rates) | 37,690 | ||
Taxable income ($50,000 + 50% of $75,000) | $87,500 | ||
Less 50% of long-term capital gain | 37,500 | ||
Taxable income exclusive of capital gains | 50,000 | ||
Partial tax (tax on $50,000) | 17,060 | ||
Plus 25% of $75,000 | 18,750 | ||
Alternative tax under section 1201(b) at 1969 rates | 35,810 | ||
Taxable income ($50,000 + 50% of $75,000) | $87,500 | ||
Deduct 50% of net section 1201 gain (net capital gain for taxable years beginning after December 31, 1976) | 37,500 | ||
50,000 | |||
Tax on $50,000 (taxable income exclusive of capital gains) | $17,060 | ||
(a) Net section 1201 gain (net capital gain for taxable years beginning after December 31, 1976) | 75,000 | ||
(b) Subsection (d) gain | 50,000 | ||
25% of $50,000 (lesser of (a) or (b)) | 12,500 | ||
(c) 29 | 7,375 | ||
(d) Ordinary income | $50,000 | ||
50% of net section 1201 gain (net capital gain for taxable years beginning after December 31, 1976) | 37,500 | ||
87,500 | |||
Tax on $87,500 | $37,690 | ||
Ordinary income | $50,000 | ||
50% of subsection (d) gain | 25,000 | ||
75,000 | |||
Tax on $75,000 | 30,470 | ||
Difference | 7,220 | ||
Lesser of (c) or (d) | $7,220 | ||
Alternative tax (total of 3 steps) at rates effective on and after January 1, 1970 | 36,780 |
1969—184/365 of $35,810 | $18,052.16 |
1970—181/365 of $36,780 | 18,238.85 |
36,291.01 | |
Tax surcharge (See § 1.51-1(d)(1)(i)) | 2,729.28 |
Total tax for the taxable year | 39,020.29 |
1970 | ||
Adjusted gross income | $18,500.00 | |
Less: | ||
Standard deduction | $1,000.00 | |
Personal exemption | 625.00 | 1,625.00 |
Taxable income under 1970 deduction provisions | 16,875.00 | |
Tax on $16,875 (1970 rates): | ||
Tax on first $16,000 | 4,330.00 | |
42 percent of $875 | 367.50 | |
Tentative tax at rates and deduction provisions effective on or after January 1, 1970 | 4,697.50 | |
1971 | ||
Adjusted gross income | $18,500.00 | |
Less: | ||
Standard deduction | $1,500 | |
Personal exemption | 650 | 2,150.00 |
Taxable income under 1971 deduction provisions | 16,350.00 | |
Tax on $16,350 (1971 rates): | ||
Tax on first $16,000 | 3,830 | |
34 percent of $350 | 119 | |
Tentative tax at rates and deduction provisions effective on or after Januray 1, 1971 | 3,949.00 | |
The 1970 and 1971 tentative taxes are apportioned as follows: | ||
1970—275/365 of $4,697.50 | 3,539.21 | |
1971—90/365 of $3,949.00 | 973.73 | |
4,512.94 | ||
Tax surcharge (see § 1.51-1(d)(1)(i)) | 56.26 | |
Total tax for the taxable year | 4,569.20 |
1969 | ||
Adjusted gross income | $12,500.00 | |
Less: | ||
Standard deduction | $1,000.00 | |
Personal exemption (2) | 1,200.00 | 2,200.00 |
Taxable income under 1969 deduction provisions | 10,300.00 | |
Taxable income reduced by one-half | 5,150.00 | |
Tax on $5,150 (1969 rates): | ||
Tax on first $4,000 | $690.00 | |
22 percent of $1,150 | 253.00 | 943.00 |
Twice the tax on $5,150 | $1,886.00 | |
Tentative tax at rates and deduction provisions effective on or after January 1, 1969 | 1,886.00 | |
1970 | ||
Adjusted gross income | $12,500.00 | |
Less: | ||
Standard deduction | $1,000.00 | |
Personal exemption (3) | 1,875.00 | 2,875.00 |
Taxable income under 1970 deduction provisions | $9,625.00 | |
Tax on $9,625 (1970 rates): | ||
Tax on first $8,000 | $1,380.00 | |
22 percent of $1,625 | 357.50 | |
Tentative tax at rates and deduction provisions effective on or after January 1, 1970 | 1,737.50 | |
The 1969 and 1970 tentative taxes are apportioned as follows: | ||
1969—122/365 of $1,886 | $630.39 | |
1970—243/365 of $1,737.50 | 1,156.75 | |
1,787.14 | ||
Tax surcharge (see § 1.51-1(d)(1)(i)) | 104.05 | |
Total tax for the taxable year | 1,891.19 |
1970 | ||
Adjusted gross income | $250,000.00 | |
Less: | ||
Itemized deductions | $34,000.00 | |
Personal exemption | 625.00 | 34,625.00 |
Taxable income under 1970 deduction provisions | 215,375.00 | |
Tax on $215,375 (1970 rates) | ||
Tax on first $100,000 | $55,490.00 | |
70 percent of $115,375 | 80,762.50 | |
Tentative tax at rates and deduction provisions effective on or after January 1, 1970 | 136,252.50 | |
Minimum tax: | ||
Total tax preference items | 175,000.00 | |
Less: | ||
Exemption | $30,000.00 | |
Income tax | 136,252.50 | 166,252.50 |
Subject to 10 percent tax | 8,747.50 | |
10 percent tax | 874.75 | |
Total tentative tax ($136,252.50 + $874.75) | 137,127.25 | |
1971 | ||
Adjusted gross income | $250,000.00 | |
Less: | ||
Itemized deductions | $34,000.00 | |
Personal exemption | 650.00 | 34,650.00 |
Taxable income under 1971 deduction provisions | 215,350.00 | |
(a) Tax on highest amount of taxable income on which rate does not exceed 60 percent ($50,000) (1971 rates) | 20,190.00 | |
(b) Earned taxable | ||
income: | ||
($215,350 × | ||
$240,000/ | ||
$250,000) | $206,736.00 | |
Less: Tax | ||
preference offset: | ||
($175,000 | ||
−$30,000) | 145,000.00 | |
61,736.00 | ||
(c) 60% of the amount by which $61,736 exceeds $50,000 | 7,041.60 | |
(d) Tax on $215,350 (1971 rates) | ||
Tax on first $100,000 | 53,090.00 | |
70% of $115,350 | 80,745.00 | |
Total | 133,835.00 | |
(e) Tax on $61,736 (1971 rates) | ||
Tax on first $60,000 | 26,390.00 | |
64% of $1,736 | 1,111.04 | |
Total | 27,501.04 | |
(f) Excess of $133,835 over $27,501.04 | 106,333.96 | |
Tentative tax (total of Steps (a), (c), and (f)) at rates and deduction provisions effective on or after January 1, 1971 | 133,565.56 | |
Minimum tax: | ||
Total tax preference items | 175,000.00 | |
Less: | ||
Exemption | $30,000.00 | |
Income tax | 133,565.56 | 163,565.56 |
Subject to 10 percent tax | $11,434.44 | |
10 percent tax | 1,143.44 | |
Total tentative tax ($133,565.56 + $1,143.44) | 134,709.00 | |
The 1970 and 1971 tentative taxes are apportioned as follows: | ||
1970—184/365 of $137,127.25 | 69,127.16 | |
1971—181/365 of $134,709 | 66,800.90 | |
Total tax for the taxable year | 135,928.06 |
1963 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1963 rates) 30 percent of $100,000 | $30,000 | |
Surtax on $75,000 (1963 rates and $25,000 surtax exemption) 22 percent of $75,000 | 16,500 | |
Total tentative tax at rates and surtax exemption effective before January 1, 1964 | 46,500 | |
1964 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1964 rates) 22 percent of $100,000 | $22,000 | |
Surtax on $95,000 (1964 rates and a $5,000 surtax exemption) 28 percent of $95,000 | 26,600 | |
Total tentative tax at rates and surtax exemption effective after January 1, 1964 | 48,600 | |
The 1963 and 1964 tentative taxes are apportioned as follows: | ||
1963—275/366 of $46,500 | 34,938.52 | |
1964—91/366 of $48,600 | 12,083.61 | |
Total tax for the taxable year | 47,022.13 | |
M has the same amount of taxable income in 1965. Its income tax liability for the fiscal year ending March 31, 1965, is computed as follows: | ||
1964 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1964 rates) 22 percent of $100,000 | $22,000 | |
Surtax on $95,000 (1964 rates and a $5,000 surtax exemption) 28 percent of $95,000 | 26,600 | |
Total tentative tax at the 1964 rates | 48,600 | |
1965 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1965 rates) 22 percent of $100,000 | $22,000 | |
Surtax on $95,000 (1965 rates and a $5,000 surtax exemption) 26 percent of $95,000 | 24,700 | |
Total tentative tax at the 1965 rates | 46,700 | |
The 1964 and 1965 tentative taxes are apportioned as follows: | ||
1964—275/365 of $48,600 | $36,616.44 | |
1965—90/365 of $46,700 | 11,515.07 | |
Total tax for the taxable year | 48,131.51 |
1963 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1963 rates) 30 percent of $100,000 | $30,000 | |
Surtax on $75,000 (1963 rates and $25,000 surtax exemption) 22 percent of $75,000 | 16,500 | |
Total tentative tax at rates and surtax exemption effective before January 1, 1964 | 46,500 | |
1964 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1964 rates) 22 percent of $100,000 | $22,000 | |
Surtax on $75,000 (1964 rates and $25,000 surtax exemption) 28 percent of $75,000 | 21,000 | |
Additional tax on $25,000 6 percent of $25,000 | 1,500 | |
Total tentative tax at rates and surtax exemption effective on and after January 1, 1964 | 44,500 | |
The 1963 and 1964 tentative taxes are apportioned as follows: | ||
1963—275/366 of $46,500 | $34,938.52 | |
1964—91/366 of $44,500 | 11,064.21 | |
Total tax for the taxable year | 46,002.73 |
1975 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1975 rates) 20 percent of $25,000 | $5,000 | |
22 percent of $75,000 | 16,500 | |
Surtax on $50,000 (1975 rates and $50,000 surtax exemption) 26 percent of $50,000 | 13,000 | |
Total tentative tax at rates and surtax exemption effective on and after January 1, 1975 | 34,500 | |
1976 | ||
Taxable income | $100,000 | |
Normal tax on $100,000 (1976 rates) 22 percent of $100,000 | $22,000 | |
Surtax on $75,000 (1976 rates and $25,000 surtax exemption) 26 percent of $75,000 | 19,500 | |
Total tentative tax at rates and surtax exemption effective on and after January 1, 1976 | 41,500 | |
The 1975 and 1976 tentative taxes are apportioned as follows: | ||
1975—184/366 of $34,500 | $17,344 | |
1976—182/366 of $41,500 | 20,637 | |
Total tax for the taxable year | 37,981 |
§ 1.21-1 Expenses for household and dependent care services necessary for gainful employment.
(a) In general. (1) Section 21 allows a credit to a taxpayer against the tax imposed by chapter 1 for employment-related expenses for household services and care (as defined in paragraph (d) of this section) of a qualifying individual (as defined in paragraph (b) of this section). The purpose of the expenses must be to enable the taxpayer to be gainfully employed (as defined in paragraph (c) of this section). For taxable years beginning after December 31, 2004, a qualifying individual must have the same principal place of abode (as defined in paragraph (g) of this section) as the taxpayer for more than one-half of the taxable year. For taxable years beginning before January 1, 2005, the taxpayer must maintain a household (as defined in paragraph (h) of this section) that includes one or more qualifying individuals.
(2) The amount of the credit is equal to the applicable percentage of the employment-related expenses that may be taken into account by the taxpayer during the taxable year (but subject to the limits prescribed in § 1.21-2). Applicable percentage means 35 percent reduced by 1 percentage point for each $2,000 (or fraction thereof) by which the taxpayer’s adjusted gross income for the taxable year exceeds $15,000, but not less than 20 percent. For example, if a taxpayer’s adjusted gross income is $31,850, the applicable percentage is 26 percent.
(3) Expenses may be taken as a credit under section 21, regardless of the taxpayer’s method of accounting, only in the taxable year the services are performed or the taxable year the expenses are paid, whichever is later.
(4) The requirements of section 21 and §§ 1.21-1 through 1.21-4 are applied at the time the services are performed, regardless of when the expenses are paid.
(5) Examples. The provisions of this paragraph (a) are illustrated by the following examples.
(b) Qualifying individual—(1) In general. For taxable years beginning after December 31, 2004, a qualifying individual is—
(i) The taxpayer’s dependent (who is a qualifying child within the meaning of section 152) who has not attained age 13;
(ii) The taxpayer’s dependent (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B)) who is physically or mentally incapable of self-care and who has the same principal place of abode as the taxpayer for more than one-half of the taxable year; or
(iii) The taxpayer’s spouse who is physically or mentally incapable of self-care and who has the same principal place of abode as the taxpayer for more than one-half of the taxable year.
(2) Taxable years beginning before January 1, 2005. For taxable years beginning before January 1, 2005, a qualifying individual is—
(i) The taxpayer’s dependent for whom the taxpayer is entitled to a deduction for a personal exemption under section 151(c) and who is under age 13;
(ii) The taxpayer’s dependent who is physically or mentally incapable of self-care; or
(iii) The taxpayer’s spouse who is physically or mentally incapable of self-care.
(3) Qualification on a daily basis. The status of an individual as a qualifying individual is determined on a daily basis. An individual is not a qualifying individual on the day the status terminates.
(4) Physical or mental incapacity. An individual is physically or mentally incapable of self-care if, as a result of a physical or mental defect, the individual is incapable of caring for the individual’s hygiene or nutritional needs, or requires full-time attention of another person for the individual’s own safety or the safety of others. The inability of an individual to engage in any substantial gainful activity or to perform the normal household functions of a homemaker or care for minor children by reason of a physical or mental condition does not of itself establish that the individual is physically or mentally incapable of self-care.
(5) Special test for divorced or separated parents or parents living apart—(i) Scope. This paragraph (b)(5) applies to a child (as defined in section 152(f)(1) for taxable years beginning after December 31, 2004, and in section 151(c)(3) for taxable years beginning before January 1, 2005) who—
(A) Is under age 13 or is physically or mentally incapable of self-care;
(B) Receives over one-half of his or her support during the calendar year from one or both parents who are divorced or legally separated under a decree of divorce or separate maintenance, are separated under a written separation agreement, or live apart at all times during the last 6 months of the calendar year; and
(C) Is in the custody of one or both parents for more than one-half of the calendar year.
(ii) Custodial parent allowed the credit. A child to whom this paragraph (b)(5) applies is the qualifying individual of only one parent in any taxable year and is the qualifying child of the custodial parent even if the noncustodial parent may claim the dependency exemption for that child for that taxable year. See section 21(e)(5). The custodial parent is the parent having custody for the greater portion of the calendar year. See section 152(e)(4)(A).
(6) Example. The provisions of this paragraph (b) are illustrated by the following examples.
(c) Gainful employment—(1) In general. Expenses are employment-related expenses only if they are for the purpose of enabling the taxpayer to be gainfully employed. The expenses must be for the care of a qualifying individual or household services performed during periods in which the taxpayer is gainfully employed or is in active search of gainful employment. Employment may consist of service within or outside the taxpayer’s home and includes self-employment. An expense is not employment-related merely because it is paid or incurred while the taxpayer is gainfully employed. The purpose of the expense must be to enable the taxpayer to be gainfully employed. Whether the purpose of an expense is to enable the taxpayer to be gainfully employed depends on the facts and circumstances of the particular case. Work as a volunteer or for a nominal consideration is not gainful employment.
(2) Determination of period of employment on a daily basis—(i) In general. Expenses paid for a period during only part of which the taxpayer is gainfully employed or in active search of gainful employment must be allocated on a daily basis.
(ii) Exception for short, temporary absences. A taxpayer who is gainfully employed is not required to allocate expenses during a short, temporary absence from work, such as for vacation or minor illness, provided that the care-giving arrangement requires the taxpayer to pay for care during the absence. An absence of 2 consecutive calendar weeks is a short, temporary absence. Whether an absence longer than 2 consecutive calendar weeks is a short, temporary absence is determined based on all the facts and circumstances.
(iii) Part-time employment. A taxpayer who is employed part-time generally must allocate expenses for dependent care between days worked and days not worked. However, if a taxpayer employed part-time is required to pay for dependent care on a periodic basis (such as weekly or monthly) that includes both days worked and days not worked, the taxpayer is not required to allocate the expenses. A day on which the taxpayer works at least 1 hour is a day of work.
(3) Examples. The provisions of this paragraph (c) are illustrated by the following examples:
(d) Care of qualifying individual and household services—(1) In general. To qualify for the dependent care credit, expenses must be for the care of a qualifying individual. Expenses are for the care of a qualifying individual if the primary function is to assure the individual’s well-being and protection. Not all expenses relating to a qualifying individual are for the individual’s care. Amounts paid for food, lodging, clothing, or education are not for the care of a qualifying individual. If, however, the care is provided in such a manner that the expenses cover other goods or services that are incidental to and inseparably a part of the care, the full amount is for care.
(2) Allocation of expenses. If an expense is partly for household services or for the care of a qualifying individual and partly for other goods or services, a reasonable allocation must be made. Only so much of the expense that is allocable to the household services or care of a qualifying individual is an employment-related expense. An allocation must be made if a housekeeper or other domestic employee performs household duties and cares for the qualifying children of the taxpayer and also performs other services for the taxpayer. No allocation is required, however, if the expense for the other purpose is minimal or insignificant or if an expense is partly attributable to the care of a qualifying individual and partly to household services.
(3) Household services. Expenses for household services may be employment-related expenses if the services are performed in connection with the care of a qualifying individual. The household services must be the performance in and about the taxpayer’s home of ordinary and usual services necessary to the maintenance of the household and attributable to the care of the qualifying individual. Services of a housekeeper are household services within the meaning of this paragraph (d)(3) if the services are provided, at least in part, to the qualifying individual. Such services as are performed by chauffeurs, bartenders, or gardeners are not household services.
(4) Manner of providing care. The manner of providing care need not be the least expensive alternative available to the taxpayer. The cost of a paid caregiver may be an expense for the care of a qualifying individual even if another caregiver is available at no cost.
(5) School or similar program. Expenses for a child in nursery school, pre-school, or similar programs for children below the level of kindergarten are for the care of a qualifying individual and may be employment-related expenses. Expenses for a child in kindergarten or a higher grade are not for the care of a qualifying individual. However, expenses for before- or after-school care of a child in kindergarten or a higher grade may be for the care of a qualifying individual.
(6) Overnight camps. Expenses for overnight camps are not employment-related expenses.
(7) Day camps. (i) The cost of a day camp or similar program may be for the care of a qualifying individual and an employment-related expense, without allocation under paragraph (d)(2) of this section, even if the day camp specializes in a particular activity. Summer school and tutoring programs are not for the care of a qualifying individual and the costs are not employment-related expenses.
(ii) A day camp that meets the definition of dependent care center in section 21(b)(2)(D) and paragraph (e)(2) of this section must comply with the requirements of section 21(b)(2)(C) and paragraph (e)(2) of this section.
(8) Transportation. The cost of transportation by a dependent care provider of a qualifying individual to or from a place where care of that qualifying individual is provided may be for the care of the qualifying individual. The cost of transportation not provided by a dependent care provider is not for the care of the qualifying individual.
(9) Employment taxes. Taxes under sections 3111 (relating to the Federal Insurance Contributions Act) and 3301 (relating to the Federal Unemployment Tax Act) and similar state payroll taxes are employment-related expenses if paid in respect of wages that are employment-related expenses.
(10) Room and board. The additional cost of providing room and board for a caregiver over usual household expenditures may be an employment-related expense.
(11) Indirect expenses. Expenses that relate to, but are not directly for, the care of a qualifying individual, such as application fees, agency fees, and deposits, may be for the care of a qualifying individual and may be employment-related expenses if the taxpayer is required to pay the expenses to obtain the related care. However, forfeited deposits and other payments are not for the care of a qualifying individual if care is not provided.
(12) Examples. The provisions of this paragraph (d) are illustrated by the following examples:
(e) Services outside the taxpayer’s household—(1) In general. The credit is allowable for expenses for services performed outside the taxpayer’s household only if the care is for one or more qualifying individuals who are described in this section at—
(i) Paragraph (b)(1)(i) or (b)(2)(i); or
(ii) Paragraph (b)(1)(ii), (b)(2)(ii), (b)(1)(iii), or (b)(2)(iii) and regularly spend at least 8 hours each day in the taxpayer’s household.
(2) Dependent care centers—(i) In general. The credit is allowable for services performed by a dependent care center only if—
(A) The center complies with all applicable laws and regulations, if any, of a state or local government, such as state or local licensing requirements and building and fire code regulations; and
(B) The requirements provided in this paragraph (e) are met.
(ii) Definition. The term dependent care center means any facility that provides full-time or part-time care for more than six individuals (other than individuals who reside at the facility) on a regular basis during the taxpayer’s taxable year, and receives a fee, payment, or grant for providing services for the individuals (regardless of whether the facility is operated for profit). For purposes of the preceding sentence, a facility is presumed to provide full-time or part-time care for six or fewer individuals on a regular basis during the taxpayer’s taxable year if the facility has six or fewer individuals (including the taxpayer’s qualifying individual) enrolled for full-time or part-time care on the day the qualifying individual is enrolled in the facility (or on the first day of the taxable year the qualifying individual attends the facility if the qualifying individual was enrolled in the facility in the preceding taxable year) unless the Internal Revenue Service demonstrates that the facility provides full-time or part-time care for more than six individuals on a regular basis during the taxpayer’s taxable year.
(f) Reimbursed expenses. Employment-related expenses for which the taxpayer is reimbursed (for example, under a dependent care assistance program) may not be taken into account for purposes of the credit.
(g) Principal place of abode. For purposes of this section, the term principal place of abode has the same meaning as in section 152.
(h) Maintenance of a household—(1) In general. For taxable years beginning before January 1, 2005, the credit is available only to a taxpayer who maintains a household that includes one or more qualifying individuals. A taxpayer maintains a household for the taxable year (or lesser period) only if the taxpayer (and spouse, if applicable) occupies the household and furnishes over one-half of the cost for the taxable year (or lesser period) of maintaining the household. The household must be the principal place of abode for the taxable year of the taxpayer and the qualifying individual or individuals.
(2) Cost of maintaining a household. (i) Except as provided in paragraph (h)(2)(ii) of this section, for purposes of this section, the term cost of maintaining a household has the same meaning as in § 1.2-2(d) without regard to the last sentence thereof.
(ii) The cost of maintaining a household does not include the value of services performed in the household by the taxpayer or by a qualifying individual described in paragraph (b) of this section or any expense paid or reimbursed by another person.
(3) Monthly proration of annual costs. In determining the cost of maintaining a household for a period of less than a taxable year, the cost for the entire taxable year must be prorated on the basis of the number of calendar months within that period. A period of less than a calendar month is treated as a full calendar month.
(4) Two or more families. If two or more families occupy living quarters in common, each of the families is treated as maintaining a separate household. A taxpayer is maintaining a household if the taxpayer provides more than one-half of the cost of maintaining the separate household. For example, if two unrelated taxpayers with their respective children occupy living quarters in common and each taxpayer pays more than one-half of the household costs for each respective family, each taxpayer is treated as maintaining a household.
(i) Reserved.
(j) Expenses qualifying as medical expenses—(1) In general. A taxpayer may not take an amount into account as both an employment-related expense under section 21 and an expense for medical care under section 213.
(2) Examples. The provisions of this paragraph (j) are illustrated by the following examples:
(k) Substantiation. A taxpayer claiming a credit for employment-related expenses must maintain adequate records or other sufficient evidence to substantiate the expenses in accordance with section 6001 and the regulations thereunder.
(l) Effective/applicability date. This section and §§ 1.21-2 through 1.21-4 apply to taxable years ending after August 14, 2007.
§ 1.21-2 Limitations on amount creditable.
(a) Annual dollar limitation. (1) The amount of employment-related expenses that may be taken into account under § 1.21-1(a) for any taxable year cannot exceed—
(i) $2,400 ($3,000 for taxable years beginning after December 31, 2002, and before January 1, 2011) if there is one qualifying individual with respect to the taxpayer at any time during the taxable year; or
(ii) $4,800 ($6,000 for taxable years beginning after December 31, 2002, and before January 1, 2011) if there are two or more qualifying individuals with respect to the taxpayer at any time during the taxable year.
(2) The amount determined under paragraph (a)(1) of this section is reduced by the aggregate amount excludable from gross income under section 129 for the taxable year.
(3) A taxpayer may take into account the total amount of employment-related expenses that do not exceed the annual dollar limitation although the amount of employment-related expenses attributable to one qualifying individual is disproportionate to the total employment-related expenses. For example, a taxpayer with expenses in 2007 of $4,000 for one qualifying individual and $1,500 for a second qualifying individual may take into account the full $5,500.
(4) A taxpayer is not required to prorate the annual dollar limitation if a qualifying individual ceases to qualify (for example, by turning age 13) during the taxable year. However, the taxpayer may take into account only amounts that qualify as employment-related expenses before the disqualifying event. See also § 1.21-1(b)(6).
(b) Earned income limitation—(1) In general. The amount of employment-related expenses that may be taken into account under section 21 for any taxable year cannot exceed—
(i) For a taxpayer who is not married at the close of the taxable year, the taxpayer’s earned income for the taxable year; or
(ii) For a taxpayer who is married at the close of the taxable year, the lesser of the taxpayer’s earned income or the earned income of the taxpayer’s spouse for the taxable year.
(2) Determination of spouse. For purposes of this paragraph (b), a taxpayer must take into account only the earned income of a spouse to whom the taxpayer is married at the close of the taxable year. The spouse’s earned income for the entire taxable year is taken into account, however, even though the taxpayer and the spouse were married for only part of the taxable year. The taxpayer is not required to take into account the earned income of a spouse who died or was divorced or separated from the taxpayer during the taxable year. See § 1.21-3(b) for rules providing that certain married taxpayers legally separated or living apart are treated as not married.
(3) Definition of earned income. For purposes of this section, the term earned income has the same meaning as in section 32(c)(2) and the regulations thereunder.
(4) Attribution of earned income to student or incapacitated spouse. (i) For purposes of this section, a spouse is deemed, for each month during which the spouse is a full-time student or is a qualifying individual described in § 1.21-1(b)(1)(iii) or (b)(2)(iii), to be gainfully employed and to have earned income of not less than—
(A) $200 ($250 for taxable years beginning after December 31, 2002, and before January 1, 2011) if there is one qualifying individual with respect to the taxpayer at any time during the taxable year; or
(B) $400 ($500 for taxable years beginning after December 31, 2002, and before January 1, 2011) if there are two or more qualifying individuals with respect to the taxpayer at any time during the taxable year.
(ii) For purposes of this paragraph (b)(4), a full-time student is an individual who, during each of 5 calendar months of the taxpayer’s taxable year, is enrolled as a student for the number of course hours considered to be a full-time course of study at an educational organization as defined in section 170(b)(1)(A)(ii). The enrollment for 5 calendar months need not be consecutive.
(iii) Earned income may be attributed under this paragraph (b)(4), in the case of any husband and wife, to only one spouse in any month.
(c) Examples. The provisions of this section are illustrated by the following examples:
(d) Cross-reference. For an additional limitation on the credit under section 21, see section 26.
§ 1.21-3 Special rules applicable to married taxpayers.
(a) Joint return requirement. No credit is allowed under section 21 for taxpayers who are married (within the meaning of section 7703 and the regulations thereunder) at the close of the taxable year unless the taxpayer and spouse file a joint return for the taxable year. See section 6013 and the regulations thereunder relating to joint returns of income tax by husband and wife.
(b) Taxpayers treated as not married. The requirements of paragraph (a) of this section do not apply to a taxpayer who is legally separated under a decree of divorce or separate maintenance or who is treated as not married under section 7703(b) and the regulations thereunder (relating to certain married taxpayers living apart). A taxpayer who is treated as not married under this paragraph (b) is not required to take into account the earned income of the taxpayer’s spouse for purposes of applying the earned income limitation on the amount of employment-related expenses under § 1.21-2(b).
(c) Death of married taxpayer. If a married taxpayer dies during the taxable year and the survivor may make a joint return with respect to the deceased spouse under section 6013(a)(3), the credit is allowed for the year only if a joint return is made. If, however, the surviving spouse remarries before the end of the taxable year in which the deceased spouse dies, a credit may be allowed on the decedent spouse’s separate return.
(a) In general. A credit is not allowed under section 21 for any amount paid by the taxpayer to an individual—
(1) For whom a deduction under section 151(c) (relating to deductions for personal exemptions for dependents) is allowable either to the taxpayer or the taxpayer’s spouse for the taxable year;
(2) Who is a child of the taxpayer (within the meaning of section 152(f)(1) for taxable years beginning after December 31, 2004, and section 151(c)(3) for taxable years beginning before January 1, 2005) and is under age 19 at the close of the taxable year;
(3) Who is the spouse of the taxpayer at any time during the taxable year; or
(4) Who is the parent of the taxpayer’s child who is a qualifying individual described in § 1.21-1(b)(1)(i) or (b)(2)(i).
(b) Payments to partnerships or other entities. In general, paragraph (a) of this section does not apply to services performed by partnerships or other entities. If, however, the partnership or other entity is established or maintained primarily to avoid the application of paragraph (a) of this section to permit the taxpayer to claim the credit, for purposes of section 21, the payments of employment-related expenses are treated as made directly to each partner or owner in proportion to that partner’s or owner’s ownership interest. Whether a partnership or other entity is established or maintained to avoid the application of paragraph (a) of this section is determined based on the facts and circumstances, including whether the partnership or other entity is established for the primary purpose of caring for the taxpayer’s qualifying individual or providing household services to the taxpayer.
(c) Examples. The provisions of this section are illustrated by the following examples:
§ 1.24-1 Partial credit allowed for certain other dependents.
(a) In general. For purposes of section 24(h)(4)(A), a taxpayer may be eligible to increase the credit determined under section 24(a) by $500 for a dependent of the taxpayer, as defined in section 152, other than a qualifying child described in section 24(c).
(b) Applicability date. This section applies to taxable years beginning on or after October 13, 2020.
§ 1.25-1T Credit for interest paid on certain home mortgages (Temporary).
(a) In general. Section 25 permits States and political subdivisions to elect to issue mortgage credit certificates in lieu of qualified mortgage bonds. An individual who holds a qualified mortgage credit certificate (as defined in § 1.25-3T) is entitled to a credit against his Federal income taxes. The amount of the credit depends upon (1) the amount of mortgage interest paid or accrued during the year and (2) the applicable certificate credit rate. See § 1.25-2T. The amount of the deduction under section 163 for interest paid or accrued during any taxable year is reduced by the amount of the credit allowable under section 25 for such year. See § 1.163-6T. The holder of a qualified mortgage credit certificate may be entitled to additional withholding allowances. See section 3402 (m) and the regulations thereunder.
(b) Definitions. For purposes of §§ 1.25-2T through 1.25-8T and this section, the following definitions apply:
(1) Mortgage. The term “mortgage” includes deeds of trust, conditional sales contracts, pledges, agreements to hold title in escrow, and any other form of owner financing.
(2) State. (i) The term “State” includes a possession of the United States and the District of Columbia.
(ii) Mortgage credit certificates issued by or on behalf of any State or political subdivision (“governmental unit”) by constituted authorities empowered to issue such certificates are the certificates of such governmental unit.
(3) Qualified home improvement loan. The term “qualified home improvement loan” has the meaning given that term under section 103A (1)(6) and the regulations thereunder.
(4) Qualified rehabilitation loan. The term “qualified rehabilitation loan” has the meaning given that term under section 103A (1)(7)(A) and the regulations thereunder.
(5) Single-family and owner-occupied residences. The terms “single-family” and “owner-occupied” have the meaning given those terms under section 103A (1)(9) and the regulations thereunder.
(6) Constitutional home rule city. The term “constitutional home rule city” means, with respect to any calendar year, any political subdivision of a State which, under a State constitution which was adopted in 1970 and effective on July 1, 1971, had home rule powers on the 1st day of the calendar year.
(7) Targeted area residence. The term “targeted area residence” has the meaning given that term under section 103A (k) and the regulations thereunder.
(8) Acquisition cost. The term “acquisition cost” has the meaning given that term under section 103A (1)(5) and the regulations thereunder.
(9) Average area purchase price. The term “average area purchase price” has the meaning given that term under subparagraphs (2), (3), and (4) of section 103A (f) and the regulations thereunder. For purposes of this paragraph (b)(9), all determinations of average area purchase price shall be made with respect to residences as that term is defined in section 103A and the regulations thereunder.
(10) Total proceeds. The “total proceeds” of an issue is the sum of the products determined by multiplying—
(i) The certified indebtedness amount of each mortgage credit certificate issued pursuant to such issue, by
(ii) The certificate credit rate specified in such certificate.
(11) Residence. The term “residence” includes stock held by a tenant-stockholder in a cooperative housing corporation (as those terms are defined in section 216(b) (1) and (2)). It does not include property such as an appliance, a piece of furniture, a radio, etc., which, under applicable local law, is not a fixture. The term also includes any manufactured home which has a minimum of 400 square feet of living space and a minimum width in excess of 102 inches and which is of a kind customarily used at a fixed location. The preceding sentence shall not apply for purposes of determining the average area purchase price for single-family residences, nor shall it apply for purposes of determining the State ceiling amount. The term “residence” does not, however, include recreational vehicles, campers, and other similar vehicles.
(12) Related person. The term “related person” has the meaning given that term under section 103(b)(6)(C)(i) and § 1.103-10(e)(1).
(13) Date of issue. A mortgage credit certificate is considered issued on the date on which a closing agreement is signed with respect to the certified indebtedness amount.
(c) Affidavits. For purposes of §§ 1.25-1T through 1.25-8T, an affidavit filed in connection with the requirements of §§ 1.25-1T through 1.25-8T shall be made under penalties of perjury. Applicants for mortgage credit certificates who are required by a lender or the issuer to sign affidavits must be informed that any fraudulent statement will result in (1) the revocation of the individual’s mortgage credit certificate, and (2) a $10,000 penalty under section 6709. Other persons required by a lender or an issuer to provide affidavits must receive similar notice. A person may not rely on an affidavit where that person knows or has reason to know that the information contained in the affidavit is false.
§ 1.25-2T Amount of credit (Temporary).
(a) In general. Except as otherwise provided, the amount of the credit allowable for any taxable year to an individual who holds a qualified mortgage credit certificate is equal to the product of the certificate credit rate (as defined in paragraph (b)) and the amount of the interest paid or accrued by the taxpayer during the taxable year on the certified indebtedness amount (as defined in paragraph (c)).
(b) Certificate credit rate—(1) In general. For purposes of §§ 1.25-1T through 1.25-8T, the term “certificate credit rate” means the rate specified by the issuer on the mortgage credit certificate. The certificate credit rate shall not be less than 10 percent nor more than 50 percent.
(2) Limitation in certain States. (i) In the case of a State which—
(A) Has a State ceiling for the calendar year in which an election is made that exceeds 20 percent of the average annual aggregate principal amount of mortgages executed during the immediately preceding 3 calendar years for single-family owner-occupied residences located within the jurisdiction of such State, or
(B) Issued qualified mortgage bonds in an aggregate amount less than $150 million for calendar year 1983.
(ii) The following example illustrates the application of this paragraph (b)(2):
(c) Certified indebtedness amount—(1) In general. The term “certified indebtedness amount” means the amount of indebtedness which is—
(i) Incurred by the taxpayer—
(A) To acquire his principal residence, § 1.25-2T(c)(1)(i),
(B) As a qualified home improvement loan, or
(C) As a qualified rehabilitation loan, and
(ii) Specified in the mortgage credit certificate.
(2) Example. The following example illustrates the application of this paragraph:
(d) Limitation on credit—(1) Limitation where certificate credit rate exceeds 20 percent. (i) If the certificate credit rate of any mortgage credit certificate exceeds 20 percent, the amount of the credit allowed to the taxpayer by section 25(a)(1) for any year shall not exceed $2,000. Any amount denied under this paragraph (d)(1) may not be carried forward under section 25(e)(1) and paragraph (d)(2) of this section.
(ii) If two or more persons hold interests in any residence, the limitation of paragraph (d)(1)(i) shall be allocated among such persons in proporation to their respective interests in the residence.
(2) Carryforward of unused credit. (i) If the credit allowable under section 25 (a) and § 1.25-2T for any taxable year exceeds the applicable tax limit for that year, the excess (the “unused credit”) will be a carryover to each of the 3 succeeding taxable years and, subject to the limitations of paragraph (d)(2)(ii), will be added to the credit allowable by section 25 (a) and § 1.25-2T for that succeeding year.
(ii) The amount of the unused credit for any taxable year (the “unused credit year”) which may be taken into account under this paragraph (d)(2) for any subsequent taxable year may not exceed the amount by which the applicable tax limit for that subsequent taxable year exceeds the sum of (A) the amount of the credit allowable under section 25 (a) and § 1.25-1T for the current taxable year, and (B) the sum of the unused credits which, by reason of this paragraph (d)(2), are carried to that subsequent taxable year and are attributable to taxable years before the unused credit year. Thus, if by reason of this paragraph (d)(2), unused credits from 2 prior taxable years are carried forward to a subsequent taxable year, the unused credit from the earlier of those 2 prior years must be taken into account before the unused credit from the later of those 2 years is taken into account.
(iii) For purposes of this paragraph (d)(2) the term “applicable tax limit” means the limitation imposed by section 26 (a) for the taxable year reduced by the sum of the credits allowable for that year under section 21, relating to expenses for household and dependent care services necessary for gainful employment, section 22, relating to the credit for the elderly and the permanently disabled, section 23, relating to the residential energy credit, and section 24, relating to contributions to candidates for public office. The limitation imposed by section 26 (a) for any taxable year is equal to the taxpayer’s tax liability (as defined in section 26 (b)) for that year.
(iv) The following examples illustrate the application of this paragraph (d)(2):
(ii) For 1987 B’s applicable tax limit is $1,500, the amount of the credit under section 25 (a) and § 1.25-2T is $1,700, and the unused credit is $200. For 1988 B’s applicable tax limit is $2,000, the amount of the credit under section 25 (a) and § 1.25-2T is $1,300, and there is no unused credit. For 1987 and 1988 B is not entitled to any of the credits described in sections 21 through 24. No portion of the unused credit for 1986 my be used in 1987. For 1988 B is entitled to claim a credit of $2,000 under section 25 (a) and § 1.25-2T, consisting of a $1,300 credit for 1988, the $600 unused credit for 1986, and $100 of the $200 unused credit for 1987. In addition, B may carry forward the remaining unused credit for 1987 ($100) to 1989 and 1990.
§ 1.25-3 Qualified mortgage credit certificate.
(a)-(g)(1)(ii) [Reserved]. For further guidance, see § 1.25-3T(a) through (g)(1)(ii).
(g)(1)(iii) Reissued certificate exception. See paragraph (p) of this section for rules regarding the exception in the case of refinancing existing mortgages.
(g)(2)-(o) [Reserved]. For further guidance, see § 1.25-3T(g)(2) through (o).
(p) Reissued certificates for certain refinancings—(1) In general. If the issuer of a qualified mortgage credit certificate reissues a certificate in place of an existing mortgage credit certificate to the holder of that existing certificate, the reissued certificate is treated as satisfying the requirements of this section. The period for which the reissued certificate is in effect begins with the date of the refinancing (that is, the date on which interest begins accruing on the refinancing loan).
(2) Meaning of existing certificate. For purposes of this paragraph (p), a mortgage credit certificate is an existing certificate only if it satisfies the requirements of this section. An existing certificate may be the original certificate, a certificate issued to a transferee under § 1.25-3T(h)(2)(ii), or a certificate previously reissued under this paragraph (p).
(3) Limitations on reissued certificate. An issuer may reissue a mortgage credit certificate only if all of the following requirements are satisfied:
(i) The reissued certificate is issued to the holder of an existing certificate with respect to the same property to which the existing certificate relates.
(ii) The reissued certificate entirely replaces the existing certificate (that is, the holder cannot retain the existing certificate with respect to any portion of the outstanding balance of the certified mortgage indebtedness specified on the existing certificate).
(iii) The certified mortgage indebtedness specified on the reissued certificate does not exceed the remaining outstanding balance of the certified mortgage indebtedness specified on the existing certificate.
(iv) The reissued certificate does not increase the certificate credit rate specified in the existing certificate.
(v) The reissued certificate does not result in an increase in the tax credit that would otherwise have been allowable to the holder under the existing certificate for any taxable year. The holder of a reissued certificate determines the amount of tax credit that would otherwise have been allowable by multiplying the interest that was scheduled to have been paid on the refinanced loan by the certificate rate of the existing certificate. In the case of a series of refinancings, the tax credit that would otherwise have been allowable is determined from the amount of interest that was scheduled to have been paid on the original loan and the certificate rate of the original certificate.
(A) In the case of a refinanced loan that is a fixed interest rate loan, the interest that was scheduled to be paid on the refinanced loan is determined using the scheduled interest method described in paragraph (p)(3)(v)(C) of this section.
(B) In the case of a refinanced loan that is not a fixed interest rate loan, the interest that was scheduled to be paid on the refinanced loan is determined using either the scheduled interest method described in paragraph (p)(3)(v)(C) of this section or the hypothetical interest method described in paragraph (p)(3)(v)(D) of this section.
(C) The scheduled interest method determines the amount of interest for each taxable year that was scheduled to have been paid in the taxable year based on the terms of the refinanced loan including any changes in the interest rate that would have been required by the terms of the refinanced loan and any payments of principal that would have been required by the terms of the refinanced loan (other than repayments required as a result of any refinancing of the loan).
(D) The hypothetical interest method (which is available only for refinanced loans that are not fixed interest rate loans) determines the amount of interest treated as having been scheduled to be paid for a taxable year by constructing an amortization schedule for a hypothetical self-amortizing loan with level payments. The hypothetical loan must have a principal amount equal to the remaining outstanding balance of the certified mortgage indebtedness specified on the existing certificate, a maturity equal to that of the refinanced loan, and interest equal to the annual percentage rate (APR) of the refinancing loan that is required to be calculated for the Federal Truth in Lending Act.
(E) A holder must consistently apply the scheduled interest method or the hypothetical interest method for all taxable years beginning with the first taxable year the tax credit is claimed by the holder based upon the reissued certificate.
(4) Examples. The following examples illustrate the application of paragraph (p)(3)(v) of this section:
(1) Applying the terms of the refinanced loan, including the variable interest rate or rates, for the taxable year as though the refinanced loan continued to exist; or
(2) Obtaining the amount of interest, and calculating the amount of credit that would have been available, from the schedule of equal payments that fully amortize a hypothetical loan with the principal amount equal to the remaining outstanding balance of the certified mortgage indebtedness specified on the existing certificate, the interest equal to the annual percentage rate (APR) of the refinancing loan, and the maturity equal to that of the refinanced loan.
(b) The holder must apply the same method for each taxable year the tax credit is claimed based upon the reissued mortgage credit certificate.
(5) Coordination with Section 143(m)(3). A refinancing loan underlying a reissued mortgage credit certificate that replaces a mortgage credit certificate issued on or before December 31, 1990, is not a federally subsidized indebtedness for the purposes of section 143(m)(3) of the Internal Revenue Code.
§ 1.25-3T Qualified mortgage credit certificate (Temporary).
(a) Definition of qualified mortgage credit certificate. For purposes of §§ 1.25-1T through 1.25-8T, the term “qualified mortgage credit certificate” means a certificate that meets all of the requirements of this section.
(b) Qualified mortgage credit certificate program. A certificate meets the requirements of this paragraph if it is issued under a qualified mortgage credit certificate program (as defined in § 1.25-4T).
(c) Required form and information. A certificate meets the requirements of this paragraph if it is in the form specified in § 1.25-6T and if all the information required by the form is specified on the form.
(d) Residence requirement—(1) In general. A certificate meets the requirements of this paragraph only if it is provided in connection with the acquisition, qualified rehabilitation, or qualified home improvement of a residence, that is—
(i) A single-family residence (as defined in § 1.25-1T(b)(5)) which, at the time the financing on the residence is executed or assumed, can reasonably be expected by the issuer to become (or, in the case of a qualified home improvement loan, to continue to be) the principal residence (as defined in section 1034 and the regulations thereunder) of the holder of the certificate within a reasonable time after the financing is executed or assumed, and
(ii) Located within the jurisdiction of the governmental unit issuing the certificate.
(2) Certification procedure. The requirements of this paragraph will be met if the issuer or its agent obtains from the holder of the certificate an affidavit stating his intent to use (or, in the case of a qualified home improvement loan, that he is currently using and intends to continue to use) the residence as his principal residence within a reasonable time (e.g., 60 days) after the mortgage credit certificate is issued and stating that the holder will notify the issuer of the mortgage credit certificate if the residence ceases to be his principal residence. The affidavit must also state facts that are sufficient for the issuer or his agent to determine whether the residence is located within the jurisdiction of the issuer that issued the mortgage credit certificate.
(e) 3-year requirement—(1) In general. A certificate meets the requirements of this paragraph only if the holder of the certificate had no present ownership interest in a principal residence at any time during the 3-year period prior to the date on which the mortgage on the residence in connection with which the certificate is provided is executed. For purposes of the preceding sentence, the holder’s interest in the residence with respect to which the certificate is being provided shall not be taken into account. See section 103A(e) and the regulations thereunder for further definitions and requirements.
(2) Exceptions. Paragraph (e)(1) shall not apply with respect to—
(i) Any certificate provided with respect to a targeted area residence (as defined in § 1.25-1T(b)(7)),
(ii) Any qualified home improvement loan (as defined in § 1.25-1T(b)(3)), and
(iii) Any qualified rehabilitation loan (as defined in § 1.25-1T(b)(4)).
(3) Certification procedure. The requirements of paragraph (e)(1) will be met if the issuer or its agent obtains from the holder of the certificate an affidavit stating that he had no present ownership interest in a principal residence at any time during the 3-year period prior to the date of which the certificate is issued and the issuer or its agent obtains from the applicant copies of the applicant’s Federal tax returns for the preceding 3 years and examines each statement to determine whether the applicant has claimed a deduction for taxes on property which was the applicant’s principal residence pursuant to section 164(a)(1) or a deduction pursuant to section 163 for interest paid on a mortgage secured by property which was the applicant’s principal residence. Where the mortgage is executed during the period between January 1 and February 15 and the applicant has not yet filed has Federal income tax return with the Internal Revenue Service, the issuer may, with respect to such year, rely on an affidavit of the applicant that the applicant is not entitled to claim deductions for taxes or interest on indebtedness with respect to property constituting his principal residence for the preceding calendar year. In the alternative, when applicable, the holder may provide an affidavit stating that one of the exceptions provided in paragraph (e)(2) applies.
(4) Special rule. An issuer may submit a plan to the Commissioner for distributing certificates, in an amount not to exceed 10 percent of the proceeds of the issue, to individuals who do not meet the requirements of this paragraph. Such plan must describe a procedure for ensuring that no more than 10 percent of the proceeds of a such issue will be used to provide certificates to such individuals. If the Commissioner approves the issuer’s plan, certificates issued in accordance with the terms of the plan to holders who do not meet the 3-year requirement do not fail to satisfy the requirements of this paragraph.
(f) Purchase price requirement—(1) In general. A certificate meets the requirements of this paragraph only if the acquisition cost (as defined in § 1.25-1T(b)(8)) of the residence, other than a targeted area residence, in connection with which the certificate is provided does not exceed 110 percent of the average area purchase price (as defined in § 1.25-1T(b)(9)) applicable to that residence. In the case of a targeted area residence (as defined in § 1.251T(b)(7)) the acquisition cost may not exceed 120 percent of the average area purchase price applicable to such residence. See section 1093A(f) and the regulations thereunder for further definitions and requirements.
(2) Certification procedure. The requirements of paragraph (f)(1) will be met if the issuer or its agent obtains affidavits executed by the seller and the buyer that state these requirements have been met. Such affidavits must include an itemized list of—
(i) Any payments made by the buyer (or a related person) or for the benefit of the buyer,
(ii) If the residence is incomplete, an estimate of the reasonable cost of completing the residence, and
(iii) If the residence is purchased subject to a ground rent, the capitalized value of the ground rent.
(g) New mortgage requirement—(1) In general. (i) A certificate meets the requirements of this paragraph only if the certificate is not issued in connection with the acquisition or replacement of an existing mortgage. Except in the case of a qualified home improvement loan, the certificate must be issued to an individual who did not have a mortgage (whether or not paid off) on the residence with respect to which the certificate is issued at any time prior to the execution of the mortgage.
(ii) Exceptions. For purposes of this paragraph, a certificate used in connection with the replacement of—
(A) Construction period loans,
(B) Bridge loans or similar temporary initial financing, and
(C) In the case of a qualified rehabilitation loan, an existing mortgage,
(2) Certification procedure. The requirements of paragraph (g)(1) will be met if the issuer or its agent obtains from the holder of the certificate an affidavit stating that the mortage being acquired in connection with the certificate will not be used to acquire or replace an existing mortgage (other than one that falls within the exceptions described in paragraph (g)(1)(ii)).
(h) Transfer of mortgage credit certificates—(1) In general. A certificate meets the requirements of this paragraph only if it is (i) not transferable or (ii) transferable only with the approval of the issuer.
(2) Transfer procedure. A certificate that is transferred with the approval of the issuer is a qualified mortgage credit certificate in the hands of the transferee only if each of the following requirements is met:
(i) The transferee assumed liability for the remaining balance of the certified indebtedness amount in connection with the acquisition of the residence from the transferor,
(ii) The issuer issues a new certificate to the transferee, and
(iii) The new certificate meets each of the requirements of paragraphs (d), (e), (f), and (i) of this section based on the facts as they exist at the time of the transfer as if the mortgage credit certificate were being issued for the first time. For example, the purchase price requirement is to be determined by reference to the average area purchase price at the time of the assumption and not when the mortgage credit certificate was originally issued.
(3) Statement on certificate. The requirements of paragraph (h)(1) will be met if the mortgage credit certificate states that the certificate may not be transferred or states that the certificate may not be transferred unless the issuer issues a new certificate in place of the original certificate.
(i) Prohibited mortgages—(1) In general. A certificate meets the requirements of this paragraph only if it is issued in connection with the acquisition of a residence none of the financing of which is provided from the proceeds of—
(i) A qualified mortgage bond (as defined under section 103A(c)(1) and the regulations thereunder), or
(ii) A qualified veterans’ mortgage bond (as defined under section 103A(c)(3) and the regulations thereunder).
(2) Certification procedure. The requirements of paragraph (i)(1) will be met if the issuer or its agent obtains from the holder of the certificate an affidavit stating that no portion of the financing of the residence in connection with which the certificate is issued is provided from the proceeds of a qualified mortgage bond or a qualified veterans’ mortgage bond.
(j) Particular lenders—(1) In general. Except as otherwise provided in paragraph (j)(2), a certificate meets the requirements of this paragraph only if the certificate is not limited to indebtedness incurred from particular lenders. A certificate is limited to indebtedness from particular lenders if the issuer, directly or indirectly, prohibits the holder of a certificate from obtaining financing from one or more lenders or requires the holder of a certificate to obtain financing from one or more lenders. For purposes of this paragraph, a lender is any person, including an issuer of mortgage credit certificates, that provides financing for the acquisition, qualified rehabilitation, or qualified home improvement of a residence.
(2) Exception. A mortgage credit certificate that is limited to indebtedness incurred from particular lenders will not cease to meet the requirements of this paragraph if the Commissioner approves the basis for such limitation. The Commissioner may approve the basis for such limitation if the issuer establishes to the satisfaction of the Commissioner that it will result in a significant economic benefit to the holders of mortgage credit certificates (e.g., substantially lower financing costs) compared to the result without such limitation.
(3) Taxable bonds. The requirements of this paragraph do not prevent an issuer of mortgage credit certificates from issuing mortgage subsidy bonds (other than obligations described in section 103 (a)) the proceeds of which are to be used to provide mortgages to holders of mortgage credit certificates provided that the holders of such certificates are not required to obtain financing from the proceeds of the bond issue. See § 1.25-4T (h) with respect to permissible fees.
(4) Lists of participating lenders. The requirements of this paragraph do not prohibit an issuer from maintaining a list of lenders that have stated that they will make loans to qualified holders of mortgage credit certificates, provided that (i) the issuer solicits such statements in a public notice similar to the notice described in § 1.25-7T, (ii) lenders are provided a reasonable period of time in which to express their interest in being included in such a list, and (iii) holders of mortgage credit certificates are not required to obtain financing from the lenders on the list. If an issuer maintains such a list, it must update the list at least annually.
(5) Certification procedure. The requirements of this paragraph will be met if (i) the issuer or its agent obtains from the holder of the certificate an affidavit stating that the certificate was not limited to indebtedness incurred from particular lenders or (ii) the issuer obtains a ruling from the Commissioner under paragraph (j)(2).
(6) Examples. The following examples illustrate the application of this paragraph:
(k) Developer certification—(1) In general. A mortgage credit certificate that is allocated by the issuer to any particular development meets the requirements of this paragraph only if the developer provides a certification to the purchaser of the residence and the issuer stating that the purchase price of that residence is not higher than the price would be if the issuer had not allocated mortgage credit certificates to the development. The certification must be made by the developer if a natural person or, if not, by a duly authorized official of the developer.
(2) Certification procedure. The requirements of this paragraph will be met if the issuer or its agent obtains from the holder of the certificate an affidavit stating that he has received from the developer the certification described in this paragraph.
(l) Expiration—(1) In general. A certificate meets the requirements of this paragraph if the certified indebtedness amount is incurred prior to the close of the second calendar year following the calendar year for which the issuer elected not to issue qualified mortgage bonds under § 1.25-4T with respect to that issue of mortgage credit certificates. Thus, for example, if on October 1, 1984, an issuing authority elects under § 1.25-4T not to issue qualified mortgage bonds, a mortgage credit certificate provided under that program does not meet the requirements of this paragraph unless the indebtedness is incurred on or before December 31, 1986.
(2) Issuer-imposed expiration dates. An issuer of mortgage credit certificates may provide that a certificate shall expire if the holder of the certificate does not incure certified indebtedness by a date that is prior to the expiration date provided in paragraph (l)(1). A certificate that expires prior to the date provided in paragraph (l)(1) may be reissued provided that the requirements of this paragraph are met.
(m) Revocation. A certificate meets the requirements of this paragraph only if it has not been revoked. Thus, the credit provided by section 25 and § 1.25-1T does not apply to interest paid or accrued following the revocation of a certificate. A certificate is treated as revoked when the residence to which the certificate relates ceases to be the holder’s principal residence. An issuer may revoke a mortgage credit certificate if the certificate does not meet all the requirements of § 1.25-3T (d), (e), (f), (g), (h), (i), (j), (k), and (n). The certificate is revoked by the issure’s notifying the holder of the certificate and the Internal Revenue Service that the certificate is revoked. The notice to the Internal Revenue Service shall be made as part of the report requred by § 1.25-8T (b)(2).
(n) Interest paid to related person—(1) In general. A certificate does not meet the requirements of this paragraph if interest on the certified indebtedness amount is paid to a person who is a related person to the holder of the certificate.
(2) Certification procedure. The requirements of this paragraph will be met if the issuer or its agent obtains from the holder of the certificate an affidavit stating that a related person does not have, and is not expected to have, an interest as a creditor in the certified indebtedness amount.
(o) Fraud. Notwithstanding any other provision of this section, a mortgage credit certificate does not meet the requirements of this section and, therefore, the certificate is not a qualified mortgage credit certificate for any calendar year, if the holder of the certificate provides a certification or any other information to the lender providing the mortgage or to the issuer of the certificate containing a material misstatement and such misstatement is due to fraud. In determining whether any misstatement is due to fraud, the rules generally applicable to underpayments of tax due to fraud (including rules relating to the statute of limitations) shall apply. See § 1.6709-1T with respect to the penalty for filing negligent or fraudulent statements.
§ 1.25-4T Qualified mortgage credit certificate program (Temporary).
(a) In general—(1) Definition of qualified mortgage credit certificate program. For purposes of §§ 1.25-1T through 1.25-8T, the term “qualified mortgage credit certificate program” means a program to issue qualified mortgage credit certificates which meets all of the requirements of paragraphs (b) through (i) of this section.
(2) Requirements are a minimum. Except as otherwise provided in this section, the requirements of this section are minimum requirements. Issuers may establish more stringent criteria for participation in a qualified mortgage credit certificate program. Thus, for example, an issuer may target 30 percent of the proceeds of an issue of mortgage credit certificates to targeted areas. Further, issuers may establish additional eligibility criteria for participation in a qualified mortgage credit certificate program. Thus, for example, issuers may impose an income limitation designed to ensure that only those individuals who could not otherwise purchase a residence will benefit from the credit.
(3) Except as otherwise provided in this section and § 1.25-3T, issuers may use mortgage credit certificates in connection with other Federal, State, and local programs provided that such use complies with the requirements of § 1.25-3T(j). Thus, for example, a mortgage credit certificate may be issued in connection with the qualified rehabilitation of a residence part of the cost of which will be paid from the proceeds of a State grant.
(b) Establishment of program. A program meets the requirements of this paragraph only if it is established by a State or political subdivision thereof for any calendar year for which it has the authority to issue qualified mortgage bonds.
(c) Election not to issue qualified mortgage bonds—(1) In general. A program meets the requirements of this paragraph only if the issuer elects, in the time and manner specified in this paragraph, not to issue an amount of qualified mortgage bonds that it may otherwise issue during the calendar year under section 103A and the regulations thereunder.
(2) Manner of making election. On or before the earlier of the date of distribution of mortgage credit certificates under a program or December 31, 1987, the issuer must file an election not to issue an amount of qualified mortgage bonds. The election (and the certification (or affidavit) described in paragraph (d)) shall be filed with the Internal Revenue Service Center, Philadelphia, Pennsylvania 19255. The election should be titled “Mortgage Credit Certificate Election” and must include—
(i) The name, address, and TIN of the issuer,
(ii) The issuer’s applicable limit, as defined in section 103A (g) and the regulations thereunder,
(iii) The aggregate amount of qualified mortgage bonds issued by the issuing authority during the calendar year,
(iv) The amount of the issuer’s applicable limit that it has surrendered to other issuers during the calendar year,
(v) The date and amount of any previous elections under this paragraph for the calendar year, and
(vi) The amount of qualfied mortgage bonds that the issuer elects not to issue.
(3) Revocation of election. Any election made under this paragraph may be revoked, in whole or in part, at any time during the calendar year in which the election was made. The revocation, however, may not be made with respect to any part of the nonissued bond amount that has been used to issue mortgage credit certificates pursuant to the election. The revocation shall be filed with the Internal Revenue Service Center, Philadelphia, Pennsylvania 19255. The revocation should be titled “Revocation of Mortgage Credit Certificate Election” and must include—
(i) The name, address, and TIN of the issuer,
(ii) The nonissued bond amount as originally elected, and
(iii) The portion of the nonissued bond amount with respect to which the election is being revoked.
(4) Special rule. If at the time that an issuer makes an election under this paragraph it does not know its applicable limit, the issuer may elect not to use all of its remaining authority to issue qualified mortgage bonds; this form of election will be treated as meeting the requirements of paragraph (c)(2) if, prior to the later of the end of the calendar year and December 31, 1985, the issuer amends its election so as to indicate the exact amount of qualified mortgage bond authority that it elected not to issue.
(5) Limitation on nonissued bond amount. The amount of qualified mortgage bonds which an issuer elects not to issue may not exceed the issuer’s applicable limit (as determined under section 103A (g) and the regulations thereunder). For example, a governmental unit that, pursuant to section 103A (g)(3), may issue $10 million of qualified mortgage bonds that elects to trade in $11 million in qualified mortgage bond authority has not met the requirements of this paragraph, and mortgage credit certificates issued pursuant to such election are not qualified mortgage credit certificates.
(d) State certification requirement—(1) In general. A program meets the requirements of this paragraph only if the State official designated by law (or, where there is no State official, the Governor) certifies, based on facts and circumstances as of the date on which the certification is requested, following a request for such certification, that the issue meets the requirements of section 103A(g) (relating to volume limitation) and the regulations thereunder. A copy of the State certification must be attached to the issuer’s election not to issue qualified mortgage bonds, except that, in the case of elections made during calendar year 1984, the certification may be filed with the Service prior to July 8, 1985 provided that mortgage credit certificates may not be distributed until the certification is filed. In the case of any constitutional home rule city, the certification shall be made by the chief executive officer of the city.
(2) Certification procedure. The official making the certification described in this paragraph (d) need not perform an independent investigation to determine whether the issuer has met the requirements of section 103A(g). In determining the aggregate amount of qualified mortgage bonds previously issued by that issuer during the calendar year the official may rely on copies of prior elections under paragraph (c) of this section made by the issuer for that year, together with an affidavit executed by an official of the issuer who is responsible for issuing bonds stating that the issuer has not, to date, issued any other issues of qualified mortgage bonds during the calendar year and stating the amount, if any, of the issuer’s applicable limit that it has surrendered to other issuers during the calendar year; for any calendar year prior to 1985, the official may rely on an affidavit executed by a duly authorized official of the issuer who states the aggregate amount of qualified mortgage bonds issued by the issuer during the year. In determining the aggregate amount of qualified mortgage bonds that the issuer has previously elected not to issue during that calendar year, the official may rely on copies of any elections not to issue qualified mortgage bonds filed by the issuer for that calendar year, together with an affidavit executed by an official of the issuer responsible for issuing mortgage credit certificates stating that the issuer has not, to date, made any other elections not to issue qualified mortgage bonds. If, based on such information, the certifying official determines that the issuer has not, as of the date on which the certification is provided, exceeded its applicable limit for the year, the official may certify that the issue meets the requirements of section 103A(g). The fact that the certification described in this paragraph (d) is provided does not ensure that the issuer has met the requirements of section 103A(g) and the regulations thereunder, nor does it preclude the application of the penalty for over-issuance of mortgage credit certificates if such over-issuance actually occurs. See § 1.25-5T.
(3) Special rule. If within 30 days after the issuer files a proper request for the certification described in this paragraph (d) the issuer has not received from the State official designated by law (or, if there is no State official, the Governor) certification that the issue meets the requirements of section 103A(g) or, in the alternative, a statement that the issue does not meet such requirements, the issuer may submit, in lieu of the certification required by this paragraph (d), an affidavit executed by an officer of the issuer responsible for issuing mortgage credit certificates stating that—
(i) The issue meets the requirements of section 103A(g) and the regulations thereunder,
(ii) At least 30 days before the execution of the affidavit the issuer filed a proper request for the certification described in this paragraph (d), and
(iii) The State official designated by law (or, if there is no State official, the Governor) has not provided the certification described in this paragraph (d) or a statement that the issue does not meet such requirements.
(e) Information reporting requirement—(1) Reports. With respect to mortgage credit certificates issued after September 30, 1985, a program meets the requirements of this paragraph only if the issuer submits a report containing the information concerning the holders of certificates issued during the preceding reporting period required by this paragraph. The report must be filed for each reporting period in which certificates (other than transferred certificates) are issued under the program. The issuer is not responsible for false information provided by a holder if the issuer did not know or have reason to know that the information was false. The report must be filed on the form prescribed by the Internal Revenue Service. If no form is prescribed, or if the form prescribed is not readily available, the issuer may use its own form provided that such form is in the format set forth in this paragraph and contains the information required by this paragraph. The report must be titled “Mortgage Credit Certificate Information Report” and must include the name, address, and TIN of the issuer, the reporting period for which the information is provided, and the following tables containing information concerning the holders of certificates issued during the reporting period for which the report is filed:
(i) A table titled “Number of Mortgage Credit Certificates by Income and Acquisition Cost” showing the number of mortgage credit certificates issued (other than those issued in connection with qualified home improvement and rehabilitation loans) according to the annualized gross income of the holders (categorized in the following intervals of income:
(A) The aggregate amount of fees charged to holders to cover any administrative costs incurred by the issuer in issuing mortgage credit certificates, and
(B) The number of holders that—
(1) Did not have a present ownership interest in a principal residence at any time during the 3-year period ending on the date the mortgage credit certificate is executed (i.e., satisfied the 3-year requirement) and purchased residences in targeted areas,
(2) Satisfied the 3-year requirement and purchased residences not located in targeted areas,
(3) Did have a present ownership interest in a principal residence at any time during the 3-year period ending on the date the mortgage credit certificate is executed (i.e., did not satisfy the 3-year requirement) and purchased residences in targeted areas, and
(4) Did not satisfy the 3-year requirement and purchased residences not located in targeted areas.
(ii) A table titled “Volume of Mortgage Credit Certificates by Income and Acquisition Cost” containing data on—
(A) The total of the certified indebtedness amounts of the certificates issued (other than those issued in connection with qualified home improvement and rehabilitation loans);
(B) The sum of the products of the certified indebtedness amount and the certificate credit rate for each certificate (other than those issued in connection with qualified home improvement and rehabilitation loans) according to annualized gross income (categorized in the same intervals of income as the preceding table) and according to the acquisition cost of the residences acquired in connection with mortgage credit certificates (categorized in the same intervals of acquisition cost as the preceding table); and
(C) For each interval of income and acquisition cost, the information described in paragraph (e)(1)(ii) (A) and (B) categorized according to the holders that—
(1) Satisfied the 3-year requirement and purchased residences in targeted areas,
(2) Satisfied the 3-year requirement and purchased residences not located in targeted areas,
(3) Did not satisfy the 3-year requirement and purchased residences in targeted areas, and
(4) Did not satisfy the 3-year requirement and purchased residences not located in targeted areas.
(iii) A table titled “Mortgage Credit Certificates for Qualified Home Improvement and Rehabilitation Loans” showing the number of mortgage credit certificates issued in connection with qualified home improvement loans and qualified rehabilitation loans, the total of the certified indebtedness amount with respect to such certificates, and the sum of the products of the certified indebtedness amount and the certificate credit rate for each certificate; the information contained in the table must also be categorized according to whether the residences with respect to which the certificates were provided are located in targeted areas.
(2) Format. If no form is prescribed by the Internal Revenue Service, or if the prescribed form is not readily available, the issuer must submit the report in the format specified in this paragraph (e)(2). The specified format of the report is the following:
Number of Mortgage Credit Certificates by Income and Acquisition Cost
3-year requirement: Annualized gross monthly income of borrowers | Satisfied | Not satisfied | Totals fees | ||
---|---|---|---|---|---|
Nontargeted area | Targeted area | Nontargeted area | Targeted area | ||
$0 to $9,999 | |||||
$10,000 to $19,999 | |||||
$20,000 to $29,999 | |||||
$30,000 to $39,999 | |||||
$40,000 to $49,999 | |||||
$50,000 to $74,999 | |||||
$75,000 or more | |||||
Total | |||||
Acquisition Cost | |||||
0 to $19,999 | |||||
$20,000 to $39,999 | |||||
$40,000 to $59,999 | |||||
$60,000 to $79,999 | |||||
$80,000 to $99,999 | |||||
$100,000 to $119,999 | |||||
$120,000 to $149,999 | |||||
$150,000 to $199,999 | |||||
$200,000 or more | |||||
Total |
Volume of Mortgage Credit Certificates by Income and Acouisition Cost
Annualized gross monthly income of holders | Holders satisfying the 3-year requirement | 3-year requirement not satisfied | Totals | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Nontargeted area | Targeted area | Nontargeted area | Targeted area | Total of the certified indebtedness amounts | Total sum of products of certified indebtedness amounts and credit rates | |||||
Total of the certified indebtedness amounts | Sum of products of certified indebtedness amounts and credit rates | Total of the certified indebtedness amounts | Sum of products of certified indebtedness amounts and credit rates | Total of the certified indebtedness amounts | Sum of products of certified indebtedness amounts and credit rates | Total of the certified indebtedness amounts | Sum of products of certified indebtedness amounts and credit rates | |||
$0 to $9,999 | ||||||||||
$10,000 to $19,999 | ||||||||||
$20,000 to $29,999 | ||||||||||
$30,000 to $39,999 | ||||||||||
$40,000 to $49,999 | ||||||||||
$50,000 to $74,999 | ||||||||||
$75,000 to more | ||||||||||
Total | ||||||||||
Acquisition Cost | ||||||||||
$0 to $19,999 | ||||||||||
$20,000 to $39,999 | ||||||||||
$40,000 to $59,999 | ||||||||||
$60,000 to $79,999 | ||||||||||
$80,000 to $99,999 | ||||||||||
$100,000 to $119,999 | ||||||||||
$120,000 to $149,999 | ||||||||||
$150,000 to $199,999 | ||||||||||
$200,000 or more | ||||||||||
Total |
Mortgage Credit Certificates for Qualified Home Improvement and Rehabilitation Loans
Nontargeted area | Targeted area | Totals | |
---|---|---|---|
Home Improvement Loans | |||
Number of mortgage credit certificates | |||
Total of the certified indebtedness amounts | |||
Product of certified indebtedness amounts and credit rates | |||
Rehabilitation Loans | |||
Number of mortgage credit certificates | |||
Total of the certified indebtedness amounts | |||
Product of certified indebtedness amounts and credit rates |
(3) Definitions and special rules. (i) For purposes of this paragraph the term “annualized gross income” means the borrower’s gross monthly income multiplied by 12. Gross monthly income is the sum of monthly gross pay, any additional income from investments, pensions, Veterans Administration (VA) compensation, part-time employment, bonuses, dividends, interest, current overtime pay, net rental income, etc., and other income (such as alimony and child support, if the borrower chooses to disclose such income). Information with respect to gross monthly income may be obtained from available loan documents, e.g., the sum of lines 23D and 23E on the Application for VA or FmHA Home Loan Guaranty or for HUD/FHA Insured Mortgage (VA Form 26-1802a, HUD 92900, Jan. 1982), or the total line from the Gross Monthly Income section of FHLMC Residential Loan Application form (FHLMC 65 Rev. 8/78).
(ii) For purposes of this paragraph, the term “reporting period” means each one year period beginning July 1 and ending June 30, except that issuers need not provide data with respect to the period prior to October 1, 1985.
(iii) For purposes of this paragraph, verification of information concerning a holder’s gross monthly income by utilizing other available information concerning the holder’s income (e.g., Federal income tax returns) is not required. In determining whether the holder of a mortgage credit certificate acquiring a residence in a targeted area satisfies the 3-year requirement, the issuer may rely on a statement signed by the holder.
(4) Time for filing. The report required by this paragraph shall be filed not later than the 15th day of the second calendar month after the close of the reporting period. The Commissioner may grant an extension of time for the filing of a report required by this paragraph if there is reasonable cause for the failure to file such report in a timely fashion. The report may be filed at any time before such date but must be complete based on facts and reasonable expectations as of the date the report is filed. The report need not be amended to reflect information learned subsequent to the date of filing, or to reflect changed circumstances with respect to any holder.
(5) Place for filing. The report required by this paragraph is to be filed at the Internal Revenue Service Center, Philadelphia, Pennsylvania 19255.
(f) Policy statement. A program established pursuant to an election under paragraph (c) made after 1984 meets the requirements of this paragraph only if the applicable elected representative of the governmental unit—
(1) Which is the issuer, or
(2) On whose behalf the certificates were issued,
(g) Targeted areas requirement—(1) In general. A program meets the requirements of this paragraph only if—
(i) The portion of the total proceeds of the issue specified in paragraph (g)(2) is made available to provide mortgage credit certificates in connection with owner financing of targeted area residents for at least 1 year after the date on which mortgage credit certificates are first made available with respect to targeted area residences, and
(ii) The issuer attempts with reasonable diligence to place such proceeds with qualified persons.
(2) Specified portion. (i) The specified portion of the total proceeds of an issue is the lesser of—
(A) 20 percent of the total proceeds, or
(B) 8 percent of the average annual aggregate principal amount of mortgages executed during the immediately preceding 3 calendar years for single-family, owner-occupied residences in targeted areas within the jurisdiction of the issuing authority.
(ii) See § 1.25-1T(b)(10)(ii) for the definition of “total proceeds”.
(h) Fees—(1) In general. A program meets the requirements of this paragraph only if each applicant is required to pay, directly or indirectly, no fee other than those fees permitted under this paragraph.
(2) Permissible fees. Applicants may be required to pay the following fees provided that they are reasonable:
(i) Points, origination fees, servicing fees, and other fees in amounts that are customarily charged with respect to mortgages not provided in connection with mortgage credit certificates,
(ii) Application fees, survey fees, credit report fees, insurance fees, or similar settlement or financing costs to the extent such amounts do not exceed the amounts charged in the area in cases where mortgages are not provided in connection with mortgage credit certificates. For example, amounts charged for FHA, VA, or similar private mortgage insurance on an individual’s mortgage are permissible so long as such amounts do not exceed the amounts charged in the area with respect to a similar mortgage that is not provided in connection with a mortgage credit certificate, and
(iii) Other fees that, taking into account all the facts and circumstances, are reasonably necessary to cover any administrative costs incurred by the issuer or its agent in issuing mortgage credit certificates.
(i) Qualified mortgage credit certificate. A program meets the requirements of this paragraph only if each mortgage credit certificate issued under the program meets each of the requirements of paragraphs (c) through (o) of § 1.25-3T.
(j) Good faith compliance efforts—(1) Eligibility requirements. (i) A program under which each of the mortgage credit certificates issued does not meet each of the requirements of paragraphs (c) through (o) of § 1.25-3T shall be treated as meeting the requirements of paragraph (i) of this section if each of the requirements of this paragraph (j)(1) is satisfied. A mortgage credit certificate program meets the requirements of this paragraph (j)(1) only if each of the following provisions is met:
(A) The issuer in good faith attempted to issue mortgage credit certificates only to individuals meeting each of the requirements of paragraphs (c) through (o) of § 1.25-3T. Good faith requires that agreements with lenders and agents and other relevant instruments contain restrictions that permit the approval of mortgage credit certificates only in accordance with the requirements of paragraphs (c) through (o) of § 1.25-3T. In addition, the issuer must establish reasonable procedures to ensure compliance with those requirements. Reasonable procedures include reasonable investigations by the issuer to determine whether individuals satisfy the requirements of paragraphs (c) through (o) of § 1.25-3T.
(B) 95 percent or more of the total proceeds of the issue were devoted to individuals with respect to whom, at the time that the certificate was issued, all the requirements of paragraphs (c) through (o) of § 1.25-3T were met. If a holder of a mortgage credit certificate fails to meet more than one of these requirements, the amount of the certificate (i.e., the certificate credit rate multiplied by the certified indebtedness amount) issued to that individual will be taken into account only once in determining whether the 95-percent requirement is met. However, all of the defects in that individual’s certificate must be corrected pursuant to paragraph (j)(1)(i)(C).
(C) Any failure to meet the requirements of paragraphs (c) through (o) of § 1.25-3T is corrected within a reasonable period after that failure is discovered. For example, if an individual fails to meet one or more of such requirements those failures can be corrected by revoking that individual’s certificate.
(ii) Examples. The following examples illustrate the application of this paragraph (j)(1):
(i) An affidavit stating that the applicant intends to use the residence in connection with which the mortgage credit certificate is issued as his principal residence within a reasonable time after the certificate is issued by County X, that the applicant will notify the County if the residence ceases to be his principal residence, and facts that are sufficient for County X to determine whether the residence is located within the jurisdiction of County X,
(ii) An affidavit stating that the applicant had no present ownership interest in a principal residence at any time during the 3-year period prior to the date on which the certificate is issued,
(iii) Copies of the applicant’s Federal tax returns for the preceding 3 years,
(iv) Affidavits from the seller of the residence with respect to which the certificate is issued and the applicant stating the purchase price of the residence, including an itemized list of (A) payments made by or for the benefit of the applicant, (B) if the residence is incomplete, an estimate of the reasonable cost of completing the residence, and (C) if the residence is subject to a ground rent, the capitalized value of the ground rent,
(v) An affidavit executed by the applicant stating that the mortgage being acquired in connection with the certificate will not be used to acquire or replace an existing mortgage,
(vi) An affidavit executed by the applicant stating that no portion of the financing for the residence in connection with which the certificate is issued is provided from the proceeds of a qualified mortgage bond or qualified veterans’ mortgage bond and that no portion of the mortgage for the residence is provided by a person related to the applicant (as defined in § 1.25-3T(n)),
(vii) An affidavit executed by the applicant stating that the certificate was not limited to indebtedness incurred from particular lenders, and
(viii) In the case of a mortgate credit certificate allocated for use in connection with a particular development, and affidavit executed by the applicant stating that the applicant received from the developer a certification stating that the price of the residence with respect to which the certificate was issued is no higher than it would be without the use of a mortgage credit certificate.
(i) An affidavit stating that the applicant intends to use the residence in connection with which the mortgage credit certificate is issued as his principal residence within a reasonable time after the certificate is issued by County W, that the applicant will notify the County if the residence ceases to be his principal residence, and facts that are sufficient for County W to determine whether the residence is located within the jurisdication of County W,
(ii) An affidavit stating that the applicant had no present ownership interest in a principal residence at any time during the 3-year period prior to the date on which the certificate is issued,
(iii) Copies of the applicant’s Federal tax returns for the preceding 3 years,
(iv) Affidavits from the seller of the residence with respect to which the certificate is issued and the applicant stating the purchase price of the residence, including an itemized list of (A) payments made by or for the benefit of the applicant, (B) if the residence is incomplete, an estimate of the reasonable cost of completing the residence, and (C) if the residence is subject to a ground rent, the capitalized value of the ground rent,
(v) An affidavit executed by the applicant stating that the mortgage being acquired in connection with the certificate will not be used to acquire or replace an existing mortgage,
(vi) An affidavit executed by the applicant stating that no portion of the financing for the residence in connection with which the certificate is issued in provided from the proceeds of a qualified mortgage bond or qualified veterans’ mortgage bond and that no portion of the mortgage for the residence is provided by a person related to the applicant (as defined in § 1.25-3T(n)),
(vii) An affidavit executed by the applicant stating that the certificate was not limited to indebtedness incurred from particular lenders, and
(viii) In the case of a mortgage credit certificate allocated for use in connection with a particular development, an affidavit executed by the applicant stating that the applicant received from the developer a certification stating that the price of the residence with respect to which the certificate was issued is no higher than it would be without the use of a mortgage credit certificate.
(2) Program requirements. (i) A mortgage credit certificate program which fails to meet one or more of the requirements of paragraphs (b) through (h) of this section shall be treated as meeting such requirements if the requirements of this paragraph (j)(2) are satisfied. A mortgage credit certificate program meets the requirements of this paragraph (j)(2) only if each of the following provisions is met:
(A) The issuer in good faith attempted to meet all of the requirements of paragraphs (b) through (h) of this section. This good faith requirement will be met if all reasonable steps are taken by the issuer to ensure that the program complies with these requirements.
(B) Any failure to meet such requirements is due to inadvertent error, e.g., mathematical error, after taking reasonable steps to comply with such requirements.
(ii) The following example illustrate the application of this paragraph (j)(2):
§ 1.25-5T Limitation on aggregate amount of mortgage credit certificates (Temporary).
(a) In general. If the aggregate amount of qualified mortgage credit certificates (as defined in paragraph (b)) issued by an issuer under a qualified mortgage credit certificate program exceeds 20 percent of the nonissued bond amount (as defined in paragraph (c)), the provisions of paragraph (d) shall apply.
(b) Aggregate amount of mortgage credit certificates—(1) In general. The aggregate amount of qualified mortgage credit certificates issued under a qualified mortgage credit certificate program is the sum of the products determined by multiplying—
(i) The certified indebtedness amount of each qualified mortgage credit certificate issued under that program, by
(ii) The certificate credit rate with respect to such certificate.
(2) Examples. The following examples illustrate the application of this paragraph (b):
(c) Nonissued bond amount. The term “nonissued bond amount” means, with respect to any qualified mortgage credit certificate program, the amount of qualified mortgage bonds (as defined in section 103A(c)(1) and the regulations thereunder) which the issuer is otherwise authorized to issue and elects not to issue under section 25(c)(2) and § 1.25-4T(b). The amount of qualified mortgage bonds which an issuing authority is authorized to issue is determined under section 103A(g) and the regulations thereunder; such determination shall take into account any prior elections by the issuer not to issue qualified mortgage bonds, the amount of any reduction in the State ceiling under paragraph (d) of this section, and the aggregate amount of qualified mortgage bonds issued by the issuer prior to its election not to issue qualified mortgage bonds.
(d) Noncompliance with limitation on aggregate amount of mortgage credit certificates—(1) In general. If the provisions of this paragraph apply, the State ceiling under section 103A(g)(4) and the regulations thereunder for the calendar year following the calendar year in which the Commissioner determines the correction amount for the State in which the issuer which exceeded the limitation on the aggregate amount of mortgage credit certificates is located shall be reduced by 1.25 times the correction amount with respect to such failure.
(2) Correction amount. (i) The term “correction amount” means an amount equal to the excess credit amount divided by .20.
(ii) The term “excess credit amount” means the excess of—
(A) The credit amount for any mortgage credit certificate program, over
(B) The amount which would have been the credit amount for such program had such program met the requirements of section 25(d)(2) and paragraph (a) of this section.
(iii) The term “credit amount” means the sum of the products determined by multiplying—
(A) The certified indebtedness amount of each qualified mortgage credit certificate issued under the program, by
(B) The certificate credit rate with respect to such certificate.
(3) Example. The following example illustrates the application of this paragraph:
(4) Cross-references. See section 103A(g)(4) and the regulations thereunder with respect to the reduction of the applicable State ceiling.
§ 1.25-6T Form of qualified mortgage credit certificate (Temporary).
(a) In general. Qualified mortgage credit certificates are to be issued on the form prescribed by the Internal Revenue Service. If no form is prescribed by the Internal Revenue Service, or if the form prescribed by the Internal Revenue Service is not readily available, the issuer may use its own form provided that such form contains the information required by this section. Each mortgage credit certificate must be issued in a form such that there are at least three copies of the form. One copy of the certificate shall be retained by the issuer; one copy shall be retained by the lender; and one copy shall be forwarded to the State official who issued the certification required by § 1.25-4T(d), unless that State official has stated in writing that he does not want to receive such copies.
(b) Required information. Each qualified mortgage credit certificate must include the following information:
(1) The name, address, and TIN of the issuer,
(2) The date of the issuer’s election not to issue qualified mortgage bonds pursuant to which the certificate is being issued,
(3) The number assigned to the certificate,
(4) The name, address, and TIN of the holder of the certificate,
(5) The certificate credit rate,
(6) The certified indebtness amount,
(7) The acquisition cost of the residence being acquired in connection with the certificate,
(8) The average area purchase price applicable to the residence,
(9) Whether the certificate meets the requirements of § 1.25-3T(d), relating to residence requirement,
(10) Whether the certificate meets the requirements of § 1.25-3T(e), relating to 3-year requirement,
(11) Whether the certificate meets the requirements of § 1.25-3T(g), relating to new mortgage requirement,
(12) Whether the certificate meets the requirements of § 1.25-3T(i), relating to prohibited mortgages,
(13) Whether the certificate meets the requirements of § 1.25-3T(j), relating to particular lenders,
(14) Whether the certificate meets the requirements of § 1.25-3T(k), relating to allocations to particular developments,
(15) Whether the certificate meets the requirements of § 1.25-3T(n), relating to interest paid to related persons,
(16) Whether the residence in connection with which the certificate is issued is a targeted area residence,
(17) The date on which a closing agreement is signed with respect to the certified indebtness amount,
(18) The expiration date of the certificate,
(19) A statement that the certificate is not transferable or a statement that the certificate may be transferred only if the issuer issues a new certificate, and
(20) A statement, signed under penalties of perjury by an authorized official of the issuer or its agent, that such person has made the determinations specified in paragraph (b) (9) through (16).
§ 1.25-7T Public notice (Temporary).
(a) In general. At least 90 days prior to the issuance of any mortgage credit certificate under a qualified mortgage credit certificate program, the issuer shall provide reasonable public notice of—
(1) The eligibility requirements for such certificate,
(2) The methods by which such certificates are to be issued, and
(3) The other information required by this section.
(b) Reasonable public notice—(1) In general. Reasonable public notice means published notice which is reasonably designed to inform individuals who would be eligible to receive mortgage credit certificates of the proposed issuance. Reasonable public notice may be provided through newspapers of general circulation.
(2) Contents of notice. The public notice required by paragraph (a) must include a brief description of the principal residence requirement, 3-year requirement, purchase price requirement, and new mortgage requirement. The notice must also provide a brief description of the methods by which the certificates are to be issued and the address and telephone number for obtaining further information.
§ 1.25-8T Reporting requirements (Temporary).
(a) Lender—(1) In general. Each person who makes a loan that is a certified indebtedness amount with respect to any mortgage credit certificate must file the report described in paragraph (a)(2) and must retain on its books and records the information described in paragraph (a)(3). The report described in paragraph (a)(2) is an annual report and must be filed on or before January 31 of the year following the calendar year to which the report relates. See section 6709(c) and the regulations thereunder for the applicable penalties with respect to failure to file reports.
(2) Information required. The report shall be submitted on Form 8329 and shall contain the information required therein. A separate Form 8329 shall be filed for each issue of mortgage credit certificates with respect to which the lender made mortgage loans during the preceding calendar year. Thus, for example, if during 1986 Bank M makes three mortgage loans which are certified indebtedness amounts with respect to State Z’s January 15, 1986, issue of mortgage credit certificates, and two mortgage loans which are certified indebtedness amounts with respect to State Z’s April 15, 1986, issue of mortgage credit certificates, and fifty mortgage loans which are certified indebtedness amounts with respect to County X’s December 31, 1985, issue of mortgage credit certificates, Bank M must file three separate reports for calendar year 1986. The lender must submit the Form 8329 with the information required therein, including—
(i) The name, address, and TIN of the issuer of the mortgage credit certificates,
(ii) The date on which the election not to issue qualified mortgage bonds with respect to that mortgage credit certificate was made,
(iii) The name, address, and TIN of the lender, and
(iv) The sum of the products determined by multiplying—
(A) The certified indebtedness amount of each mortgage credit certificate issued under such program, by
(B) The certificate credit rate with respect to such certificate.
(3) Recordkeeping requirements. Each person who makes a loan that is a certified indebtedness amount with respect to any mortgage credit certificate must retain the information specified in this paragraph (a)(3) on its books and records for 6 years following the year in which the loan was made. With respect to each loan the lender must retain the following information:
(i) The name, address, and TIN of each holder of a qualified mortgage credit certificate with respect to which a loan is made,
(ii) The name, address, and TIN of the issuer of such certificate, and
(iii) The date the loan for the certified indebtedness amount is closed, the certified indebtedness amount, and the certificate credit rate of such certificate.
(b) Issuers—(1) In general. Each issuer of mortgage credit certificates shall file the report described in paragraph (b)(2) of this section.
(2) Quarterly reports. (i) Each issuer which elects to issue mortgage credit certificates shall file reports on Form 8330. These reports shall be filed on a quarterly basis, beginning with the quarter in which the election is made, and are due on the following dates: April 30 (for the quarter ending March 31), July 31 (for the quarter ending June 30), October 31 (for the quarter ending September 30), and January 31 (for the quarter ending December 31). For elections made prior to May 8, 1985, the first report need not be filed until July 31, 1985. An issuer shall file a separate report for each issue of mortgage credit certificates. In the quarter in which the last qualified mortgage credit certificate that may be issued under a program is issued, the issuer must state that fact on the report to be filed for that quarter; the issuer is not required to file any subsequent reports with respect to that program. See section 6709(c) for the penalties with respect to failure to file a report.
(ii) The report shall be submitted on Form 8330 and shall contain the information required therein, including—
(A) The name, address, and TIN of the issuer of the mortgage credit certificates,
(B) The date of the issuer’s election not to issue qualified mortgage bonds with respect to the mortgage credit certificate program and the nonissued bond amount of the program,
(C) The sum of the products determined by multiplying—
(1) The certified indebtedness amount of each qualified mortgage credit certificate issued under that program during the calendar quarter, by
(2) The certificate credit rate with respect to such certificate, and
(D) A listing of the name, address, and TIN of each holder of a qualified mortgage credit certificate which has been revoked during the calendar quarter.
(c) Extensions of time for filing reports. The Commissioner may grant an extension of time for the filing of a report required by this section if there is reasonable cause for the failure to file such report in a timely fashion.
(d) Place for filing. The reports required by this section are to be filed at the Internal Revenue Service Center, Philadelphia, Pennsylvania 19225.
(e) Cross reference. See section 6709 and the regulations thereunder with respect to the penalty for failure to file a report required by this section.
§ 1.25A-0 Table of contents.
This section lists captions contained in §§ 1.25A-1, 1.25A-2, 1.25A-3, 1.25A-4, and 1.25A-5.
(a) Amount of education tax credit.
(b) Coordination of Hope Scholarship Credit and Lifetime Learning Credit.
(1) In general.
(2) Hope Scholarship Credit.
(3) Lifetime Learning Credit.
(4) Examples.
(c) Limitation based on modified adjusted gross income.
(1) In general.
(2) Modified adjusted gross income defined.
(3) Inflation adjustment.
(d) Election.
(e) Identification requirement.
(f) Claiming the credit in the case of a dependent.
(1) In general.
(2) Examples.
(g) Married taxpayers.
(h) Nonresident alien taxpayers and dependents.
(a) Claimed dependent.
(b) Eligible educational institution.
(1) In general.
(2) Rules on Federal financial aid programs.
(c) Academic period.
(d) Qualified tuition and related expenses.
(1) In general.
(2) Required fees.
(i) In general.
(ii) Books, supplies, and equipment.
(iii) Nonacademic fees.
(3) Personal expenses.
(4) Treatment of a comprehensive or bundled fee.
(5) Hobby courses.
(6) Examples.
(a) Amount of the credit.
(1) In general.
(2) Maximum credit.
(b) Per student credit.
(1) In general.
(2) Example.
(c) Credit allowed for only two taxable years.
(d) Eligible student.
(1) Eligible student defined.
(i) Degree requirement.
(ii) Work load requirement.
(iii) Year of study requirement.
(iv) No felony drug conviction.
(2) Examples.
(e) Academic period for prepayments.
(1) In general.
(2) Example.
(f) Effective date.
(a) Amount of the credit.
(1) Taxable years beginning before January 1, 2003.
(2) Taxable years beginning after December 31, 2002.
(3) Coordination with the Hope Scholarship Credit.
(4) Examples.
(b) Credit allowed for unlimited number of taxable years.
(c) Both degree and nondegree courses are eligible for the credit.
(1) In general.
(2) Examples.
(d) Effective date.
(a) Educational expenses paid by claimed dependent.
(b) Educational expenses paid by a third party.
(1) In general.
(2) Special rule for tuition reduction included in gross income of employee.
(3) Examples.
(c) Adjustment to qualified tuition and related expenses for certain excludable educational assistance.
(1) In general.
(2) No adjustment for excludable educational assistance attributable to expenses paid in a prior year.
(3) Scholarships and fellowship grants.
(4) Examples.
(d) No double benefit.
(e) Timing rules.
(1) In general.
(2) Prepayment rule.
(i) In general.
(ii) Example.
(3) Expenses paid with loan proceeds.
(4) Expenses paid through third party installment payment plans.
(i) In general.
(ii) Example.
(f) Refund of qualified tuition and related expenses.
(1) Payment and refund of qualified tuition and related expenses in the same taxable year.
(2) Payment of qualified tuition and related expenses in one taxable year and refund in subsequent taxable year before return filed for prior taxable year.
(3) Payment of qualified tuition and related expenses in one taxable year and refund in subsequent taxable year.
(i) In general.
(ii) Recapture amount.
(4) Refund of loan proceeds treated as refund of qualified tuition and related expenses.
(5) Excludable educational assistance received in a subsequent taxable year treated as a refund.
(6) Examples.
§ 1.25A-1 Calculation of education tax credit and general eligibility requirements.
(a) Amount of education tax credit. An individual taxpayer is allowed a nonrefundable education tax credit against income tax imposed by chapter 1 of the Internal Revenue Code for the taxable year. The amount of the education tax credit is the total of the Hope Scholarship Credit (as described in § 1.25A-3) plus the Lifetime Learning Credit (as described in § 1.25A-4). For limitations on the credits allowed by subpart A of part IV of subchapter A of chapter 1 of the Internal Revenue Code, see section 26.
(b) Coordination of Hope Scholarship Credit and Lifetime Learning Credit—(1) In general. In the same taxable year, a taxpayer may claim a Hope Scholarship Credit for each eligible student’s qualified tuition and related expenses (as defined in § 1.25A-2(d)) and a Lifetime Learning Credit for one or more other students’ qualified tuition and related expenses. However, a taxpayer may not claim both a Hope Scholarship Credit and a Lifetime Learning Credit with respect to the same student in the same taxable year.
(2) Hope Scholarship Credit. Subject to certain limitations, a Hope Scholarship Credit may be claimed for the qualified tuition and related expenses paid during a taxable year with respect to each eligible student (as defined in § 1.25A-3(d)). Qualified tuition and related expenses paid during a taxable year with respect to one student may not be taken into account in computing the amount of the Hope Scholarship Credit with respect to any other student. In addition, qualified tuition and related expenses paid during a taxable year with respect to any student for whom a Hope Scholarship Credit is claimed may not be taken into account in computing the amount of the Lifetime Learning Credit.
(3) Lifetime Learning Credit. Subject to certain limitations, a Lifetime Learning Credit may be claimed for the aggregate amount of qualified tuition and related expenses paid during a taxable year with respect to students for whom no Hope Scholarship Credit is claimed.
(4) Examples. The following examples illustrate the rules of this paragraph (b):
(c) Limitation based on modified adjusted gross income—(1) In general. The education tax credit that a taxpayer may otherwise claim is phased out ratably for taxpayers with modified adjusted gross income between $40,000 and $50,000 ($80,000 and $100,000 for married individuals who file a joint return). Thus, taxpayers with modified adjusted gross income above $50,000 (or $100,000 for joint filers) may not claim an education tax credit.
(2) Modified adjusted gross income defined. The term modified adjusted gross income means the adjusted gross income (as defined in section 62) of the taxpayer for the taxable year increased by any amount excluded from gross income under section 911, 931, or 933 (relating to income earned abroad or from certain U.S. possessions or Puerto Rico).
(3) Inflation adjustment. For taxable years beginning after 2001, the amounts in paragraph (c)(1) of this section will be increased for inflation occurring after 2000 in accordance with section 1(f)(3). If any amount adjusted under this paragraph (c)(3) is not a multiple of $1,000, the amount will be rounded to the next lowest multiple of $1,000.
(d) Election. No education tax credit is allowed unless a taxpayer elects to claim the credit on the taxpayer’s federal income tax return for the taxable year in which the credit is claimed. The election is made by attaching Form 8863, “Education Credits (Hope and Lifetime Learning Credits),” to the federal income tax return.
(e) Identification requirement. No education tax credit is allowed unless a taxpayer includes on the federal income tax return claiming the credit the name and the taxpayer identification number of the student for whom the credit is claimed. For rules relating to assessment for an omission of a correct taxpayer identification number, see section 6213(b) and (g)(2)(J).
(f) Claiming the credit in the case of a dependent—(1) In general. If a student is a claimed dependent of another taxpayer, only that taxpayer may claim the education tax credit for the student’s qualified tuition and related expenses. However, if another taxpayer is eligible to, but does not, claim the student as a dependent, only the student may claim the education tax credit for the student’s qualified tuition and related expenses.
(2) Examples. The following examples illustrate the rules of this paragraph (f):
(g) Married taxpayers. If a taxpayer is married (within the meaning of section 7703), no education tax credit is allowed to the taxpayer unless the taxpayer and the taxpayer’s spouse file a joint Federal income tax return for the taxable year.
(h) Nonresident alien taxpayers and dependents. If a taxpayer or the taxpayer’s spouse is a nonresident alien for any portion of the taxable year, no education tax credit is allowed unless the nonresident alien is treated as a resident alien by reason of an election under section 6013(g) or (h). In addition, if a student is a nonresident alien, a taxpayer may not claim an education tax credit with respect to the qualified tuition and related expenses of the student unless the student is a claimed dependent (as defined in § 1.25A-2(a)).
§ 1.25A-2 Definitions.
(a) Claimed dependent. A claimed dependent means a dependent (as defined in section 152) for whom a deduction under section 151 is allowed on a taxpayer’s federal income tax return for the taxable year. Among other requirements under section 152, a nonresident alien student must be a resident of a country contiguous to the United States in order to be treated as a dependent.
(b) Eligible educational institution—(1) In general. In general, an eligible educational institution means a college, university, vocational school, or other postsecondary educational institution that is—
(i) Described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088) as in effect on August 5, 1997, (generally all accredited public, nonprofit, and proprietary postsecondary institutions); and
(ii) Participating in a Federal financial aid program under title IV of the Higher Education Act of 1965 or is certified by the Department of Education as eligible to participate in such a program but chooses not to participate.
(2) Rules on Federal financial aid programs. For rules governing an educational institution’s eligibility to participate in Federal financial aid programs, see 20 U.S.C. 1070; 20 U.S.C. 1094; and 34 CFR 600 and 668.
(c) Academic period. Academic period means a quarter, semester, trimester, or other period of study as reasonably determined by an eligible educational institution. In the case of an eligible educational institution that uses credit hours or clock hours, and does not have academic terms, each payment period (as defined in 34 CFR 668.4, revised as of July 1, 2002) may be treated as an academic period.
(d) Qualified tuition and related expenses—(1) In general. Qualified tuition and related expenses means tuition and fees required for the enrollment or attendance of a student for courses of instruction at an eligible educational institution.
(2) Required fees—(i) In general. Except as provided in paragraph (d)(3) of this section, the test for determining whether any fee is a qualified tuition and related expense is whether the fee is required to be paid to the eligible educational institution as a condition of the student’s enrollment or attendance at the institution.
(ii) Books, supplies, and equipment. Qualified tuition and related expenses include fees for books, supplies, and equipment used in a course of study only if the fees must be paid to the eligible educational institution for the enrollment or attendance of the student at the institution.
(iii) Nonacademic fees. Except as provided in paragraph (d)(3) of this section, qualified tuition and related expenses include fees charged by an eligible educational institution that are not used directly for, or allocated to, an academic course of instruction only if the fee must be paid to the eligible educational institution for the enrollment or attendance of the student at the institution.
(3) Personal expenses. Qualified tuition and related expenses do not include the costs of room and board, insurance, medical expenses (including student health fees), transportation, and similar personal, living, or family expenses, regardless of whether the fee must be paid to the eligible educational institution for the enrollment or attendance of the student at the institution.
(4) Treatment of a comprehensive or bundled fee. If a student is required to pay a fee (such as a comprehensive fee or a bundled fee) to an eligible educational institution that combines charges for qualified tuition and related expenses with charges for personal expenses described in paragraph (d)(3) of this section, the portion of the fee that is allocable to personal expenses is not included in qualified tuition and related expenses. The determination of what portion of the fee relates to qualified tuition and related expenses and what portion relates to personal expenses must be made by the institution using a reasonable method of allocation.
(5) Hobby courses. Qualified tuition and related expenses do not include expenses that relate to any course of instruction or other education that involves sports, games, or hobbies, or any noncredit course, unless the course or other education is part of the student’s degree program, or in the case of the Lifetime Learning Credit, the student takes the course to acquire or improve job skills.
(6) Examples. The following examples illustrate the rules of this paragraph (d). In each example, assume that the institution is an eligible educational institution and that all other relevant requirements to claim an education tax credit are met. The examples are as follows:
§ 1.25A-3 Hope Scholarship Credit.
(a) Amount of the credit—(1) In general. Subject to the phaseout of the education tax credit described in § 1.25A-1(c), the Hope Scholarship Credit amount is the total of—
(i) 100 percent of the first $1,000 of qualified tuition and related expenses paid during the taxable year for education furnished to an eligible student (as defined in paragraph (d) of this section) who is the taxpayer, the taxpayer’s spouse, or any claimed dependent during any academic period beginning in the taxable year (or treated as beginning in the taxable year, see § 1.25A-5(e)(2)); plus
(ii) 50 percent of the next $1,000 of such expenses paid with respect to that student.
(2) Maximum credit. For taxable years beginning before 2002, the maximum Hope Scholarship Credit allowed for each eligible student is $1,500. For taxable years beginning after 2001, the amounts used in paragraph (a)(1) of this section to determine the maximum credit will be increased for inflation occurring after 2000 in accordance with section 1(f)(3). If any amount adjusted under this paragraph (a)(2) is not a multiple of $100, the amount will be rounded to the next lowest multiple of $100.
(b) Per student credit—(1) In general. A Hope Scholarship Credit may be claimed for the qualified tuition and related expenses of each eligible student (as defined in paragraph (d) of this section).
(2) Example. The following example illustrates the rule of this paragraph (b). In the example, assume that all the requirements to claim an education tax credit are met. The example is as follows:
(c) Credit allowed for only two taxable years. For each eligible student, the Hope Scholarship Credit may be claimed for no more than two taxable years.
(d) Eligible student—(1) Eligible student defined. For purposes of the Hope Scholarship Credit, the term eligible student means a student who satisfies all of the following requirements—
(i) Degree requirement. For at least one academic period that begins during the taxable year, the student enrolls at an eligible educational institution in a program leading toward a postsecondary degree, certificate, or other recognized postsecondary educational credential;
(ii) Work load requirement. For at least one academic period that begins during the taxable year, the student enrolls for at least one-half of the normal full-time work load for the course of study the student is pursuing. The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard for half-time may not be lower than the applicable standard for half-time established by the Department of Education under the Higher Education Act of 1965 and set forth in 34 CFR 674.2(b) (revised as of July 1, 2002) for a half-time undergraduate student;
(iii) Year of study requirement. As of the beginning of the taxable year, the student has not completed the first two years of postsecondary education at an eligible educational institution. Whether a student has completed the first two years of postsecondary education at an eligible educational institution as of the beginning of a taxable year is determined based on whether the institution in which the student is enrolled in a degree program (as described in paragraph (d)(1)(i) of this section) awards the student two years of academic credit at that institution for postsecondary course work completed by the student prior to the beginning of the taxable year. Any academic credit awarded by the eligible educational institution solely on the basis of the student’s performance on proficiency examinations is disregarded in determining whether the student has completed two years of postsecondary education; and
(iv) No felony drug conviction. The student has not been convicted of a Federal or State felony offense for possession or distribution of a controlled substance as of the end of the taxable year for which the credit is claimed.
(2) Examples. The following examples illustrate the rules of this paragraph (d). In each example, assume that the student has not been convicted of a felony drug offense, that the institution is an eligible educational institution unless otherwise stated, that the qualified tuition and related expenses are paid during the same taxable year that the academic period begins, and that a Hope Scholarship Credit has not previously been claimed for the student (see paragraph (c) of this section). The examples are as follows:
(e) Academic period for prepayments—(1) In general. For purposes of determining whether a student meets the requirements in paragraph (d) of this section for a taxable year, if qualified tuition and related expenses are paid during one taxable year for an academic period that begins during January, February or March of the next taxable year (for taxpayers on a fiscal taxable year, use the first three months of the next taxable year), the academic period is treated as beginning during the taxable year in which the payment is made.
(2) Example. The following example illustrates the rule of this paragraph (e). In the example, assume that all the requirements to claim a Hope Scholarship Credit are met. The example is as follows:
(f) Effective date. The Hope Scholarship Credit is applicable for qualified tuition and related expenses paid after December 31, 1997, for education furnished in academic periods beginning after December 31, 1997.
§ 1.25A-4 Lifetime Learning Credit.
(a) Amount of the credit—(1) Taxable years beginning before January 1, 2003. Subject to the phaseout of the education tax credit described in § 1.25A-1(c), for taxable years beginning before 2003, the Lifetime Learning Credit amount is 20 percent of up to $5,000 of qualified tuition and related expenses paid during the taxable year for education furnished to the taxpayer, the taxpayer’s spouse, and any claimed dependent during any academic period beginning in the taxable year (or treated as beginning in the taxable year, see § 1.25A-5(e)(2)).
(2) Taxable years beginning after December 31, 2002. Subject to the phaseout of the education tax credit described in § 1.25A-1(c), for taxable years beginning after 2002, the Lifetime Learning Credit amount is 20 percent of up to $10,000 of qualified tuition and related expenses paid during the taxable year for education furnished to the taxpayer, the taxpayer’s spouse, and any claimed dependent during any academic period beginning in the taxable year (or treated as beginning in the taxable year, see § 1.25A-5(e)(2)).
(3) Coordination with the Hope Scholarship Credit. Expenses paid with respect to a student for whom the Hope Scholarship Credit is claimed are not eligible for the Lifetime Learning Credit.
(4) Examples. The following examples illustrate the rules of this paragraph (a). In each example, assume that all the requirements to claim a Lifetime Learning Credit or a Hope Scholarship Credit, as applicable, are met. The examples are as follows:
(b) Credit allowed for unlimited number of taxable years. There is no limit to the number of taxable years that a taxpayer may claim a Lifetime Learning Credit with respect to any student.
(c) Both degree and nondegree courses are eligible for the credit—(1) In general. For purposes of the Lifetime Learning Credit, amounts paid for a course at an eligible educational institution are qualified tuition and related expenses if the course is either part of a postsecondary degree program or is not part of a postsecondary degree program but is taken by the student to acquire or improve job skills.
(2) Examples. The following examples illustrate the rule of this paragraph (c). In each example, assume that all the requirements to claim a Lifetime Learning Credit are met. The examples are as follows:
(d) Effective date. The Lifetime Learning Credit is applicable for qualified tuition and related expenses paid after June 30, 1998, for education furnished in academic periods beginning after June 30, 1998.
§ 1.25A-5 Special rules relating to characterization and timing of payments.
(a) Educational expenses paid by claimed dependent. For any taxable year for which the student is a claimed dependent of another taxpayer, qualified tuition and related expenses paid by the student are treated as paid by the taxpayer to whom the deduction under section 151 is allowed.
(b) Educational expenses paid by a third party—(1) In general. Solely for purposes of section 25A, if a third party (someone other than the taxpayer, the taxpayer’s spouse if the taxpayer is treated as married within the meaning of section 7703, or a claimed dependent) makes a payment directly to an eligible educational institution to pay for a student’s qualified tuition and related expenses, the student is treated as receiving the payment from the third party and, in turn, paying the qualified tuition and related expenses to the institution.
(2) Special rule for tuition reduction included in gross income of employee. Solely for purposes of section 25A, if an eligible educational institution provides a reduction in tuition to an employee of the institution (or to the spouse or dependent child of an employee, as described in section 132(h)(2)) and the amount of the tuition reduction is included in the employee’s gross income, the employee is treated as receiving payment of an amount equal to the tuition reduction and, in turn, paying such amount to the institution.
(3) Examples. The following examples illustrate the rules of this paragraph (b). In each example, assume that all the requirements to claim an education tax credit are met. The examples are as follows:
(c) Adjustment to qualified tuition and related expenses for certain excludable educational assistance—(1) In general. In determining the amount of an education tax credit, qualified tuition and related expenses for any academic period must be reduced by the amount of any tax-free educational assistance allocable to such period. For this purpose, tax-free educational assistance means—
(i) A qualified scholarship that is excludable from income under section 117;
(ii) A veterans’ or member of the armed forces’ educational assistance allowance under chapter 30, 31, 32, 34 or 35 of title 38, United States Code, or under chapter 1606 of title 10, United States Code;
(iii) Employer-provided educational assistance that is excludable from income under section 127; or
(iv) Any other educational assistance that is excludable from gross income (other than as a gift, bequest, devise, or inheritance within the meaning of section 102(a)).
(2) No adjustment for excludable educational assistance attributable to expenses paid in a prior year. A reduction is not required under paragraph (c)(1) of this section if the amount of excludable educational assistance received during the taxable year is treated as a refund of qualified tuition and related expenses paid in a prior taxable year. See paragraph (f)(5) of this section.
(3) Scholarships and fellowship grants. For purposes of paragraph (c)(1)(i) of this section, a scholarship or fellowship grant is treated as a qualified scholarship excludable under section 117 except to the extent—
(i) The scholarship or fellowship grant (or any portion thereof) may be applied, by its terms, to expenses other than qualified tuition and related expenses within the meaning of section 117(b)(2) (such as room and board) and the student reports the grant (or the appropriate portion thereof) as income on the student’s federal income tax return if the student is required to file a return; or
(ii) The scholarship or fellowship grant (or any portion thereof) must be applied, by its terms, to expenses other than qualified tuition and related expenses within the meaning of section 117(b)(2) (such as room and board) and the student reports the grant (or the appropriate portion thereof) as income on the student’s federal income tax return if the student is required to file a return.
(4) Examples. The following examples illustrate the rules of this paragraph (c). In each example, assume that all the requirements to claim an education tax credit are met. The examples are as follows:
(d) No double benefit. Qualified tuition and related expenses do not include any expense for which a deduction is allowed under section 162, section 222, or any other provision of chapter 1 of the Internal Revenue Code.
(e) Timing rules—(1) In general. Except as provided in paragraph (e)(2) of this section, an education tax credit is allowed only for payments of qualified tuition and related expenses for an academic period beginning in the same taxable year as the year the payment is made. Except for certain individuals who do not use the cash receipts and disbursements method of accounting, qualified tuition and related expenses are treated as paid in the year in which the expenses are actually paid. See § 1.461-1(a)(1).
(2) Prepayment rule—(i) In general. If qualified tuition and related expenses are paid during one taxable year for an academic period that begins during the first three months of the taxpayer’s next taxable year (i.e., in January, February, or March of the next taxable year for calendar year taxpayers), an education tax credit is allowed with respect to the qualified tuition and related expenses only in the taxable year in which the expenses are paid.
(ii) Example. The following example illustrates the rule of this paragraph (e)(2). In the example, assume that all the requirements to claim an education tax credit are met. The example is as follows:
(3) Expenses paid with loan proceeds. An education tax credit may be claimed for qualified tuition and related expenses paid with the proceeds of a loan only in the taxable year in which the expenses are paid, and may not be claimed in the taxable year in which the loan is repaid. Loan proceeds disbursed directly to an eligible educational institution will be treated as paid on the date the institution credits the proceeds to the student’s account. For example, in the case of any loan issued or guaranteed as part of a Federal student loan program under title IV of the Higher Education Act of 1965, loan proceeds will be treated as paid on the date of disbursement (as defined in 34 CFR 668.164(a), revised as of July 1, 2002) by the eligible educational institution. If a taxpayer does not know the date the institution credits the student’s account, the taxpayer must treat the qualified tuition and related expenses as paid on the last date for payment prescribed by the institution.
(4) Expenses paid through third party installment payment plans—(i) In general. A taxpayer, an eligible educational institution, and a third party installment payment company may enter into an agreement in which the company agrees to collect installment payments of qualified tuition and related expenses from the taxpayer and to remit the installment payments to the institution. If the third party installment payment company is the taxpayer’s agent for purposes of paying qualified tuition and related expenses to the eligible educational institution, the taxpayer is treated as paying the qualified expenses on the date the company pays the institution. However, if the third party installment payment company is the eligible educational institution’s agent for purposes of collecting payments of qualified tuition and related expenses from the taxpayer, the taxpayer is treated as paying the qualified expenses on the date the taxpayer pays the company.
(ii) Example. The following example illustrates the rule of this paragraph (e)(4). The example is as follows:
(f) Refund of qualified tuition and related expenses—(1) Payment and refund of qualified tuition and related expenses in the same taxable year. With respect to any student, the amount of qualified tuition and related expenses for a taxable year is calculated by adding all qualified tuition and related expenses paid for the taxable year, and subtracting any refund of such expenses received from the eligible educational institution during the same taxable year (including refunds of loan proceeds described in paragraph (f)(4) of this section).
(2) Payment of qualified tuition and related expenses in one taxable year and refund in subsequent taxable year before return filed for prior taxable year. If, in a taxable year, a taxpayer or someone other than the taxpayer receives a refund (including refunds of loan proceeds described in paragraph (f)(4) of this section) of qualified tuition and related expenses paid on behalf of a student in a prior taxable year and the refund is received before the taxpayer files a federal income tax return for the prior taxable year, the amount of the qualified tuition and related expenses for the prior taxable year is reduced by the amount of the refund.
(3) Payment of qualified tuition and related expenses in one taxable year and refund in subsequent taxable year—(i) In general. If, in a taxable year (refund year), a taxpayer or someone other than the taxpayer receives a refund (including refunds of loan proceeds described in paragraph (f)(4) of this section) of qualified tuition and related expenses paid on behalf of a student for which the taxpayer claimed an education tax credit in a prior taxable year, the tax imposed by chapter 1 of the Internal Revenue Code for the refund year is increased by the recapture amount.
(ii) Recapture amount. The recapture amount is the difference in tax liability for the prior taxable year (taking into account any redetermination of such tax liability by audit or amended return) that results when the tax liability for the prior year is calculated using the taxpayer’s redetermined credit. The redetermined credit is computed by reducing the amount of the qualified tuition and related expenses taken into account in determining any credit claimed in the prior taxable year by the amount of the refund of the qualified tuition and related expenses (redetermined qualified expenses), and computing the allowable credit using the redetermined qualified expenses and the relevant facts and circumstances of the prior taxable year, such as modified adjusted gross income (redetermined credit).
(4) Refund of loan proceeds treated as refund of qualified tuition and related expenses. If loan proceeds used to pay qualified tuition and related expenses (as described in paragraph (e)(3) of this section) during a taxable year are refunded by an eligible educational institution to a lender on behalf of the borrower, the refund is treated as a refund of qualified tuition and related expenses for purposes of paragraphs (f)(1), (2), and (3) of this section.
(5) Excludable educational assistance received in a subsequent taxable year treated as a refund. If, in a taxable year, a taxpayer or someone other than the taxpayer receives any excludable educational assistance (described in paragraph (c)(1) of this section) for the qualified tuition and related expenses paid on behalf of a student during a prior taxable year (or attributable to enrollment at an eligible educational institution during a prior taxable year), the educational assistance is treated as a refund of qualified tuition and related expenses for purposes of paragraphs (f)(2) and (3) of this section. If the excludable educational assistance is received before the taxpayer files a federal income tax return for the prior taxable year, the amount of the qualified tuition and related expenses for the prior taxable year is reduced by the amount of the excludable educational assistance as provided in paragraph (f)(2) of this section. If the excludable educational assistance is received after the taxpayer has filed a federal income tax return for the prior taxable year, any education tax credit claimed for the prior taxable year is subject to recapture as provided in paragraph (f)(3) of this section.
(6) Examples. The following examples illustrate the rules of this paragraph (f). In each example, assume that all the requirements to claim an education tax credit are met. The examples are as follows:
(i) Adding all qualified expenses paid during the taxable year ($2,000 + 1,000 = $3,000);
(ii) Adding all refunds of qualified tuition and related expenses received during the taxable year ($750 + $250 = $1,000); and, then
(iii) Subtracting paragraph (ii) of this Example 1 from paragraph (i) of this Example 1 ($3,000 −$1,000 = $2,000). Therefore, Student A’s qualified tuition and related expenses for 1998 are $2,000.
(ii) Student B calculates the increase in tax for 1999 by—
(A) Calculating the redetermined qualified expenses for 1998 ($2,000 − $500 = $1,500);
(B) Calculating the redetermined credit for the redetermined qualified expenses ($1,500 × .20 = $300); and
(C) Calculating the difference in tax liability for 1998 resulting from the redetermined credit. Because Student B’s tax liability for 1998 was reduced by the full amount of the $400 education tax credit claimed on her 1998 income tax return, the difference in tax liability can be determined by subtracting the redetermined credit from the credit claimed in 1998 ($400−$300 = $100).
(iii) Therefore, Student B must increase the tax on her 1999 federal income tax return by $100.
§ 1.28-0 Credit for clinical testing expenses for certain drugs for rare diseases or conditions; table of contents.
In order to facilitate use of § 1.28-1, this section lists the paragraphs, subparagraphs, and subdivisions contained in § 1.28-1.
(a) General rule.
(b) Qualified clinical testing expenses.
(1) In general.
(2) Modification of section 41(b).
(3) Exclusion for amounts funded by another person.
(i) In general.
(ii) Clinical testing in which taxpayer retains no rights.
(iii) Clinical testing in which taxpayer retains substantial rights.
(A) In general.
(B) Drug by drug determination.
(iv) Funding for qualified clinical testing expenses determinable only in subsequent taxable years.
(4) Special rule governing the application of section 41(b) beyond its expiration date.
(c) Clinical testing.
(1) In general.
(2) Definition of “human clinical testing”.
(3) Definition of “carried out under” section 505(i).
(d) Definition and special rules.
(1) Definition of “rare disease or condition”.
(i) In general.
(ii) Cost of developing and making available the designated drug.
(A) In general.
(B) Exclusion of costs funded by another person.
(C) Computation of cost.
(D) Allocation of common costs. Costs for developing and making available the designated drug for both the disease or condition for which it is designated and one or more other diseases or conditions.
(iii) Recovery from sales.
(iv) Recordkeeping requirements.
(2) Tax liability limitation.
(i) Taxable years beginning after December 31, 1986.
(ii) Taxable years beginning before January 1, 1987, and after December 31, 1983.
(iii) Taxable years beginning before January 1, 1984.
(3) Special limitations on foreign testing.
(i) Clinical testing conducted outside the United States—In general.
(ii) Insufficient testing population in the United States.
(A) In general.
(B) “Insufficient testing population”.
(C) “Unrelated to the taxpayer”.
(4) Special limitations for certain corporations.
(i) Corporations to which section 936 applies.
(ii) Corporations to which section 934(b) applies.
(5) Aggregation of expenditures.
(i) Controlled group of corporations: organizations under common control.
(A) In general.
(B) Definition of controlled group of corporations.
(C) Definition of organization.
(D) Determination of common control.
(ii) Tax accounting periods used.
(A) In general.
(B) Special rule where the timing of clinical testing is manipulated.
(iii) Membership during taxable year in more than one group.
(iv) Intra-group transactions.
(A) In general.
(B) In-house research expenses.
(C) Contract research expenses.
(D) Lease payments.
(E) Payments for supplies.
(6) Allocations.
(i) Pass-through in the case of an S corporation
(ii) Pass-through in the case of an estate or a trust.
(iii) Pass-through in the case of a partnership.
(A) In general.
(B) Certain partnership non-business expenditures.
(C) Apportionment.
(iv) Year in which taken into account.
(v) Credit allowed subject to limitation.
(7) Manner of making an election.
§ 1.28-1 Credit for clinical testing expenses for certain drugs for rare diseases or conditions.
(a) General rule. Section 28 provides a credit against the tax imposed by chapter 1 of the Internal Revenue Code. The amount of the credit is equal to 50 percent of the qualified clinical testing expenses (as defined in paragraph (b) of this section) for the taxable year. The credit applies to qualified clinical testing expenses paid or incurred by the taxpayer after December 31, 1982, and before January 1, 1991. The credit may not exceed the taxpayer’s tax liability for the taxable year (as determined under paragraph (d)(2) of this section).
(b) Qualified clinical testing expenses—(1) In general. Except as otherwise provided in paragraph (b)(3) of this section, the term “qualified clinical testing expenses” means the amounts which are paid or incurred during the taxable year which would constitute “qualified research expenses” within the meaning of section 41(b) (relating to the credit for increasing research activities) as modified by section 28(b)(1)(B) and paragraph (b)(2) of this section. For example, amounts paid or incurred for the acquisition of depreciable property used in the conduct of clinical testing (as defined in paragraph (c) of this section) are not qualified clinical testing expenses.
(2) Modification of section 41(b). For purposes of paragraph (b)(1) of this section, section 41(b) is modified by substituting “clinical testing” for “qualified research” each place it appears in paragraph (2) of section 41(b) (relating to in-house research expenses) and paragraph (3) of section 41(b) (relating to contract research expenses). In addition, “100 percent” is substituted for “65 percent” in paragraph (3)(A) of section 41(b).
(3) Exclusion for amounts funded by another person—(i) In general. The term “qualified clinical testing expenses” shall not include any amount which would otherwise constitute qualified clinical testing expenses, to the extent such amount is funded by a grant, contract, or otherwise by another person (or any governmental entity). The determination of the extent to which an amount is funded shall be made in light of all the facts and circumstances. For a special rule regarding funding between commonly controlled businesses, see paragraph (d)(5)(iv) of § 1.28-1.
(ii) Clinical testing in which taxpayer retains no rights. If a taxpayer conducting clinical testing with respect to the designated drug for another person retains no substantial rights in the clinical testing under the agreement providing for the clinical testing the taxpayer’s clinical testing expenses are treated as fully funded for purposes of section 28(b)(1)(C). Thus, for example, if the taxpayer incurs clinical testing expenses under an agreement that confers on another person the exclusive right to exploit the results of the clinical testing, those expenses do not constitute qualified clinical testing expenses because they are fully funded under this paragraph (b)(3)(ii). Incidental benefits to the taxpayer from the conduct of the clinical testing (for example, increased experience in the field of human clinical testing) do not constitute substantial rights in the clinical testing.
(iii) Clinical testing in which taxpayer retains substantial rights—(A) In general. If a taxpayer conducting clinical testing with respect to the designated drug for another person retains substantial rights in the clinical testing under the agreement providing for the clinical testing, the clinical testing expenses are funded to the extent of the payments (and fair market value of any property at the time of transfer) to which the taxpayer becomes entitled by conducting the clinical testing. The taxpayer shall reduce the amount paid or incurred by the taxpayer for the clinical testing expenses that would, but for section 28(b)(1)(C) constitute qualified clinical testing expenses of the taxpayer by the amount of the funding determined under the preceding sentence. Rights retained in the clinical testing are not treated as property for purposes of this paragraph (b)(3)(iii)(A). If the property that is transferred to the taxpayer is to be consumed in the clinical testing (for example, supplies), the taxpayer should exclude the value of that property from both the payments received and the expenses paid or incurred for the clinical testing.
(B) Drug by drug determination. The provisions of this paragraph (b)(3) shall be applied separately to each designated drug tested by the taxpayer.
(iv) Funding for qualified clinical testing expenses determinable only in subsequent taxable years. If, at the time the taxpayer files its return for a taxable year, it is impossible to determine to what extent some or all of the qualified clinical testing expenses may be funded, the taxpayer shall treat the clinical testing expenses as fully funded for purposes of that return. When the amount of funding for qualified clinical testing expenses is finally determined, the taxpayer should amend the return and any interim returns to reflect the amount of funding for qualified clinical testing expenses.
(4) Special rule governing the application of section 41(b) beyond its expiration date. For purposes of section 28 and this section, section 41(b), as amended, and the regulations thereunder shall be deemed to remain in effect after December 31, 1988.
(c) Clinical testing—(1) In general. The term “clinical testing” means any human clinical testing which—
(i) Is carried out under an exemption under section 505(i) of the Federal Food, Drug, and Cosmetic Act (21 U.S.C. 355(i)) and the regulations relating thereto (21 CFR part 312) for the purpose of testing a drug for a rare disease or condition as defined in paragraph (d)(1) of this section,
(ii) Occurs after the date the drug is designated as a drug for a rare disease or condition under section 526 of the Federal Food, Drug, and Cosmetic Act (21 U.S.C. 360bb),
(iii) Occurs before the date on which an application for the designated drug is approved under section 505(b) of the Federal Food, Drug, and Cosmetic Act (21 U.S.C. 355(b)) or, if the drug is a biological product (other than a radioactive biological product intended for human use), before the date on which a license for such drug is issued under section 351 of the Public Health Services Act (42 U.S.C. 262), and
(iv) Is conducted by or on behalf of the taxpayer to whom the designation under section 526 of the Federal Food, Drug, and Cosmetic Act applies.
(2) Definition of “human clinical testing.” Testing is considered to be human clinical testing only to the extent that it uses human subjects to determine the effect of the designated drug on humans and is necessary for the designated drug either to be approved under section 505(b) of the Federal Food, Drug, and Cosmetic Act and the regulations thereunder (21 CFR part 314), or if the designated drug is a biological product (other than a radioactive biological product intended for human use), to be licensed under section 351 of the Public Health Services Act and the regulations thereunder (21 CFR part 601). For purposes of this paragraph (c)(2), a human subject is an individual who is a participant in research, either as a recipient of the drug or as a control. A subject may be either a healthy individual or a patient.
(3) Definition of “carried out under” section 505(i). Human clinical testing is not carried out under section 505(i) of the Federal Food, Drug, and Cosmetic Act and the regulations thereunder (21 CFR part 312) unless the primary purpose of the human clinical testing is to ascertain the data necessary to qualify the designated drug for sale in the United States, and not to ascertain data unrelated or only incidentally related to that needed to qualify the designated drug. Whether or not this primary purpose test is met shall be determined in light of all of the facts and circumstances.
(d) Definition and special rules—(1) Definition of “rare disease or condition”—(i) In general. The term “rare disease or condition” means any disease or condition which—
(A) Afflicts 200,000 or fewer persons in the United States, or
(B) Afflicts more than 200,000 persons in the United States but for which there is no reasonable expectation that the cost of developing and making available in the United States (as defined in section 7701(a)(9)) a drug for such disease or condition will be recovered from sales in the United States (as so defined) of such drug.
(ii) Cost of developing and making available the designated drug—(A) In general. Except as otherwise provided in this paragraph (d)(1)(ii), the taxpayer’s computation of the cost of developing and making available in the United States the designated drug shall include only the costs that the taxpayer (or any person whose right to make sales of the drug is directly or indirectly derived from the taxpayer, e.g., a licensee or transferee) has incurred or reasonably expects to incur in developing and making available in the United States the designated drug for the disease or condition for which it is designated. For example, if, prior to designation under section 526, the taxpayer incurred costs of $125,000 to test the drug for the rare disease or condition for which it is subsequently designated and incurred $500,000 to test the same drug for other diseases, and if, on the date of designation, the taxpayer expects to incur costs of $1.2 million to test the drug for the rare disease or condition for which it is designated, the taxpayer shall include in its cost computation both the $125,000 incurred prior to designation and the $1.2 million expected to be incurred after designation to test the drug for the rare disease or condition for which it is designated. The taxpayer shall not include the $500,000 incurred to test the drug for other diseases.
(B) Exclusion of costs funded by another person. In computing the cost of developing and making available in the United States the designated drug, the taxpayer shall not include any cost incurred or expected to be incurred by the taxpayer to the extent that the cost is funded or is reasonably expected to be funded (determined under the principles of paragraph (b)(3)) by a grant, contract, or otherwise by another person (or any governmental entity).
(C) Computation of cost. The cost computation shall use only reasonable costs incurred after the first indication of an orphan application for the designated drug. Such costs shall include the costs of obtaining data needed, and of meetings to be held, in connection with a request for FDA assistance under section 525 of the Federal, Food, Drug, and Cosmetic Act (21 U.S.C. 360aa) or a request for orphan designation under section 526 of that Act; costs of determining patentability of the drug; costs of screening, animal and clinical studies; costs associated with preparation of a Notice of Claimed Investigational Exemption for a New Drug (IND) and a New Drug Application (NDA); costs of possible distribution of drug under a “treatment” protocol; costs of development of a dosage form; manufacturing costs; distribution costs; promotion costs; costs to maintain required records and reports; and costs of the taxpayer in acquiring the right to market a drug from the owner of that right prior to designation. The taxpayer shall also include general overhead, depreciation costs and premiums for insurance against liability losses to the extent that the taxpayer can demonstrate that these costs are properly allocable to the designated drug under the established standards of financial accounting and reporting of research and development costs.
(D) Allocation of common costs. Costs for developing and making available the designated drug for both the disease or condition for which it is designated and one or more other diseases or conditions. In the case where the costs incurred or expected to be incurred in developing and making available the designated drug for the disease or condition for which it is designated are also incurred or expected to be incurred in developing and making available in the United States the same drug for one or more other diseases or conditions (whether or not they are also designated or expected to be designated), the costs shall be allocated between the cost of developing and making available the designated drug for the disease or condition for which the drug is designated and the cost of developing and making available the designated drug for the other diseases or conditions. The amount of the common costs to be allocated to the cost of developing and making available the designated drug for the disease or condition for which it is designated is determined by multiplying the common costs by a fraction the numerator of which is the sum of the expected amount of sales in the United States of the designated drug for the disease or condition for which the drug is designated and the denominator of which is the total expected amount of sales in the United States of the designated drug. For example, if prior to designation, the taxpayer incurs (among other costs) costs of $100,000 in testing the designated drug for its toxic effect on animals (without reference to any disease or condition), and if the taxpayer expects to recover $500,000 from sales in the United States of the designated drug for disease X, the disease for which the drug is designated, and further expects to recover another $1.5 million from the sales in the United States of the designated drug for disease Y, the taxpayer must allocate a proportionate amount of the common costs of $100,000 to the cost of developing and making available the designated drug for both disease X and disease Y. Since the ratio of the expected amount of sales in the United States of the designated drug for disease X to the total of both the expected amount of sales in the United States of the designated drug for disease X and the expected amount of sales in the United States of the designated drug for disease Y is $500,000/$2,000,000, 25% of the common costs of $100,000 (i.e., $25,000) is allocated to the cost of developing and making available the designated drug for disease X.
(iii) Recovery from sales. In determining whether the taxpayer’s cost described in paragraph (d)(1)(ii) of this section will be recovered from sales in the United States of the designated drug for the disease or condition for which the drug is designated, the taxpayer shall include anticipated sales by the taxpayer or any person whose right to make such sales is directly or indirectly derived from the taxpayer (such as a licensee or transferee). The anticipated sales shall be based upon the size of the anticipated patient population for which the designated drug would be useful, including the following factors: the degree of effectiveness and safety of the designated drug, if known: the projected fraction of the anticipated patient population expected to be given the designated drug and to continue to take it; other available agents and other types of therapy; the likelihood that superior agents will become available within a few years; and the number of years during which the designated drug would be exclusively available, e.g., under a patent.
(iv) Recordkeeping requirements. The taxpayer shall keep records sufficient to substantiate the cost and sales estimates made pursuant to this paragraph (d)(1). The records required by this paragraph (d)(1)(iv) shall be retained so long as the contents thereof may become material in the administration of section 28.
(2) Tax liability limitation—(i) Taxable years beginning after December 31, 1986. The credit allowed by section 28 shall not exceed the excess (if any) of—
(A) The taxpayer’s regular tax liability for the taxable year (as defined in section 26(b)), reduced by the sum of the credits allowable under—
(1) Section 21 (relating to expenses for household and dependent care services necessary for gainful employment),
(2) Section 22 (relating to the elderly and permanently and totally disabled),
(3) Section 23 (relating to residential energy),
(4) Section 25 (relating to interest on certain home mortgages), and
(5) Section 27 (relating to taxes on foreign countries and possessions of the United States), over
(B) The tentative minimum tax for the taxable year (as determined under section 55(b)(1)).
(ii) Taxable years beginning before January 1, 1987, and after December 31, 1983. The credit allowed by section 28 shall not exceed the taxpayer’s tax liability for the taxable year (as defined in section 26 (b) prior to its amendment by the Tax Reform Act of 1986 (Pub. L. 99-514)), reduced by the sum of the credits allowable under—
(A) Section 21 (relating to expenses for household dependent care services necessary for gainful employment),
(B) Section 22 (relating to the elderly and permanently and totally disabled),
(C) Section 23 (relating to residential energy),
(D) Section 24 (relating to contributions to candidates for public office),
(E) Section 25 (relating to interest on certain home mortgages), and
(F) Section 27 (relating to the taxes on foreign countries and possessions of the United States).
(iii) Taxable years beginning before January 1, 1984. The credit allowed by section 28 shall not exceed the amount of the tax imposed by chapter 1 of the Internal Revenue Code for the taxable year, reduced by the sum of the credits allowable under the following sections as designated prior to the enactment of the Tax Reform Act of 1984 (Pub. Law 98-369):
(A) Section 32 (relating to tax withheld at source on nonresident aliens and foreign corporations and on tax-free convenant bonds),
(B) Sections 33 (relating to taxes of foreign countries and possessions of the United States),
(C) Section 37 (relating to the retirement income),
(D) Section 38 (relating to investment in certain depreciable property),
(E) Section 40 (relating to expenses of work incentive programs).
(F) Section 41 (relating to contributions to candidates for public office).
(G) Section 44 (relating to purchase of new principal residence).
(H) Section 44A (relating to expenses for household and dependent care services necessary for gainful employment).
(I) Section 44B (relating to employment of certain new employees).
(J) Section 44C (relating to residential energy).
(K) Section 44D (relating to producing fuel from a nonconventional source).
(L) Section 44E (relating to alcohol used as fuel).
(M) Section 44F (relating to increasing research activities), and
(N) Section 44G (relating to employee stock ownership).
(3) Special limitations on foreign testing—(i) Clinical testing conducted outside of the United States—In general. Except as otherwise provided in this paragraph (d)(3), expenses paid or incurred with respect to clinical testing conducted outside the United States (as defined in section 7701(a)(9)) are not eligible for credit under this section. Thus, for example, wages paid an employee clinical investigator for clinical testing conducted in medical facilities in the United States and Mexico generally must be apportioned between the clinical testing conducted within the United States and the clinical testing conducted outside the United States, and only the wages apportioned to the clinical testing conducted within the United States are qualified clinical testing expenses.
(ii) Insufficient testing population in the United States—(A) In general. If clinical testing is conducted outside of the United States because there is an insufficient testing population in the United States, and if the clinical testing is conducted by a United States person (as defined in section 7701(a)(30)) or is conducted by any other person unrelated to the taxpayer to whom the designation under section 526 of the Federal Food, Drug, and Cosmetic Act applies, then the expenses paid or incurred for clinical testing conducted outside of the United States are eligible for the credit provided by section 28.
(B) “Insufficient testing population.” The testing population in the United States is insufficient if there are not within the United States the number of available and appropriate human subjects needed to produce reliable data from the clinical investigation.
(C) “Unrelated to the taxpayer.” For the purpose of determining whether a person is unrelated to the taxpayer to whom the designation under section 526 of the Federal Food, Drug, and Cosmetic Act and the regulations thereunder applies, the rules of section 613A(d)(3) shall apply except that the number “5” in section 613A(d)(3) (A), (B), and (C) shall be deleted and the number “10” inserted in lieu thereof.
(4) Special limitations for certain corporations—(i) Corporations to which section 936 applies. Expenses paid or incurred for clinical testing conducted either inside or outside the United States by a corporation to which section 936 (relating to Puerto Rico and possessions tax credit) applies are not eligible for the credit under section 28.
(ii) Corporations to which section 934(b) applies. For taxable years beginning before January 1, 1987, expenses paid or incurred for clinical testing conducted either inside or outside the United States by a corporation to which section 934(b) (relating to the limitation on reduction in income tax liability incurred to the Virgin Islands), as in effect prior to its amendment by the Tax Reform Act of 1986, applies are not eligible for the credit under section 28. For taxable years beginning after December 31, 1986, see section 1277(c)(1) of the Tax Reform Act of 1986 (100 Stat. 2600) which makes the rule set forth in the preceding sentence inapplicable with respect to corporations created or organized in the Virgin Islands only if (and so long as) an implementing agreement described in that section is in effect between the United States and the Virgin Islands.
(5) Aggregation of expenditures—(i) Controlled group of corporations; organizations under common control—(A) In general. In determining the amount of the credit allowable with respect to an organization that at the end of its taxable year is a member of a controlled group of corporations or a member of a group of organizations under common control, all members of the group are treated as a single taxpayer and the credit (if any) allowable to the member is determined on the basis of its proportionate share of the qualified clinical testing expenses of the aggregated group.
(B) Definition of controlled group of corporations. For purposes of this section, the term “controlled group of corporations” shall have the meaning given to the term by section 41(f)(5).
(C) Definition of organization. For purposes of this section, an organization is a sole proprietorship, a partnership, a trust, an estate, or a corporation, that is carrying on a trade or business (within the meaning of section 162). For purposes of this section, any corporation that is a member of a commonly controlled group shall be deemed to be carrying on a trade or business if any other member of that group is carrying on any trade or business.
(D) Determination of common control. Whether organizations are under common control shall be determined under the principles set forth in paragraphs (b) through (g) of 26 CFR 1.52-1.
(ii) Tax accounting periods used—(A) In general. The credit allowable to a member of a controlled group of corporations or a group of organizations under common control is that member’s share of the aggregate credit computed as of the end of such member’s taxable year.
(B) Special rule where the timing of clinical testing is manipulated. If the timing of clinical testing by members using different tax accounting periods is manipulated to generate a credit in excess of the amount that would be allowable if all members of the group used the same tax accounting period, the district director may require all members of the group to calculate the credit in the current taxable year and all future years by using the “conformed years” method. Each member computing a credit under the “conformed years” method shall compute the credit as if all members of the group had the same taxable year as the computing member.
(iii) Membership during taxable year in more than one group. An organization may be a member of only one group for a taxable year. If, without application of this paragraph (d)(5)(iii), an organization would be a member of more than one group at the end of its taxable year, the organization shall be treated as a member of the group in which it was included for its preceding taxable year. If the organization was not included for its preceding taxable year in any group in which it could be included as of the end of its taxable year, the organization shall designate in its timely filed return the group in which it is being included. If the return for a taxable year is due before May 1, 1985, the organization may designate its group membership through an amended return for that year filed on or before April 30, 1985. If the organization does not so designate, then the district director with audit jurisdiction of the return will determine the group in which the business is to be included.
(iv) Intra-group transactions—(A) In general. Because all members of a group under common control are treated as a single taxpayer for purposes of determining the credit, transactions between members of the group are generally disregarded.
(B) In-house research expenses. If one member of a group conducts clinical testing on behalf of another member, the member conducting the clinical testing shall include in its qualified clinical testing expenses any in-house research expenses for that work and shall not treat any amount received or accrued from the other member as funding the clinical testing. Conversely, the member for whom the clinical testing is conducted shall not treat any part of any amount paid or incurred as a contract research expense. For purposes of determining whether the in-house research for that work is clinical testing, the member performing the clinical testing shall be treated as carrying on any trade or business carried on by the member on whose behalf the clinical testing is performed.
(C) Contract research expenses. If a member of a group pays or incurs contract research expenses to a person outside the group in carrying on the member’s trade or business, that member shall include those expenses as qualified clinical testing expenses. However, if the expenses are not paid or incurred in carrying on any trade or business of that member, those expenses may be taken into account as contract research expenses by another member of the group provided that the other member—
(1) Reimburses the member paying or incurring the expenses, and
(2) Carries on a trade or business to which the clinical testing relates.
(D) Lease payments. Amounts paid or incurred to another member of the group for the lease of personal property owned by a person outside the group shall be taken into account as in-house research expenses for purposes of section 28 only to the extent of the lesser of—
(1) The amount paid or incurred to the other member, or
(2) The amount of the lease expense paid to a person outside the group.
The amount paid or incurred to another member of the group for the lease of personal property owned by a member of the group is not taken into account for purposes of section 28.
(E) Payment for supplies. Amounts paid or incurred to another member of the group for supplies shall be taken into account as in-house research expenses for purposes of section 28 only to the extent of the lesser of—
(1) The amount paid or incurred to the other member, or
(2) The amount of the other member’s basis in the supplies.
(6) Allocations—(i) Pass-through in the case of an S corporation. In the case of an S corporation (as defined in section 1361), the amount of the credit for qualified clinical testing expenses computed for the corporation for any taxable year shall be allocated among the persons who are shareholders of the corporation during the taxable year according to the provisions of section 1366 and section 1377.
(ii) Pass-through in the case of an estate or a trust. In the case of an estate or a trust, the amount of the credit for qualified clinical testing expenses computed for the estate or trust for any taxable year shall be apportioned between the estate or trust and the beneficiaries on the basis of the income of the estate or trust allocable to each.
(iii) Pass-through in the case of a partnership—(A) In general. In the case of a partnership, the credit for qualified clinical testing expenses computed for the partnership for any taxable year shall be apportioned among the persons who are partners during the taxable year in accordance with section 704 and the regulations thereunder.
(B) Certain partnership non-business expenditures. A partner’s share of an in-house research expense or contract research expense paid or incurred by a partnership other than in carrying on a trade or business of the partnership constitutes a qualified clinical testing expense of the partner if—
(1) The partner is entitled to make independent use of the result of the clinical testing, and
(2) The clinical testing expense paid or incurred in carrying on the clinical testing would have been paid or incurred by the partner in carrying on a trade or business of the partner if the partner had carried on the clinical testing that was in fact carried on by the partnership.
(C) Apportionment. Qualified clinical testing expenses to which paragraph (d)(6)(iii)(B) of this section applies shall be apportioned among the persons who are partners during the taxable year in accordance with section 704 and the regulations thereunder. For purposes of section 28, these expenses shall be treated as paid or incurred directly by the partners rather than by the partnership. Thus, the partnership shall disregard these expenses in computing the credit to be apportioned under paragraph (d)(6)(iii)(A) of this section, and each partner shall aggregate the portion of these expenses allocated to the partner with other qualified clinical testing expenses of the partner in making the computations under section 28.
(iv) Year in which taken into account. An amount apportioned to a person under paragraph (d)(6) of this section shall be taken into account by the person in the taxable year of such person in which or with which the taxable year of the corporation, estate, trust, or partnership (as the case may be) ends.
(v) Credit allowed subject to limitation. Any person to whom any amount has been apportioned under paragraph (d)(6)(i), (ii), or (iii) of this section is allowed, subject to the limitation provided in section 28(d)(2), a credit for that amount.
(7) Manner of making an election. To make an election to have section 28 apply for its taxable year, the taxpayer shall file Form 6765 (Credit for Increasing Research Activities (or for claiming the orphan drugs credit)) containing all the information required by that form.
Credits Against Tax
credits allowable under sections 30 through 45D
§ 1.30-1 Definition of qualified electric vehicle and recapture of credit for qualified electric vehicle.
(a) Definition of qualified electric vehicle. A qualified electric vehicle is a motor vehicle that meets the requirements of section 30(c). Accordingly, a qualified electric vehicle does not include any motor vehicle that has ever been used (for either personal or business use) as a non-electric vehicle.
(b) Recapture of credit for qualified electric vehicle—(1) In general—(i) Addition to tax. If a recapture event occurs with respect to a taxpayer’s qualified electric vehicle, the taxpayer must add the recapture amount to the amount of tax due in the taxable year in which the recapture event occurs. The recapture amount is not treated as income tax imposed on the taxpayer by chapter 1 of the Internal Revenue Code for purposes of computing the alternative minimum tax or determining the amount of any other allowable credits for the taxable year in which the recapture event occurs.
(ii) Reduction of carryover. If a recapture event occurs with respect to a taxpayer’s qualified electric vehicle, and if a portion of the section 30 credit for the cost of that vehicle was disallowed under section 30(b)(3)(B) and consequently added to the taxpayer’s minimum tax credit pursuant to section 53(d)(1)(B)(iii), the taxpayer must reduce its minimum tax credit carryover by an amount equal to the portion of any minimum tax credit carryover attributable to the disallowed section 30 credit, multiplied by the recapture percentage for the taxable year of recapture. Similarly, the taxpayer must reduce any other credit carryover amounts (such as under section 469) by the portion of the carryover attributable to section 30, multiplied by the recapture percentage.
(2) Recapture event—(i) In general. A recapture event occurs if, within 3 full years from the date a qualified electric vehicle is placed in service, the vehicle ceases to be a qualified electric vehicle. A vehicle ceases to be a qualified electric vehicle if—
(A) The vehicle is modified so that it is no longer primarily powered by electricity;
(B) The vehicle is used in a manner described in section 50(b); or
(C) The taxpayer receiving the credit under section 30 sells or disposes of the vehicle and knows or has reason to know that the vehicle will be used in a manner described in paragraph (b)(2)(i)(A) or (B) of this section.
(ii) Exception for disposition. Except as provided in paragraph (b)(2)(i)(C) of this section, a sale or other disposition (including a disposition by reason of an accident or other casualty) of a qualified electric vehicle is not a recapture event.
(3) Recapture amount. The recapture amount is equal to the recapture percentage times the decrease in the credits allowed under section 30 for all prior taxable years that would have resulted solely from reducing to zero the cost taken into account under section 30 with respect to such vehicle, including any credits allowed attributable to section 30 (such as under sections 53 and 469).
(4) Recapture date. The recapture date is the actual date of the recapture event unless a recapture event described in paragraph (b)(2)(i)(B) of this section occurs, in which case the recapture date is the first day of the recapture year.
(5) Recapture percentage. For purposes of this section, the recapture percentage is—
(i) 100, if the recapture date is within the first full year after the date the vehicle is placed in service;
(ii) 66
(iii) 33
(6) Basis adjustment. As of the first day of the taxable year in which the recapture event occurs, the basis of the qualified electric vehicle is increased by the recapture amount and the carryover reductions taken into account under paragraphs (b)(1)(i) and (ii) of this section, respectively. For a vehicle that is of a character that is subject to an allowance for depreciation, this increase in basis is recoverable over the remaining recovery period for the vehicle beginning as of the first day of the taxable year of recapture.
(7) Application of section 1245 for sales and other dispositions. For purposes of section 1245, the amount of the credit allowable under section 30(a) with respect to any qualified electric vehicle that is (or has been) of a character subject to an allowance for depreciation is treated as a deduction allowed for depreciation under section 167. Therefore, upon a sale or other disposition of a depreciable qualified electric vehicle, section 1245 will apply to any gain recognized to the extent the basis of the depreciable vehicle was reduced under section 30(d)(1) net of any basis increase described in paragraph (b)(6) of this section.
(8) Examples. The following examples illustrate the provisions of this section:
(c) Effective date. This section is effective on October 14, 1994. If the recapture date is before the effective date of this section, a taxpayer may use any reasonable method to recapture the benefit of any credit allowable under section 30(a) consistent with section 30 and its legislative history. For this purpose, the recapture date is defined in paragraph (b)(4) of this section.
§ 1.31-1 Credit for tax withheld on wages.
(a) The tax deducted and withheld at the source upon wages under chapter 24 of the Internal Revenue Code of 1954 (or in the case of amounts withheld in 1954, under subchapter D, chapter 9 of the Internal Revenue Code of 1939) is allowable as a credit against the tax imposed by Subtitle A of the Internal Revenue Code of 1954, upon the recipient of the income. If the tax has actually been withheld at the source, credit or refund shall be made to the recipient of the income even though such tax has not been paid over to the Government by the employer. For the purpose of the credit, the recipient of the income is the person subject to tax imposed under Subtitle A upon the wages from which the tax was withheld. For instance, if a husband and wife domiciled in a State recognized as a community property State for Federal tax purposes make separate returns, each reporting for income tax purposes one- half of the wages received by the husband, each spouse is entitled to one-half of the credit allowable for the tax withheld at source with respect to such wages.
(b) The tax withheld during any calendar year shall be allowed as a credit against the tax imposed by Subtitle A for the taxable year of the recipient of the income which begins in that calendar year. If such recipient has more than one taxable year beginning in that calendar year, the credit shall be allowed against the tax for the last taxable year so beginning.
(a) In general. (1) In the case of an employee receiving wages from more than one employer during the calendar year, amounts may be deducted and withheld as employee social security tax with respect to more than $3,600 of wages received during the calendar year 1954, and with respect to more than $4,200 of wages received during a calendar year after 1954. For example, employee social security tax may be deducted and withheld on $5,000 of wages received by an employee during a particular calendar year if the employee is paid wages in such year in the amount of $3,000 by one employer and in the amount of $2,000 by another employer. Section 6413(c) (as amended by section 202 of the Social Security Amendments of 1954 (68 Stat. 1089)), permits, under certain conditions, a so-called “special refund” of the amount of employee social security tax deducted and withheld with respect to wages paid to an employee in a calendar year after 1954 in excess of $4,200 ($3,600 for the calendar year 1954) by reason of the employee receiving wages from more than one employer during the calendar year. For provisions relating to the imposition of the employee tax and the limitation on wages, see with respect to the calendar year 1954, sections 1400 and 1426(a)(1) of the Internal Revenue Code of 1939 and, with respect to calendar years after 1954, sections 3101 and 3121(a)(1) of the Internal Revenue Code of 1954, as amended by sections 208(b) and 204(a), respectively, of the Social Security Amendments of 1954 (68 Stat. 1094, 1091).
(2) An employee who is entitled to a special refund of employee tax with respect to wages received during a calendar year and who is also required to file an income tax return for such calendar year (or for his last taxable year beginning in such calendar year) may obtain the benefits of such special refund only by claiming credit for such special refund in the same manner as if such special refund were an amount deducted and withheld as income tax at the source. For provisions for claiming special refunds for 1955 and subsequent years in the case of employees not required to file income tax returns, see section 6413(c) and the regulations thereunder. For provisions relating to such refunds for 1954, see 26 CFR (1939) 408.802 (regulations 128).
(3) The amount of the special refund allowed as a credit shall be considered as an amount deducted and withheld as income tax at the source under chapter 24 of the Internal Revenue Code of 1954 (or, in the case of a special refund for 1954, subchapter D, chapter 9 of the Internal Revenue Code of 1939). If the amount of such special refund when added to amounts deducted and withheld as income tax exceeds the taxes imposed by subtitle A of the Internal Revenue Code of 1954, the amount of the excess constitutes an overpayment of income tax under Subtitle A, and interest on such overpayment is allowed to the extent provided under section 6611 upon an overpayment of income tax resulting from a credit for income tax withheld at source. See section 6401(b).
(b) Federal and State employees and employees of certain foreign corporations. The provisions of this section shall apply to the amount of a special refund allowable to an employee of a Federal agency or a wholly owned instrumentality of the United States, to the amount of a special refund allowable to an employee of any State or political subdivision thereof (or any instrumentality of any one or more of the foregoing), and to the amount of a special refund allowable to employees of certain foreign corporations. See, with respect to such special refunds for 1954, section 1401(d)(4) of the Internal Revenue Code of 1939, and with respect to such special refunds for 1955 and subsequent years, section 6413(c)(2) of the Internal Revenue Code of 1954, as amended by section 202 of the Social Security amendments of 1954.
§ 1.32-2 Earned income credit for taxable years beginning after December 31, 1978.
(a) [Reserved]
(b) Limitations. (1) [Reserved]
(2) Married individuals. No credit is allowed by section 32 in the case of an eligible individual who is married (within the meaning of section 7703 and the regulations thereunder) unless the individual and spouse file a single return jointly (a joint return) for the taxable year (see section 6013 and the regulations thereunder relating to joint returns of income tax by husband and wife). The requirements of the preceding sentence do not apply to an eligible individual who is not considered as married under section 7703(b) and the regulations thereunder (relating to certain married individuals living apart).
(3) Length of taxable year. No credit is allowed by section 32 in the case of a taxable year covering a period of less than 12 months. However, the rule of the preceding sentence does not apply to a taxable year closed by reason of the death of the eligible individual.
(c) Definitions. (1) [Reserved]
(2) Earned income. For purposes of this section, earned income is computed without regard to any community property laws which may otherwise be applicable. Earned income is reduced by any net loss in earnings from self-employment. Earned income does not include amounts received as a pension, an annuity, unemployment compensation, or workmen’s compensation, or an amount to which section 871(a) and the regulations thereunder apply (relating to income of nonresident alien individuals not connected with United States business).
(d) [Reserved]
(e) Coordination of credit with advance payments—(1) Recapture of excess advance payments. If any advance payment of earned income credit under section 3507 is made to an individual by an employer during any calendar year, then the total amount of these advance payments to the individual in that calendar year is treated as an additional amount of tax imposed (by chapter 1 of the Code) upon the individual on the tax return for the individual’s last taxable year beginning in that calendar year.
(2) Reconciliation of payments advanced and credit allowed. Any additional amount of tax under paragraph (e)(1) of this section is not treated as a tax imposed by chapter 1 of the Internal Revenue Code for purposes of determining the amount of any credit (other than the earned income credit) allowable under part IV, subchapter A, chapter 1 of the Internal Revenue Code.
§ 1.32-3 Eligibility requirements after denial of the earned income credit.
(a) In general. A taxpayer who has been denied the earned income credit (EIC), in whole or in part, as a result of the deficiency procedures under subchapter B of chapter 63 (deficiency procedures) is ineligible to file a return claiming the EIC subsequent to the denial until the taxpayer demonstrates eligibility for the EIC in accordance with paragraph (c) of this section. If a taxpayer demonstrates eligibility for a taxable year in accordance with paragraph (c) of this section, the taxpayer need not comply with those requirements for any subsequent taxable year unless the Service again denies the EIC as a result of the deficiency procedures.
(b) Denial of the EIC as a result of the deficiency procedures. For purposes of this section, denial of the EIC as a result of the deficiency procedures occurs when a tax on account of the EIC is assessed as a deficiency (other than as a mathematical or clerical error under section 6213(b)(1)).
(c) Demonstration of eligibility. In the case of a taxpayer to whom paragraph (a) of this section applies, and except as otherwise provided by the Commissioner in the instructions for Form 8862, “Information To Claim Earned Income Credit After Disallowance,” no claim for the EIC filed subsequent to the denial is allowed unless the taxpayer properly completes Form 8862, demonstrating eligibility for the EIC, and otherwise is eligible for the EIC. If any item of information on Form 8862 is incorrect or inconsistent with any item on the return, the taxpayer will be treated as not demonstrating eligibility for the EIC. The taxpayer must follow the instructions for Form 8862 to determine the income tax return to which Form 8862 must be attached. If the taxpayer attaches Form 8862 to an incorrect tax return, the taxpayer will not be relieved of the requirement that the taxpayer attach Form 8862 to the correct tax return and will, therefore, not be treated as meeting the taxpayer’s obligation under paragraph (a) of this section.
(d) Failure to demonstrate eligibility. If a taxpayer to whom paragraph (a) of this section applies fails to satisfy the requirements of paragraph (c) of this section with respect to a particular taxable year, the IRS can deny the EIC as a mathematical or clerical error under section 6213(g)(2)(K).
(e) Special rule where one spouse denied EIC. The eligibility requirements set forth in this section apply to taxpayers filing a joint return where one spouse was denied the EIC for a taxable year prior to marriage and has not established eligibility as either an unmarried or married taxpayer for a subsequent taxable year.
(f) Effective date. This section applies to returns claiming the EIC for taxable years beginning after December 31, 1997, where the EIC was denied for a taxable year beginning after December 31, 1996.
§ 1.34-1 Special rule for owners of certain business entities.
Amounts payable under sections 6420, 6421, and 6427 to a business entity that is treated as separate from its owner under § 1.1361-4(a)(8) (relating to certain qualified subchapter S subsidiaries) or § 301.7701-2(c)(2)(v) of this chapter (relating to certain wholly-owned entities) are, for purposes of section 34, treated as payable to the owner of that entity.
§ 1.35-1 Partially tax-exempt interest received by individuals.
(a) The credit against tax under section 35 shall be allowed only to individuals and if the requirements of both paragraphs (1) and (2) of section 35(a) are met. Where the alternative tax on capital gains is imposed under section 1201(b), the taxable income for such taxable year is the taxable income as defined in section 63, which includes 50 percent of the excess of net long-term capital gain over net short-term capital loss.
(b) For the treatment of partially tax-exempt interest in the case of amounts not allocable to any beneficiary of an estate or trust, see section 642(a)(1), and for treatment of amounts allocable to a beneficiary, see sections 652 and 662. For treatment of partially tax-exempt interest received by a partnership, see section 702(a)(7). For treatment of such interest received by a common trust fund, see section 584(c)(2).
(c) The application of section 35 may be illustrated by the following example:
Partially tax-exempt interest | $4,500 | |
Credit computed under section 35(a); 3 percent of $4,500 | 135 | |
Tax imposed by chapter 1 | 840 | |
Less: | ||
Credit allowed under section 33 | $610 | |
Credit allowed under section 34 | 120 | |
____ | $730 | |
Limitation on credit under section 35(b)(1) | 110 | |
Taxable income | 4,000 | |
Limitation on credit under section 35(b)(2); 3 percent of $4,000 | 120 |
§ 1.35-2 Taxpayers not entitled to credit.
For taxable years beginning after December 31, 1957, no credit shall be allowed under section 35 to a nonresident alien individual with respect to whom a tax is imposed for such taxable year under section 871(a).
§ 1.36B-0 Table of contents.
This section lists the captions contained in §§ 1.36B-1 through 1.36B-6.
(A) Plans other than health reimbursement arrangements (HRAs) or other account-based group health plans described in paragraph (c)(3)(i)(B) of this section.
(B) HRAs and other account-based group health plans integrated with individual health insurance coverage.
(5) Affordable HRA or other account-based group health plan.
(i) In general.
(ii) Required HRA contribution.
(iii) Monthly amounts.
(A) Monthly lowest cost silver plan premium.
(B) Monthly HRA amount.
(iv) Employee safe harbor.
(v) Amounts used for affordability determination.
(vi) Affordability for part-year period.
(vii) Related individual not allowed as a personal exemption deduction.
(viii) Post-employment coverage.
(ix) Examples.
(A) In general.
(B) Individuals enrolled by a taxpayer and claimed by another taxpayer.
(C) Responsibility for advance credit payments for an individual not reported on any taxpayer’s return.
(a) In general.
(1) Employees.
(2) Related individuals
(i) In general.
(ii) Plans providing MV to employees.
(b) MV standard population.
(c) MV percentage.
(1) In general.
(2) Wellness program incentives.
(i) In general.
(ii) Example.
(3) Employer contributions to health savings accounts.
(4) Employer contributions to health reimbursement arrangements.
(5) Expected spending adjustments for health savings accounts and health reimbursement arrangements.
(d) Methods for determining MV.
(e) Scope of essential health benefits and adjustment for benefits not included in MV Calculator.
(f) Actuarial certification.
(1) In general.
(2) Membership in American Academy of Actuaries.
(3) Actuarial analysis.
(4) Use of MV Calculator.
(g) Effective/applicability date.
(1) In general.
(2) Exceptions.
§ 1.36B-1 Premium tax credit definitions.
(a) In general. Section 36B allows a refundable premium tax credit for taxable years ending after December 31, 2013. The definitions in this section apply to this section and §§ 1.36B-2 through 1.36B-5.
(b) Affordable Care Act. The term Affordable Care Act refers to the Patient Protection and Affordable Care Act, Public Law 111-148 (124 Stat. 119 (2010)), and the Health Care and Education Reconciliation Act of 2010, Public Law 111-152 (124 Stat. 1029 (2010)), as amended by the Medicare and Medicaid Extenders Act of 2010, Public Law 111-309 (124 Stat. 3285 (2010)), the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, Public Law 112-9 (125 Stat. 36 (2011)), the Department of Defense and Full-Year Continuing Appropriations Act, 2011, Public Law 112-10 (125 Stat. 38 (2011)), and the 3% Withholding Repeal and Job Creation Act, Public Law 112-56 (125 Stat. 711 (2011)).
(c) Qualified health plan. The term qualified health plan has the same meaning as in section 1301(a) of the Affordable Care Act (42 U.S.C. 18021(a)) but does not include a catastrophic plan described in section 1302(e) of the Affordable Care Act (42 U.S.C. 18022(e)).
(d) Family and family size—(1) In general. A taxpayer’s family means the individuals for whom a taxpayer properly claims a deduction for a personal exemption under section 151 for the taxable year. Family size means the number of individuals in the family. Family and family size may include individuals who are not subject to or are exempt from the penalty under section 5000A for failing to maintain minimum essential coverage.
(2) Special rule for tax years to which section 151(d)(5) applies. For taxable years to which section 151(d)(5) applies, a taxpayer’s family means the taxpayer, including both spouses in the case of a joint return, except for individuals who qualify as a dependent of another taxpayer under section 152, and any other individual for whom the taxpayer is allowed a personal exemption deduction and whom the taxpayer properly reports on the taxpayer’s income tax return for the taxable year. For purposes of this paragraph (d)(2), an individual is reported on the taxpayer’s income tax return if the individual’s name and taxpayer identification number (TIN) are listed on the taxpayer’s Form 1040 series return. See § 601.602 of this chapter.
(e) Household income—(1) In general. Household income means the sum of—
(i) A taxpayer’s modified adjusted gross income (including the modified adjusted gross income of a child for whom an election under section 1(g)(7) is made for the taxable year);
(ii) The aggregate modified adjusted gross income of all other individuals who—
(A) Are included in the taxpayer’s family under paragraph (d) of this section; and
(B) Are required to file a return of tax imposed by section 1 for the taxable year.
(2) Modified adjusted gross income. Modified adjusted gross income means adjusted gross income (within the meaning of section 62) increased by—
(i) Amounts excluded from gross income under section 911;
(ii) Tax-exempt interest the taxpayer receives or accrues during the taxable year; and
(iii) Social security benefits (within the meaning of section 86(d)) not included in gross income under section 86.
(f) Dependent. Dependent has the same meaning as in section 152.
(g) Lawfully present. Lawfully present has the same meaning as in 45 CFR 155.20.
(h) Federal poverty line. The Federal poverty line means the most recently published poverty guidelines (updated periodically in the
(i) [Reserved]
(j) Advance credit payment. Advance credit payment means an advance payment of the premium tax credit as provided in section 1412 of the Affordable Care Act (42 U.S.C. 18082).
(k) Exchange. Exchange has the same meaning as in 45 CFR 155.20.
(l) Self-only coverage. Self-only coverage means health insurance that covers one individual and provides coverage for the essential health benefits as defined in section 1302(b)(1) of the Affordable Care Act (42 U.S.C. 18022).
(m) Family coverage. Family coverage means health insurance that covers more than one individual and provides coverage for the essential health benefits as defined in section 1302(b)(1) of the Affordable Care Act (42 U.S.C. 18022).
(n) Rating area. The term rating area has the same meaning as used in section 2701(a)(2) of the Public Health Service Act (42 U.S.C. 300gg(a)(2)) and 45 CFR 147.102(b).
(o) Applicability dates. (1) Except for paragraphs (d)(2), (l), and (m) of this section, this section applies to taxable years ending after December 31, 2013.
(2) Paragraph (d)(2) of this section applies to taxable years ending on or after December 31, 2020.
(3) Paragraphs (l) and (m) of this section apply to taxable years beginning after December 31, 2018. Paragraphs (l) and (m) of § 1.36B-1 as contained in 26 CFR part 1 edition revised as of April 1, 2016, apply to taxable years ending after December 31, 2013, and beginning before January 1, 2019.
(a) In general. An applicable taxpayer (within the meaning of paragraph (b) of this section) is allowed a premium assistance amount only for any month that one or more members of the applicable taxpayer’s family (the applicable taxpayer or the applicable taxpayer’s spouse or dependent)—
(1) Is enrolled in one or more qualified health plans through an Exchange; and
(2) Is not eligible for minimum essential coverage (within the meaning of paragraph (c) of this section) other than coverage described in section 5000A(f)(1)(C) (relating to coverage in the individual market).
(b) Applicable taxpayer—(1) In general. Except as otherwise provided in this paragraph (b), an applicable taxpayer is a taxpayer whose household income is at least 100 percent but not more than 400 percent of the Federal poverty line for the taxpayer’s family size for the taxable year.
(2) Married taxpayers must file joint return—(i) In general. Except as provided in paragraph (b)(2)(ii) of this section, a taxpayer who is married (within the meaning of section 7703) at the close of the taxable year is an applicable taxpayer only if the taxpayer and the taxpayer’s spouse file a joint return for the taxable year.
(ii) Victims of domestic abuse and abandonment. Except as provided in paragraph (b)(2)(v) of this section, a married taxpayer satisfies the joint filing requirement of paragraph (b)(2)(i) of this section if the taxpayer files a tax return using a filing status of married filing separately and the taxpayer—
(A) Is living apart from the taxpayer’s spouse at the time the taxpayer files the tax return;
(B) Is unable to file a joint return because the taxpayer is a victim of domestic abuse, as described in paragraph (b)(2)(iii) of this section, or spousal abandonment, as described in paragraph (b)(2)(iv) of this section; and
(C) Certifies on the return, in accordance with the relevant instructions, that the taxpayer meets the criteria of this paragraph (b)(2)(ii).
(iii) Domestic abuse. For purposes of paragraph (b)(2)(ii) of this section, domestic abuse includes physical, psychological, sexual, or emotional abuse, including efforts to control, isolate, humiliate, and intimidate, or to undermine the victim’s ability to reason independently. All the facts and circumstances are considered in determining whether an individual is abused, including the effects of alcohol or drug abuse by the victim’s spouse. Depending on the facts and circumstances, abuse of the victim’s child or another family member living in the household may constitute abuse of the victim.
(iv) Abandonment. For purposes of paragraph (b)(2)(ii) of this section, a taxpayer is a victim of spousal abandonment for a taxable year if, taking into account all facts and circumstances, the taxpayer is unable to locate his or her spouse after reasonable diligence.
(v) Three-year rule. Paragraph (b)(2)(ii) of this section does not apply if the taxpayer met the requirements of paragraph (b)(2)(ii) of this section for each of the three preceding taxable years.
(3) Dependents. An individual is not an applicable taxpayer if another taxpayer may claim a deduction under section 151 for the individual for a taxable year beginning in the calendar year in which the individual’s taxable year begins.
(4) Individuals not lawfully present or incarcerated. An individual who is not lawfully present in the United States or is incarcerated (other than incarceration pending disposition of charges) is not eligible to enroll in a qualified health plan through an Exchange. However, the individual may be an applicable taxpayer if a family member is eligible to enroll in a qualified health plan. See sections 1312(f)(1)(B) and 1312(f)(3) of the Affordable Care Act (42 U.S.C. 18032(f)(1)(B) and (f)(3)) and § 1.36B-3(b)(2).
(5) Individuals lawfully present. If a taxpayer’s household income is less than 100 percent of the Federal poverty line for the taxpayer’s family size and the taxpayer or a member of the taxpayer’s family is an alien lawfully present in the United States, the taxpayer is treated as an applicable taxpayer if—
(i) The lawfully present taxpayer or family member is not eligible for the Medicaid program; and
(ii) The taxpayer would be an applicable taxpayer if the taxpayer’s household income for the taxable year was between 100 and 400 percent of the Federal poverty line for the taxpayer’s family size.
(6) Special rule for taxpayers with household income below 100 percent of the Federal poverty line for the taxable year—(i) In general. A taxpayer (other than a taxpayer described in paragraph (b)(5) of this section) whose household income for a taxable year is less than 100 percent of the Federal poverty line for the taxpayer’s family size is treated as an applicable taxpayer for the taxable year if—
(A) The taxpayer or a family member enrolls in a qualified health plan through an Exchange for one or more months during the taxable year;
(B) An Exchange estimates at the time of enrollment that the taxpayer’s household income will be at least 100 percent but not more than 400 percent of the Federal poverty line for the taxable year;
(C) Advance credit payments are authorized and paid for one or more months during the taxable year; and
(D) The taxpayer would be an applicable taxpayer if the taxpayer’s household income for the taxable year was at least 100 but not more than 400 percent of the Federal poverty line for the taxpayer’s family size.
(ii) Exceptions. This paragraph (b)(6) does not apply for an individual who, with intentional or reckless disregard for the facts, provides incorrect information to an Exchange for the year of coverage. A reckless disregard of the facts occurs if the taxpayer makes little or no effort to determine whether the information provided to the Exchange is accurate under circumstances that demonstrate a substantial deviation from the standard of conduct a reasonable person would observe. A disregard of the facts is intentional if the taxpayer knows the information provided to the Exchange is inaccurate.
(iii) Advance credit payments are authorized and paid for one or more months during the taxable year; and
(iv) The taxpayer would be an applicable taxpayer if the taxpayer’s household income for the taxable year was between 100 and 400 percent of the Federal poverty line for the taxpayer’s family size.
(7) Computation of premium assistance amounts for taxpayers with household income below 100 percent of the Federal poverty line. If a taxpayer is treated as an applicable taxpayer under paragraph (b)(5) or (b)(6) of this section, the taxpayer’s actual household income for the taxable year is used to compute the premium assistance amounts under § 1.36B-3(d).
(c) Minimum essential coverage—(1) In general. Minimum essential coverage is defined in section 5000A(f) and regulations issued under that section. As described in section 5000A(f), government-sponsored programs, eligible employer-sponsored plans, grandfathered health plans, and certain other health benefits coverage are minimum essential coverage.
(2) Government-sponsored minimum essential coverage—(i) In general. An individual is eligible for government-sponsored minimum essential coverage if the individual meets the criteria for coverage under a government-sponsored program described in section 5000A(f)(1)(A) as of the first day of the first full month the individual may receive benefits under the program, subject to the limitation in paragraph (c)(2)(ii) of this section. The Commissioner may define eligibility for specific government-sponsored programs further in additional published guidance, see § 601.601(d)(2) of this chapter.
(ii) Obligation to complete administrative requirements to obtain coverage. An individual who meets the criteria for eligibility for government-sponsored minimum essential coverage must complete the requirements necessary to receive benefits. An individual who fails by the last day of the third full calendar month following the event that establishes eligibility under paragraph (c)(2)(i) of this section to complete the requirements to obtain government-sponsored minimum essential coverage (other than a veteran’s health care program) is treated as eligible for government-sponsored minimum essential coverage as of the first day of the fourth calendar month following the event that establishes eligibility.
(iii) Special rule for coverage for veterans and other individuals under chapter 17 or 18 of title 38, U.S.C. An individual is eligible for minimum essential coverage under a health care program under chapter 17 or 18 of title 38, U.S.C. only if the individual is enrolled in a health care program under chapter 17 or 18 of title 38, U.S.C. identified as minimum essential coverage in regulations issued under section 5000A.
(iv) Retroactive effect of eligibility determination. If an individual receiving advance credit payments is determined to be eligible for government-sponsored minimum essential coverage that is effective retroactively (such as Medicaid), the individual is treated as eligible for minimum essential coverage under that program no earlier than the first day of the first calendar month beginning after the approval.
(v) Determination of Medicaid or Children’s Health Insurance Program (CHIP) ineligibility. An individual is treated as not eligible for Medicaid, CHIP, or a similar program for a period of coverage under a qualified health plan if, when the individual enrolls in the qualified health plan, an Exchange determines or considers (within the meaning of 45 CFR 155.302(b)) the individual to be not eligible for Medicaid or CHIP. This paragraph (c)(2)(v) does not apply for an individual who, with intentional or reckless disregard for the facts, provides incorrect information to an Exchange for the year of coverage. A reckless disregard of the facts occurs if the taxpayer makes little or no effort to determine whether the information provided to the Exchange is accurate under circumstances that demonstrate a substantial deviation from the standard of conduct a reasonable person would observe. A disregard of the facts is intentional if the taxpayer knows that information provided to the Exchange is inaccurate.
(vi) Examples. The following examples illustrate the provisions of this paragraph (c)(2):
(3) Employer-sponsored minimum essential coverage—(i)(A) Plans other than health reimbursement arrangements (HRAs) or other account-based group health plans described in paragraph (c)(3)(i)(B) of this section. For purposes of section 36B, an employee who may enroll in an eligible employer-sponsored plan (as defined in section 5000A(f)(2) and the regulations under that section) that is minimum essential coverage, and an individual who may enroll in the plan because of a relationship to the employee (a related individual), are eligible for minimum essential coverage under the plan for any month only if the plan is affordable and provides minimum value. Except for the Nonappropriated Fund Health Benefits Program of the Department of Defense, established under section 349 of the National Defense Authorization Act for Fiscal Year 1995 (Public Law 103-337; 10 U.S.C. 1587 note), government-sponsored minimum essential coverage is not an eligible employer-sponsored plan. The Nonappropriated Fund Health Benefits Program of the Department of Defense is considered eligible employer-sponsored coverage, but not government-sponsored coverage, for purposes of determining if an individual is eligible for minimum essential coverage under this section.
(B) HRAs and other account-based group health plans integrated with individual health insurance coverage. An employee who is offered an HRA or other account-based group health plan that would be integrated with individual health insurance coverage (or Medicare Part A and B or Medicare Part C), within the meaning of §§ 54.9802-4 and 54.9815-2711(d)(4) of this chapter, if the employee enrolls in individual health insurance coverage (or Medicare Part A and B or Medicare Part C), and an individual who is offered the HRA or other account-based group health plan because of a relationship to the employee (a related HRA individual), are eligible for minimum essential coverage under an eligible employer-sponsored plan for any month for which the HRA or other account-based group health plan is offered if the HRA or other account-based group health plan is affordable for the month under paragraph (c)(5) of this section or if the employee does not opt out of and waive future reimbursements from the HRA or other account-based group health plan. An HRA or other account-based group health plan described in this paragraph (c)(3)(i)(B) that is affordable for a month under paragraph (c)(5) of this section is treated as providing minimum value for the month. For purposes of paragraphs (c)(3) and (5) of this section, the definitions under § 54.9815-2711(d)(6) of this chapter apply.
(ii) Plan year. For purposes of this paragraph (c)(3), a plan year is an eligible employer-sponsored plan’s regular 12-month coverage period (or the remainder of a 12-month coverage period for a new employee or an individual who enrolls during a special enrollment period). The plan year for an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is the plan’s 12-month coverage period (or the remainder of the 12-month coverage period for a newly eligible individual or an individual who enrolls during a special enrollment period).
(iii) Eligibility for months during a plan year—(A) Failure to enroll in plan. An employee or related individual may be eligible for minimum essential coverage under an eligible employer-sponsored plan for a month during a plan year if the employee or related individual could have enrolled in the plan for that month during an open or special enrollment period for the plan year. If an enrollment period relates to coverage for not only the upcoming plan year (or the current plan year in the case of an enrollment period other than an open enrollment period), but also coverage in one or more succeeding plan years, this paragraph (c)(3)(iii)(A) applies only to eligibility for the coverage in the upcoming plan year (or the current plan year in the case of an enrollment period other than an open enrollment period).
(B) Waiting periods. An employee or related individual is not eligible for minimum essential coverage under an eligible employer-sponsored plan during a required waiting period before the coverage becomes effective.
(C) Example. The following example illustrates the provisions of this paragraph (c)(3)(iii):
(ii) B could have enrolled in X’s plan during the August 1 to September 15 enrollment period. Therefore, unless X’s plan is not affordable for B or does not provide minimum value, B is eligible for minimum essential coverage under X’s plan for the months that B is enrolled in the qualified health plan during X’s plan year (January through September 2015).
(iv) Post-employment coverage. A former employee (including a retiree), or an individual related (within the meaning of paragraph (c)(3)(i) of this section) to a former employee, who may enroll in eligible employer-sponsored coverage or in continuation coverage required under Federal law or a State law that provides comparable continuation coverage is eligible for minimum essential coverage under this coverage only for months that the former employee or related individual is enrolled in the coverage.
(v) Affordable coverage—(A) In general—(1) Affordability for employee. Except as provided in paragraph (c)(3)(v)(A)(3) of this section, an eligible employer-sponsored plan is affordable for an employee if the portion of the annual premium the employee must pay, whether by salary reduction or otherwise (required contribution), for self-only coverage does not exceed the required contribution percentage (as defined in paragraph (c)(3)(v)(C) of this section) of the applicable taxpayer’s household income for the taxable year. See paragraph (c)(5) of this section for rules for when an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is affordable for an employee for a month.
(2) Affordability for related individual.
Except as provided in paragraph (c)(3)(v)(A)(3) of this section, an eligible employer-sponsored plan is affordable for a related individual if the employee’s required contribution for family coverage under the plan does not exceed the required contribution percentage, as defined in paragraph (c)(3)(v)(C) of this section, of the applicable taxpayer’s household income for the taxable year. For purposes of this paragraph (c)(3)(v)(A)(2), an employee’s required contribution for family coverage is the portion of the annual premium the employee must pay for coverage of the employee and all other individuals included in the employee’s family, as defined in § 1.36B-1(d), who are offered coverage under the eligible employer-sponsored plan.
(3) Employee safe harbor. An eligible employer-sponsored plan is not affordable for an employee or a related individual for a plan year if, when the employee or a related individual enrolls in a qualified health plan for a period coinciding with the plan year (in whole or in part), an Exchange determines that the eligible employer-sponsored plan is not affordable for that plan year. This paragraph (c)(3)(v)(A)(3) does not apply to a determination made as part of the redetermination process described in 45 CFR 155.335 unless the individual receiving an Exchange redetermination notification affirmatively responds and provides current information about affordability. This paragraph (c)(3)(v)(A)(3) does not apply for an individual who, with intentional or reckless disregard for the facts, provides incorrect information to an Exchange concerning the portion of the annual premium for coverage for the employee or related individual under the plan. A reckless disregard of the facts occurs if the taxpayer makes little or no effort to determine whether the information provided to the Exchange is accurate under circumstances that demonstrate a substantial deviation from the standard of conduct a reasonable person would observe. A disregard of the facts is intentional if the taxpayer knows that the information provided to the Exchange is inaccurate. See paragraph (c)(5) of this section for an employee safe harbor that applies when an Exchange determines that an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is not affordable for an employee or a related HRA individual for the period of enrollment in a qualified health plan.
(4) Wellness program incentives. Nondiscriminatory wellness program incentives offered by an eligible employer-sponsored plan that affect premiums are treated as earned in determining an employee’s required contribution for purposes of affordability of an eligible employer-sponsored plan to the extent the incentives relate exclusively to tobacco use. Wellness program incentives that do not relate to tobacco use or that include a component unrelated to tobacco use are treated as not earned for this purpose. For purposes of this section, the term wellness program incentive has the same meaning as the term reward in § 54.9802-1(f)(1)(i) of this chapter.
(5) Employer contributions to HRAs integrated with eligible employer-sponsored plans. Amounts newly made available for the current plan year under an HRA that an employee may use to pay premiums, or may use to pay cost-sharing or benefits not covered by the primary plan in addition to premiums, reduce the employee’s required contribution if the HRA would be integrated, within the meaning of § 54.9815-2711(d)(2) of this chapter, with an eligible employer-sponsored plan for an employee enrolled in the plan. The eligible employer-sponsored plan and the HRA must be offered by the same employer. Employer contributions to an HRA described in this paragraph (c)(3)(v)(A)(5) reduce an employee’s required contribution only to the extent the amount of the annual contribution is required under the terms of the plan or otherwise determinable within a reasonable time before the employee must decide whether to enroll in the eligible employer-sponsored plan.
(6) Employer contributions to cafeteria plans. Amounts made available for the current plan year under a cafeteria plan, within the meaning of section 125, reduce an employee’s or a related individual’s required contribution if—
(i) The employee may not opt to receive the amount as a taxable benefit;
(ii) The employee may use the amount to pay for minimum essential coverage; and
(iii) The employee may use the amount exclusively to pay for medical care, within the meaning of section 213.
(7) Opt-out arrangements. [Reserved]
(8) Multiple offers of coverage. An individual who has offers of coverage under eligible employer-sponsored plans from multiple employers, either as an employee or a related individual, has an offer of affordable coverage if at least one of the offers of coverage is affordable under paragraph (c)(3)(v)(A)(1) or (2) of this section.
(B) Affordability for part-year period. Affordability under paragraph (c)(3)(v)(A) of this section is determined separately for each employment period that is less than a full calendar year or for the portions of an employer’s plan year that fall in different taxable years of an applicable taxpayer (a part-year period). Coverage under an eligible employer-sponsored plan is affordable for a part-year period if the annualized required contribution for self-only coverage, in the case of an employee, or family coverage, in the case of a related individual, under the plan for the part-year period does not exceed the required contribution percentage of the applicable taxpayer’s household income for the taxable year. The employee’s annualized required contribution is the employee’s required contribution for the part-year period times a fraction, the numerator of which is 12 and the denominator of which is the number of months in the part-year period during the applicable taxpayer’s taxable year. Only full calendar months are included in the computation under this paragraph (c)(3)(v)(B).
(C) Required contribution percentage. The required contribution percentage is 9.5 percent. For plan years beginning in a calendar year after 2014, the percentage will be adjusted by the ratio of premium growth to income growth for the preceding calendar year and may be further adjusted to reflect changes to the data used to compute the ratio of premium growth to income growth for the 2014 calendar year or the data sources used to compute the ratio of premium growth to income growth. Premium growth and income growth will be determined under published guidance, see § 601.601(d)(2) of this chapter. In addition, the percentage may be adjusted for plan years beginning in a calendar year after 2018 to reflect rates of premium growth relative to growth in the consumer price index.
(D) Examples. The following examples illustrate the provisions of this paragraph (c)(3)(v). Unless stated otherwise, in each example the taxpayer is single and has no dependents, the employer’s plan is an eligible employer-sponsored plan and provides minimum value, the employee is not eligible for other minimum essential coverage, and the taxpayer, related individual, and employer-sponsored plan have a calendar taxable year:
(1) Example 1: Basic determination of affordability. For all of 2023, taxpayer C works for an employer, X, that offers its employees and their spouses a health insurance plan under which, to enroll in self-only coverage, C must contribute an amount for 2023 that does not exceed the required contribution percentage of C’s 2023 household income. Because C’s required contribution for self-only coverage does not exceed the required contribution percentage of C’s household income, under paragraph (c)(3)(v)(A)(1) of this section, X’s plan is affordable for C, and C is eligible for minimum essential coverage for all months in 2023.
(2) Example 2: Basic determination of affordability for a related individual. (i) The facts are the same as in paragraph (c)(3)(v)(D)(1) of this section (Example 1), except that C is married to J, they file a joint return, and to enroll C and J, X’s plan requires C to contribute an amount for coverage for C and J for 2023 that exceeds the required contribution percentage of C’s and J’s household income. J does not work for an employer that offers employer-sponsored coverage.
(ii) J is a member of C’s family as defined in § 1.36B-1(d). Because C’s required contribution for coverage of C and J exceeds the required contribution percentage of C’s and J’s household income, under paragraph (c)(3)(v)(A)(2) of this section, X’s plan is unaffordable for J. Accordingly, J is not eligible for minimum essential coverage for 2023. However, under paragraph (c)(3)(v)(A)(1) of this section, X’s plan is affordable for C, and C is eligible for minimum essential coverage for all months in 2023.
(3) Example 3: Multiple offers of coverage. The facts are the same as in paragraph (c)(3)(v)(D)(2) of this section (Example 2), except that J works all year for an employer that offers employer-sponsored coverage to employees. J’s required contribution for the cost of self-only coverage from J’s employer does not exceed the required contribution percentage of C’s and J’s household income. Although the coverage offered by C’s employer for C and J is unaffordable for J, the coverage offered by J’s employer is affordable for J. Consequently, under paragraphs (c)(3)(v)(A)(1) and (8) of this section, J is eligible for minimum essential coverage for all months in 2023.
(4) Example 4: Cost of covering individuals not part of taxpayer’s family. (i) D and E are married, file a joint return, and have two children, F and G, under age 26. F is a dependent of D and E, but G is not. D works all year for an employer that offers employer-sponsored coverage to employees, their spouses, and their children under age 26. E, F, and G do not work for employers offering coverage. D’s required contribution for self-only coverage under D’s employer’s coverage does not exceed the required contribution percentage of D’s and E’s household income. D’s required contribution for coverage of D, E, F, and G exceeds the required contribution percentage of D’s and E’s household income, but D’s required contribution for coverage of D, E, and F does not exceed the required contribution percentage of the household income.
(ii) E and F are members of D’s family as defined in § 1.36B-1(d). G is not a member of D’s family under § 1.36B-1(d), because G is not D’s dependent. Under paragraph (c)(3)(v)(A)(1) of this section, D’s employer’s coverage is affordable for D because D’s required contribution for self-only coverage does not exceed the required contribution percentage of D’s and E’s household income. D’s employer’s coverage also is affordable for E and F, because, under paragraph (c)(3)(v)(A)(2) of this section, D’s required contribution for coverage of D, E, and F does not exceed the required contribution percentage of D’s and E’s household income. Although D’s cost to cover D, E, F, and G exceeds the required contribution percentage of D’s and E’s household income, under paragraph (c)(3)(v)(A)(2) of this section, the cost to cover G is not considered in determining whether D’s employer’s coverage is affordable for E and F, regardless of whether G actually enrolls in the plan, because G is not in D’s family. D, E, and F are eligible for minimum essential coverage for all months in 2023. Under paragraph (c)(4)(i) of this section, G is considered eligible for the coverage offered by D’s employer only if G enrolls in the coverage.
(5) Example 5: More than one family member with an employer offering coverage. (i) K and L are married, file a joint return, and have one dependent child, M. K works all year for an employer that offers coverage to employees, spouses, and children under age 26. L works all year for an employer that offers coverage to employees only. K’s required contribution for self-only coverage under K’s employer’s coverage does not exceed the required contribution percentage of K’s and L’s household income. Likewise, L’s required contribution for self-only coverage under L’s employer’s coverage does not exceed the required contribution percentage of K’s and L’s household income. However, K’s required contribution for coverage of K, L, and M exceeds the required contribution percentage of K’s and L’s household income.
(ii) L and M are members of K’s family as defined in § 1.36B-1(d). Under paragraph (c)(3)(v)(A)(1) of this section, K’s employer’s coverage is affordable for K because K’s required contribution for self-only coverage does not exceed the required contribution percentage of K’s and L’s household income. Similarly, L’s employer’s coverage is affordable for L, because L’s required contribution for self-only coverage does not exceed the required contribution percentage of K’s and L’s household income. Thus, K and L are eligible for minimum essential coverage for all months in 2023. However, under paragraph (c)(3)(v)(A)(2) of this section, K’s employer’s coverage is unaffordable for M, because K’s required contribution for coverage of K, L, and M exceeds the required contribution percentage of K’s and L’s household income. Accordingly, M is not eligible for minimum essential coverage for 2023.
(6) Example 6: Multiple offers of coverage for a related individual. (i) The facts are the same as in paragraph (c)(3)(v)(D)(5) of this section (Example 5), except that L works all year for an employer that offers coverage to employees, spouses, and children under age 26. L’s required contribution for coverage of K, L, and M does not exceed the required contribution percentage of K’s and L’s household income.
(ii) Although M is not eligible for affordable employer coverage under K’s employer’s coverage, paragraph (c)(3)(v)(A)(8) of this section dictates that L’s employer coverage must be evaluated to determine whether L’s employer coverage is affordable for M. Under paragraph (c)(3)(v)(A)(2) of this section, L’s employer’s coverage is affordable for M, because L’s required contribution for K, L, and M does not exceed the required contribution percentage of K’s and L’s household income. Accordingly, M is eligible for minimum essential coverage for all months in 2023.
(7) Example 7: Determination of unaffordability at enrollment. (i) Taxpayer D is an employee of Employer X. In November 2013 the Exchange for D’s rating area projects that D’s 2014 household income will be $37,000. It also verifies that D’s required contribution for self-only coverage under X’s health insurance plan will be $3,700 (10 percent of household income). Consequently, the Exchange determines that X’s plan is unaffordable. D enrolls in a qualified health plan and not in X’s plan. In December 2014, X pays D a $2,500 bonus. Thus, D’s actual 2014 household income is $39,500 and D’s required contribution for coverage under X’s plan is 9.4 percent of D’s household income.
(ii) Based on D’s actual 2014 household income, D’s required contribution does not exceed 9.5 percent of household income and X’s health plan is affordable for D. However, when D enrolled in a qualified health plan for 2014, the Exchange determined that X’s plan was not affordable for D for 2014. Consequently, under paragraph (c)(3)(v)(A)(3) of this section, X’s plan is not affordable for D and D is not eligible for minimum essential coverage under X’s plan for 2014.
(8) Example 8: Determination of unaffordability for plan year. The facts are the same as in paragraph (c)(3)(v)(D)(7) of this section (Example 7), except that X’s employee health insurance plan year is September 1 to August 31.
The Exchange for D’s rating area determines in August 2014 that X’s plan is unaffordable for D based on D’s projected household income for 2014. D enrolls in a qualified health plan as of September 1, 2014. Under paragraph (c)(3)(v)(A)(3) of this section, X’s plan is not affordable for D and D is not eligible for minimum essential coverage under X’s plan for the coverage months September to December 2014 and January through August 2015.
(9) Example 9: No affordability information affirmatively provided for annual redetermination. (i) The facts are the same as in paragraph (c)(3)(v)(D)(7) of this section (Example 7), except the Exchange redetermines D’s eligibility for advance credit payments for 2015. D does not affirmatively provide the Exchange with current information regarding affordability and the Exchange determines that D’s coverage is not affordable for 2015 and approves advance credit payments based on information from the previous enrollment period. In 2015, D’s required contribution for coverage under X’s plan is 9.4 percent of D’s household income.
(ii) Because D does not respond to the Exchange notification and the Exchange makes an affordability determination based on information from an earlier year, the employee safe harbor in paragraph (c)(3)(v)(A)(3) of this section does not apply. D’s required contribution for 2015 does not exceed 9.5 percent of D’s household income. Thus, X’s plan is affordable for D for 2015 and D is eligible for minimum essential coverage for all months in 2015.
(10) Example 10: Determination of unaffordability for part of plan year (part-year period). (i) Taxpayer E is an employee of Employer X beginning in May 2015. X’s employee health insurance plan year is September 1 to August 31. E’s required contribution for self-only coverage for May through August is $150 per month ($1,800 for the full plan year). The Exchange for E’s rating area projects E’s household income for purposes of eligibility for advance credit payments as $18,000. E’s actual household income for the 2015 taxable year is $20,000.
(ii) Under paragraph (c)(3)(v)(B) of this section, whether coverage under X’s plan is affordable for E is determined for the remainder of X’s plan year (May through August). E’s required contribution for a full plan year ($1,800) exceeds 9.5 percent of E’s household income (1,800/18,000 = 10 percent). Therefore, the Exchange determines that X’s coverage is unaffordable for May through August. Although E’s actual household income for 2015 is $20,000 (and E’s required contribution of $1,800 does not exceed 9.5 percent of E’s household income), under paragraph (c)(3)(v)(A)(3) of this section, X’s plan is unaffordable for E for the part of the plan year May through August 2015. Consequently, E is not eligible for minimum essential coverage under X’s plan for the period May through August 2015.
(11) Example 11: Affordability determined for part of a taxable year (part-year period). (i) Taxpayer F is an employee of Employer X. X’s employee health insurance plan year is September 1 to August 31. F’s required contribution for self-only coverage for the period September 2014 through August 2015 is $150 per month or $1,800 for the plan year. F does not enroll in X’s plan during X’s open season but enrolls in a qualified health plan for September through December 2014. F does not request advance credit payments and does not ask the Exchange for his rating area to determine whether X’s coverage is affordable for F. F’s household income in 2014 is $18,000.
(ii) Because F is a calendar year taxpayer and Employer X’s plan is not a calendar year plan, F must determine the affordability of X’s coverage for the part-year period in 2014 (September-December) under paragraph (c)(3)(v)(B) of this section. F determines the affordability of X’s plan for the September through December 2014 period by comparing the annual premiums ($1,800) to F’s 2014 household income. F’s required contribution of $1,800 is 10 percent of F’s 2014 household income. Because F’s required contribution exceeds 9.5 percent of F’s 2014 household income, X’s plan is not affordable for F for the part-year period September through December 2014 and F is not eligible for minimum essential coverage under X’s plan for that period.
(iii) F enrolls in Exchange coverage for 2015 and does not ask the Exchange to approve advance credit payments or determine whether X’s coverage is affordable. F’s 2015 household income is $20,000.
(iv) F must determine if X’s plan is affordable for the part-year period January 2015 through August 2015. F’s annual required contribution ($1,800) is 9 percent of F’s 2015 household income. Because F’s required contribution does not exceed 9.5 percent of F’s 2015 household income, X’s plan is affordable for F for the part-year period January through August 2015 and F is eligible for minimum essential coverage for that period.
(12) Example 12: Coverage unaffordable at year end. Taxpayer G is employed by Employer X. In November 2014, the Exchange for G’s rating area determines that G is eligible for affordable employer-sponsored coverage for 2015. G nonetheless enrolls in a qualified health plan for 2015 but does not receive advance credit payments. G’s 2015 household income is less than expected and G’s required contribution for employer-sponsored coverage for 2015 exceeds 9.5 percent of G’s actual 2015 household income. Under paragraph (c)(3)(v)(A)(1) of this section, G is not eligible for minimum essential coverage under X’s plan for 2015.
(13) Wellness program incentives: (i) Employer X offers an eligible employer-sponsored plan with a nondiscriminatory wellness program that reduces premiums by $300 for employees who do not use tobacco products or who complete a smoking cessation course. Premiums are reduced by $200 if an employee completes cholesterol screening within the first six months of the plan year. Employee B does not use tobacco and the cost of his premiums is $3,700. Employee C uses tobacco and the cost of her premiums is $4,000.
(ii) Under paragraph (c)(3)(v)(A)(4) of this section, only the incentives related to tobacco use are counted toward the premium amount used to determine the affordability of X’s plan. C is treated as having earned the $300 incentive for attending a smoking cessation course regardless of whether C actually attends the course. Thus, the required contribution for determining affordability for both Employee B and Employee C is $3,700. The $200 incentive for completing cholesterol screening is treated as not earned and does not reduce their required contribution.
(vi) Minimum value. See § 1.36B-6 for rules for determining whether an eligible employer-sponsored plan provides minimum value. An HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section that is affordable for a month under paragraph (c)(5) of this section is treated as providing minimum value for the month.
(vii) Enrollment in eligible employer-sponsored plan—(A) In general. Except as provided in paragraph (c)(3)(vii)(B) of this section, the requirements of affordability and minimum value do not apply for months that an individual is enrolled in an eligible employer-sponsored plan.
(B) Automatic enrollment. An employee or related individual is treated as not enrolled in an eligible employer-sponsored plan for a month in a plan year or other period for which the employee or related individual is automatically enrolled if the employee or related individual terminates the coverage before the later of the first day of the second full calendar month of that plan year or other period or the last day of any permissible opt-out period provided by the employer-sponsored plan or in regulations to be issued by the Department of Labor, for that plan year or other period.
(C) Examples. The following examples illustrate the provisions of this paragraph (c)(3)(vii):
(4) Special eligibility rules—(i) Related individual. An individual who may enroll in minimum essential coverage because of a relationship to another person eligible for the coverage, but is not included in the family, as defined in § 1.36B-1(d), of the other eligible person, is treated as eligible for such minimum essential coverage only for months that the related individual is enrolled in the coverage.
(ii) Exchange unable to discontinue advance credit payments—(A) In general. If an individual who is enrolled in a qualified health plan for which advance credit payments are made informs the Exchange that the individual is or will soon be eligible for other minimum essential coverage and that advance credit payments should be discontinued, but the Exchange does not discontinue advance credit payments for the first calendar month beginning after the month the individual informs the Exchange, the individual is treated as eligible for the other minimum essential coverage no earlier than the first day of the second calendar month beginning after the first month the individual may enroll in the other minimum essential coverage.
(B) Medicaid or CHIP. If a determination is made that an individual who is enrolled in a qualified health plan for which advance credit payments are made is eligible for Medicaid or CHIP but the advance credit payments are not discontinued for the first calendar month beginning after the eligibility determination, the individual is treated as eligible for the Medicaid or CHIP no earlier than the first day of the second calendar month beginning after the eligibility determination.
(5) Affordable HRA or other account-based group health plan—(i) In general. Except as otherwise provided in this paragraph (c)(5), an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is affordable for a month if the employee’s required HRA contribution (as defined in paragraph (c)(5)(ii) of this section) for the month does not exceed 1/12 of the product of the employee’s household income for the taxable year and the required contribution percentage (as defined in paragraph (c)(3)(v)(C) of this section).
(ii) Required HRA contribution. An employee’s required HRA contribution is the excess of—
(A) The monthly premium for the lowest cost silver plan for self-only coverage of the employee offered in the Exchange for the rating area in which the employee resides, over
(B) The monthly self-only HRA or other account-based group health plan amount (or the monthly maximum amount available to the employee under the HRA or other account-based group health plan if the HRA or other account-based group health plan provides for reimbursements up to a single dollar amount regardless of whether an employee has self-only or other-than-self-only coverage).
(iii) Monthly amounts—(A) Monthly lowest cost silver plan premium. For purposes of paragraph (c)(5)(ii)(A) of this section, the premium for the lowest cost silver plan is determined without regard to any wellness program incentive that affects premiums unless the wellness program incentive relates exclusively to tobacco use, in which case the incentive is treated as earned. If the premium differs for tobacco users and non-tobacco users, the premium for the lowest cost silver plan is the premium that applies to non-tobacco users. For the purpose of this paragraph (c)(5)(iii)(A), the term wellness program incentive has the same meaning as the term reward in 26 CFR 54.9802-1(f)(1)(i). A silver-level qualified health plan that is used for purposes of determining a taxpayer’s lowest cost silver plan for self-only coverage under paragraph (c)(5)(ii)(A) of this section does not cease to be the taxpayer’s lowest cost silver plan for self-only coverage solely because the plan terminates or closes to enrollment during the taxable year.
(B) Monthly HRA amount. For purposes of paragraph (c)(5)(ii)(B) of this section, the monthly self-only HRA or other account-based group health plan amount is the self-only HRA or other account-based group health plan amount newly made available under the HRA for the plan year, divided by the number of months in the plan year the HRA or other account-based group health plan is available to the employee. The monthly maximum amount available to the employee under the HRA or other account-based group health plan is the maximum amount newly made available for the plan year to the employee under the plan, divided by the number of months in the plan year the HRA or other account-based group health plan is available to the employee.
(iv) Employee safe harbor. An HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is not affordable for a month for an employee or a related HRA individual if, when the employee or related HRA individual enrolls in a qualified health plan for a period coinciding with the period the HRA or other account-based group health plan is available to the employee or related HRA individual (in whole or in part), an Exchange determines that the HRA or other account-based group health plan is not affordable for the period of enrollment in the qualified health plan. This paragraph (c)(5)(iv) does not apply to a determination made as part of the redetermination process described in 45 CFR 155.335 unless the individual receiving an Exchange redetermination notification affirmatively responds and provides current information about affordability. This paragraph (c)(5)(iv) does not apply for an individual who, with intentional or reckless disregard for the facts, provides incorrect information to an Exchange concerning the relevant HRA or other account-based group health plan amount offered by the employee’s employer. A reckless disregard of the facts occurs if the taxpayer makes little or no effort to determine whether the information provided to the Exchange is accurate under circumstances that demonstrate a substantial deviation from the standard of conduct a reasonable person would observe. A disregard of the facts is intentional if the taxpayer knows that the information provided to the Exchange is inaccurate.
(v) Amounts used for affordability determination. Only amounts that are newly made available for the plan year of the HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section and determinable within a reasonable time before the beginning of the plan year of the HRA or other account-based health plan are considered in determining whether an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is affordable. Amounts made available for a prior plan year that carry over to the current plan year are not taken into account for purposes of this paragraph (c)(5). Similarly, amounts made available to account for amounts remaining in a different HRA or other account-based group health plan the employer previously provided to the employee and under which the employee is no longer covered are not taken into account for purposes of this paragraph (c)(5).
(vi) Affordability for part-year period. Affordability under this paragraph (c)(5) is determined separately for each employment period that is less than a full calendar year or for the portions of the plan year of an employer’s HRA or other account-based group health plan that fall in different taxable years of an applicable taxpayer. An HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is affordable for a part-year period if the employee’s annualized required HRA contribution for the part-year period does not exceed the required contribution percentage of the applicable taxpayer’s household income for the taxable year. The employee’s annualized required HRA contribution is the employee’s required HRA contribution for the part-year period times a fraction, the numerator of which is 12 and the denominator of which is the number of months in the part-year period during the applicable taxpayer’s taxable year. Only full calendar months are included in the computation under this paragraph (c)(5)(vi).
(vii) Related individual not allowed as a personal exemption deduction. A related HRA individual is treated as ineligible for minimum essential coverage under an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section for months that the employee opted out of and waived future reimbursements from the HRA or other account-based group health plan and the employee is not allowed a personal exemption deduction under section 151 for the related HRA individual.
(viii) Post-employment coverage. An individual who is offered an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section, for months after an employee terminates employment with the employer offering the HRA or other account-based group health plan, is eligible for minimum essential coverage under the HRA or other account-based group health plan for months after termination of employment only if the employee does not forfeit or opt out of and waive future reimbursements from the HRA or other account-based group health plan for months after termination of employment.
(ix) Examples. The following examples illustrate the provisions of this paragraph (c)(5). The required contribution percentage is defined in paragraph (c)(3)(v)(C) of this section and is updated annually. Because the required contribution percentage for 2020 has not yet been determined, the examples assume a required contribution percentage for 2020 of 9.78 percent.
(A) Example 1: Determination of affordability—(1) Facts. In 2020 Taxpayer A is single, has no dependents, and has household income of $28,000. A is an employee of Employer X for all of 2020. X offers its employees an HRA described in paragraph (c)(3)(i)(B) of this section that reimburses $2,400 of medical care expenses for single employees with no children (the self-only HRA amount) and $4,000 for employees with a spouse or children for the medical expenses of the employees and their family members. A enrolls in a qualified health plan through the Exchange in the rating area in which A resides and remains enrolled for all of 2020. The monthly premium for the lowest cost silver plan for self-only coverage of A that is offered in the Exchange for the rating area in which A resides is $500.
(2) Conclusion. A’s required HRA contribution, as defined in paragraph (c)(5)(ii) of this section, is $300, the excess of $500 (the monthly premium for the lowest cost silver plan for self-only coverage of A) over $200 (1/12 of the self-only HRA amount provided by Employer X to its employees). In addition, 1/12 of the product of 9.78 percent and A’s household income is $228 ($28,000 × .0978 = $2,738; $2,738/12 = $228). Because A’s required HRA contribution of $300 exceeds $228 (1/12 of the product of 9.78 percent and A’s household income), the HRA is unaffordable for A for each month of 2020 under paragraph (c)(5) of this section. If A opts out of and waives future reimbursements from the HRA, A is not eligible for minimum essential coverage under the HRA for each month of 2020 under paragraph (c)(3)(i)(B) of this section.
(B) Example 2: Determination of affordability for a related HRA individual—(1) Facts. In 2020 Taxpayer B is married and has one child who is a dependent of B for 2020. B has household income of $28,000. B is an employee of Employer X for all of 2020. X offers its employees an HRA described in paragraph (c)(3)(i)(B) of this section that reimburses $3,600 of medical care expenses for single employees with no children (the self-only HRA amount) and $5,000 for employees with a spouse or children for the medical expenses of the employees and their family members. B, B’s spouse, and B’s child enroll in a qualified health plan through the Exchange in the rating area in which B resides and they remain enrolled for all of 2020. No advance credit payments are made for their coverage. The monthly premium for the lowest cost silver plan for self-only coverage of B that is offered in the Exchange for the rating area in which B resides is $500.
(2) Conclusion. B’s required HRA contribution, as defined in paragraph (c)(5)(ii) of this section, is $200, the excess of $500 (the monthly premium for the lowest cost silver plan for self-only coverage for B) over $300 (1/12 of the self-only HRA amount provided by Employer X to its employees). In addition, 1/12 of the product of 9.78 percent and B’s household income for 2020 is $228 ($28,000 × .0978 = $2,738; $2,738/12 = $228). Because B’s required HRA contribution of $200 does not exceed $228 (1/12 of the product of 9.78 percent and B’s household income for 2020), the HRA is affordable for B under paragraph (c)(5) of this section, and B is eligible for minimum essential coverage under an eligible employer-sponsored plan for each month of 2020 under paragraph (c)(3)(i)(B) of this section. In addition, B’s spouse and child are also eligible for minimum essential coverage under an eligible employer-sponsored plan for each month of 2020 under paragraph (c)(3)(i)(B) of this section.
(C) Example 3: Exchange determines that HRA is unaffordable—(1) Facts. The facts are the same as in paragraph (c)(5)(ix)(B) of this section (Example 2), except that B, when enrolling in Exchange coverage for B’s family, received a determination by the Exchange that the HRA was unaffordable, because B believed B’s household income would be lower than it turned out to be. Consequently, advance credit payments were made for their 2020 coverage.
(2) Conclusion. Under paragraph (c)(5)(iv) of this section, the HRA is considered unaffordable for B, B’s spouse, and B’s child for each month of 2020 provided that B did not, with intentional or reckless disregard for the facts, provide incorrect information to the Exchange concerning the HRA.
(D) Example 4: Affordability determined for part of a taxable year (part-year period)—(1) Facts. Taxpayer C is an employee of Employer X. C’s household income for 2020 is $28,000. X offers its employees an HRA described in paragraph (c)(3)(i)(B) of this section that reimburses medical care expenses of $3,600 for single employees without children (the self-only HRA amount) and $5,000 to employees with a spouse or children for the medical expenses of the employees and their family members. X’s HRA plan year is September 1 to August 31 and C is first eligible to participate in the HRA for the period beginning September 1, 2020. C enrolls in a qualified health plan through the Exchange in the rating area in which C resides for all of 2020. The monthly premium for the lowest cost silver plan for self-only coverage of C that is offered in the Exchange for the rating area in which C resides for 2020 is $500.
(2) Conclusion. Under paragraph (c)(3)(vi) of this section, the affordability of the HRA is determined separately for the period September 1 through December 31, 2020, and for the period January 1 through August 31, 2021. C’s required HRA contribution, as defined in paragraph (c)(5)(ii) of this section, for the period September 1 through December 31, 2020, is $200, the excess of $500 (the monthly premium for the lowest cost silver plan for self-only coverage for C) over $300 (1/12 of the self-only HRA amount provided by X to its employees). In addition, 1/12 of the product of 9.78 percent and C’s household income is $228 ($28,000 × .0978 = $2,738; $2,738/12 = $228). Because C’s required HRA contribution of $200 does not exceed $228, the HRA is affordable for C for each month in the period September 1 through December 31, 2020, under paragraph (c)(5) of this section. Affordability for the period January 1 through August 31, 2021, is determined using C’s 2021 household income and required HRA contribution.
(E) Example 5: Carryover amounts ignored in determining affordability—(1) Facts. Taxpayer D is an employee of Employer X for all of 2020 and 2021. D is single. For each of 2020 and 2021, X offers its employees an HRA described in paragraph (c)(3)(i)(B) of this section that provides reimbursement for medical care expenses of $2,400 to single employees with no children (the self-only HRA amount) and $4,000 to employees with a spouse or children for the medical expenses of the employees and their family members. Under the terms of the HRA, amounts that an employee does not use in a calendar year may be carried over and used in the next calendar year. In 2020, D used only $1,500 of her $2,400 maximum reimbursement and the unused $900 is carried over and may be used by D in 2021.
(2) Conclusion. Under paragraph (c)(5)(v) of this section, only the $2,400 self-only HRA amount offered to D for 2021 is considered in determining whether D’s HRA is affordable for D. The $900 carryover amount is not considered in determining the affordability of the HRA.
(d) Applicability date. Paragraphs (b)(2) and (c)(3)(v)(C) of this section apply to taxable years beginning after December 31, 2013.
(e) Applicability dates. (1) Except as provided in paragraphs (e)(2) through (5) of this section, this section applies to taxable years ending after December 31, 2013.
(2) Paragraph (b)(6)(ii), the last three sentences of paragraph (c)(2)(v), paragraph (c)(3)(i), paragraph (c)(3)(iii)(A), the last three sentences of paragraph (c)(3)(v)(A)(3), and paragraph (c)(4) of this section apply to taxable years beginning after December 31, 2016. Paragraphs (b)(6), (c)(3)(i), (c)(3)(iii)(A), and (c)(4) of § 1.36B-2 as contained in 26 CFR part I edition revised as of April 1, 2016, apply to taxable years ending after December 31, 2013, and beginning before January 1, 2017.
(3) Paragraphs (c)(3)(i)(B) and (c)(5) of this section, and the last sentences of paragraphs (c)(3)(ii), (c)(3)(v)(A)(1) through (3), and (c)(3)(vi) of this section apply to taxable years beginning on or after January 1, 2020.
(4) Paragraph (c)(4)(i) of this section applies to taxable years ending on or after December 31, 2020.
(5) The first two sentences of paragraph (c)(3)(v)(A)(2), paragraph (c)(3)(v)(A)(8), the second sentence of paragraph (c)(3)(v)(B), paragraphs (c)(3)(v)(D)(1) through (6), and the first sentences of paragraphs (c)(3)(v)(D)(8) and (9) of this section apply to taxable years beginning after December 31, 2022.
(a) In general. A taxpayer’s premium assistance credit amount for a taxable year is the sum of the premium assistance amounts determined under paragraph (d) of this section for all coverage months for individuals in the taxpayer’s family.
(b) Definitions. For purposes of this section—
(1) The cost of a qualified health plan is the premium the plan charges; and
(2) The term coverage family means, in each month, the members of a taxpayer’s family for whom the month is a coverage month.
(c) Coverage month—(1) In general. A month is a coverage month for an individual if—
(i) As of the first day of the month, the individual is enrolled in a qualified health plan through an Exchange;
(ii) The taxpayer pays the taxpayer’s share of the premium for the individual’s coverage under the plan for the month by the unextended due date for filing the taxpayer’s income tax return for that taxable year, or the full premium for the month is paid by advance credit payments; and
(iii) The individual is not eligible for the full calendar month for minimum essential coverage (within the meaning of § 1.36B-2(c)) other than coverage described in section 5000A(f)(1)(C) (relating to coverage in the individual market).
(2) Certain individuals enrolled during a month. If an individual enrolls in a qualified health plan and the enrollment is effective on the date of the individual’s birth, adoption, or placement for adoption or in foster care, or on the effective date of a court order, the individual is treated as enrolled as of the first day of that month for purposes of this paragraph (c).
(3) Premiums paid for a taxpayer. Premiums another person pays for coverage of the taxpayer, taxpayer’s spouse, or dependent are treated as paid by the taxpayer.
(4) Appeals of coverage eligibility. A taxpayer who is eligible for advance credit payments pursuant to an eligibility appeal decision implemented under 45 CFR 155.545(c)(1)(ii) for coverage of a member of the taxpayer’s coverage family who, based on the appeal decision, retroactively enrolls in a qualified health plan is considered to have met the requirement in paragraph (c)(1)(ii) of this section for a month if the taxpayer pays the taxpayer’s share of the premiums for coverage under the plan for the month on or before the 120th day following the date of the appeals decision.
(5) Examples. The following examples illustrate the provisions of this paragraph (c):
(ii) Under paragraph (c)(1) of this section, January through May 2014 are coverage months for M. June through December 2014 are not coverage months because M is eligible for minimum essential coverage for those months. Thus, under paragraph (a) of this section, M’s premium assistance credit amount for 2014 is the sum of the premium assistance amounts for the months January through May.
(ii) Under paragraph (c)(1) of this section, January through December of 2014 are coverage months for N and August through December are coverage months for N and S. N’s premium assistance credit amount for 2014 is the sum of the premium assistance amounts for these coverage months.
(ii) Because P claims T as a dependent, P (and not O) may claim a premium tax credit for coverage for T. See § 1.36B-2(a). Under paragraph (c)(2) of this section, the premiums that O pays for coverage for T are treated as paid by P. Thus, the months when T is covered by a qualified health plan and not eligible for other minimum essential coverage are coverage months under paragraph (c)(1) of this section in computing P’s premium tax credit under paragraph (a) of this section.
(d) Premium assistance amount—(1) Premium assistance amount. The premium assistance amount for a coverage month is the lesser of—
(i) The premiums for the month, reduced by any amounts that were refunded in the same taxable year as the premium liability is incurred, for one or more qualified health plans in which a taxpayer or a member of the taxpayer’s family enrolls (enrollment premiums); or
(ii) The excess of the adjusted monthly premium for the applicable benchmark plan (benchmark plan premium) over
(2) Examples. The following examples illustrate the rules of paragraph (d)(1) of this section.
(ii) The issuer of R’s qualified health plan is notified that R died on September 20. The issuer terminates coverage as of that date and refunds the remaining portion of the September enrollment premiums ($150) for R’s coverage.
(iii) R’s premium assistance amount for each coverage month from January through August is $420 (the lesser of $450 and $420). Under paragraph (d)(1) of this section, R’s premium assistance amount for September is the lesser of the enrollment premiums for the month, reduced by any amounts that were refunded ($300 ($450-$150)) or the difference between the benchmark plan premium and the contribution amount for the month ($420). R’s premium assistance amount for September is $300, the lesser of $420 and $300.
(e) Adjusted monthly premium. The adjusted monthly premium is the premium an issuer would charge for the applicable benchmark plan to cover all members of the taxpayer’s coverage family, adjusted only for the age of each member of the coverage family as allowed under section 2701 of the Public Health Service Act (42 U.S.C. 300gg). The adjusted monthly premium is determined without regard to any premium discount or rebate under the wellness discount demonstration project under section 2705(d) of the Public Health Service Act (42 U.S.C. 300gg-4(d)) and may not include any adjustments for tobacco use. The adjusted monthly premium for a coverage month is determined as of the first day of the month.
(f) Applicable benchmark plan—(1) In general. Except as otherwise provided in this paragraph (f), the applicable benchmark plan for each coverage month is the second-lowest-cost silver plan (as described in section 1302(d)(1)(B) of the Affordable Care Act (42 U.S.C. 18022(d)(1)(B))) offered to the taxpayer’s coverage family through the Exchange for the rating area where the taxpayer resides for—
(i) Self-only coverage for a taxpayer—
(A) Who computes tax under section 1(c) (unmarried individuals other than surviving spouses and heads of household) and is not allowed a deduction under section 151 for a dependent for the taxable year;
(B) Who purchases only self-only coverage for one individual; or
(C) Whose coverage family includes only one individual; and
(ii) Family coverage for all other taxpayers.
(2) Family coverage. The applicable benchmark plan for family coverage is the second lowest-cost silver plan that would cover the members of the taxpayer’s coverage family (such as a plan covering two adults if the members of a taxpayer’s coverage family are two adults).
(3) Silver-level plan not covering pediatric dental benefits. If one or more silver-level qualified health plans offered through an Exchange do not cover pediatric dental benefits, the premium for the applicable benchmark plan is determined based on the second lowest-cost option among—
(i) The silver-level qualified health plans that are offered by the Exchange to the members of the coverage family and that provide pediatric dental benefits; and
(ii) The silver-level qualified health plans that are offered by the Exchange to the members of the coverage family that do not provide pediatric dental benefits in conjunction with the second lowest-cost portion of the premium for a stand-alone dental plan (within the meaning of section 1311(d)(2)(B)(ii) of the Affordable Care Act (42 U.S.C. 18031(d)(2)(B)(ii)) offered by the Exchange to the members of the coverage family that is properly allocable to pediatric dental benefits determined under guidance issued by the Secretary of Health and Human Services.
(4) Family members residing in different locations. If members of a taxpayer’s coverage family reside in different locations, the taxpayer’s benchmark plan premium is the sum of the premiums for the applicable benchmark plans for each group of coverage family members residing in different locations, based on the plans offered to the group through the Exchange where the group resides. If all members of a taxpayer’s coverage family reside in a single location that is different from where the taxpayer resides, the taxpayer’s benchmark plan premium is the premium for the applicable benchmark plan for the coverage family, based on the plans offered through the Exchange to the taxpayer’s coverage family for the rating area where the coverage family resides.
(5) Single or multiple policies needed to cover the family—(i) Policy covering a taxpayer’s family. If a silver-level plan or a stand-alone dental plan offers coverage to all members of a taxpayer’s coverage family who reside in the same location under a single policy, the premium (or allocable portion thereof, in the case of a stand-alone dental plan) taken into account for the plan for purposes of determining the applicable benchmark plan under paragraphs (f)(1), (f)(2), and (f)(3) of this section is the premium for this single policy.
(ii) Policy not covering a taxpayer’s family. If a silver-level qualified health plan or a stand-alone dental plan would require multiple policies to cover all members of a taxpayer’s coverage family who reside in the same location (for example, because of the relationships within the family), the premium (or allocable portion thereof, in the case of a standalone dental plan) taken into account for the plan for purposes of determining the applicable benchmark plan under paragraphs (f)(1), (f)(2), and (f)(3) of this section is the sum of the premiums (or allocable portion thereof, in the case of a stand-alone dental plan) for self-only policies under the plan for each member of the coverage family who resides in the same location.
(6) Plan not available for enrollment. A silver-level qualified health plan or a stand-alone dental plan that is not open to enrollment by a taxpayer or family member at the time the taxpayer or family member enrolls in a qualified health plan is disregarded in determining the applicable benchmark plan.
(7) Benchmark plan terminates or closes to enrollment during the year. A silver-level qualified health plan or a stand-alone dental plan that is used for purposes of determining the applicable benchmark plan under this paragraph (f) for a taxpayer does not cease to be the applicable benchmark plan for a taxable year solely because the plan or a lower cost plan terminates or closes to enrollment during the taxable year.
(8) Only one silver-level plan offered to the coverage family. If there is only one silver-level qualified health plan or one stand-alone dental plan offered through an Exchange that would cover all members of a taxpayer’s coverage family who reside in the same location (whether under one policy or multiple policies), that plan is used for purposes of determining the taxpayer’s applicable benchmark plan.
(9) Examples. The following examples illustrate the rules of this paragraph (f). Unless otherwise stated, in each example the plans are open to enrollment to a taxpayer or family member at the time of enrollment and are offered through the Exchange for the rating area where the taxpayer resides:
(ii) Under paragraph (f)(4) of this section, because the members of N’s coverage family reside in different locations, the monthly premium for N’s applicable benchmark plan is the sum of $1,000, the monthly premiums for the applicable benchmark plan for N, O, and P, who reside together, and $220, the monthly applicable benchmark plan premium for Q, who resides in a different location than N, O, and P. Consequently, the premium for N’s applicable benchmark plan is $1,220.
(ii) Under paragraph (f)(5) of this section, Issuer C’s silver-level plan that covers R, S, and T under one policy ($1,200 monthly premium) and Issuer A’s and Issuer B’s silver-level plans that do not cover R, S and T under one policy are considered in determining R’s and S’s applicable benchmark plan. In addition, under paragraph (f)(5)(ii) of this section, in determining R’s and S’s applicable benchmark plan, the premium taken into account for Issuer A’s plan is $1,450 (the aggregate premiums for self-only policies covering R ($400), S ($450), and T ($600) and the premium taken into account for Issuer B’s plan is $1,000 (the aggregate premiums for self-only policies covering R ($250), S ($300), and T ($450). Consequently, R’s and S’s applicable benchmark plan is the Issuer C silver-level plan covering R’s and S’s coverage family and the premium for their applicable benchmark plan is $1,200.
(ii) Under paragraph (f)(5)(ii) of this section, because multiple policies are required to cover U and V, the members of U’s coverage family who reside together in Location 1, the premium taken into account in determining U’s benchmark plan is $1,000, the sum of the premiums for the second-lowest aggregate cost of self-only policies covering U ($400) and V ($600) offered by the Exchange to U and V for the rating area in which U and V reside. Under paragraph (f)(5)(i) of this section, because all silver-level plans offered by the Exchange in which W and X reside cover W and X under a single policy, the premium for W and X’s coverage that is taken into account in determining U’s benchmark plan is $500, the second-lowest cost silver policy covering W and X that is offered by the Exchange for the rating area in which W and X reside. Under paragraph (f)(4) of this section, because the members of U’s coverage family reside in different locations, U’s monthly benchmark plan premium is $1,500, the sum of the premiums for the applicable benchmark plans for each group of family members residing in different locations ($1,000 for U and V, who reside in Location 1, plus $500 for W and X, who reside in Location 2).
(ii) Under paragraphs (f)(1), (f)(2), (f)(3), and (f)(7) of this section, the silver-level plan that BB and CC use to determine their applicable benchmark plan for all coverage months during the year is Plan 2. The applicable benchmark plan that DD uses to determine DD’s applicable benchmark plan is Plan 3, because Plan 2 is not open to enrollment through the Exchange when the DD family enrolls.
(g) Applicable percentage—(1) In general. The applicable percentage multiplied by a taxpayer’s household income determines the taxpayer’s annual required share of premiums for the benchmark plan. The required share is divided by 12 and this monthly amount is subtracted from the adjusted monthly premium for the applicable benchmark plan when computing the premium assistance amount. The applicable percentage is computed by first determining the percentage that the taxpayer’s household income bears to the Federal poverty line for the taxpayer’s family size. The resulting Federal poverty line percentage is then compared to the income categories described in the table in paragraph (g)(2) of this section. An applicable percentage within an income category increases on a sliding scale in a linear manner and is rounded to the nearest one-hundredth of one percent. For taxable years beginning after December 31, 2014, the applicable percentages in the table will be adjusted by the ratio of premium growth to income growth for the preceding calendar year and may be further adjusted to reflect changes to the data used to compute the ratio of premium growth to income growth for the 2014 calendar year or the data sources used to compute the ratio of premium growth to income growth. Premium growth and income growth will be determined in accordance with published guidance, see § 601.601(d)(2) of this chapter. In addition, the applicable percentages in the table may be adjusted for taxable years beginning after December 31, 2018, to reflect rates of premium growth relative to growth in the consumer price index.
(2) Applicable percentage table.
Household income percentage of Federal poverty line | Initial percentage | Final percentage |
---|---|---|
Less than 133% | 2.0 | 2.0 |
At least 133% but less than 150% | 3.0 | 4.0 |
At least 150% but less than 200% | 4.0 | 6.3 |
At least 200% but less than 250% | 6.3 | 8.05 |
At least 250% but less than 300% | 8.05 | 9.5 |
At least 300% but not more than 400% | 9.5 | 9.5 |
(3) Examples. The following examples illustrate the rules of this paragraph (g):
(ii) Determine the excess of B’s Federal poverty line percentage (210) over the initial household income percentage in B’s range (200), which is 10. Determine the difference between the initial household income percentage in the taxpayer’s range (200) and the ending household income percentage in the taxpayer’s range (250), which is 50. Divide the first amount by the second amount:
(iv) Multiply the amount in the first calculation (.20) by the amount in the second calculation (1.75) and add the product (.35) to the initial premium percentage in B’s range (6.3), resulting in B’s applicable percentage of 6.65:
(h) Plan covering more than one family—(1) In general. If a qualified health plan covers more than one family under a single policy, each applicable taxpayer covered by the plan may claim a premium tax credit, if otherwise allowable. Each taxpayer computes the credit using that taxpayer’s applicable percentage, household income, and the benchmark plan that applies to the taxpayer under paragraph (f) of this section. In determining whether the amount computed under paragraph (d)(1)(i) of this section (the premiums for the qualified health plan in which the taxpayer enrolls) is less than the amount computed under paragraph (d)(1)(ii) of this section (the benchmark plan premium minus the product of household income and the applicable percentage), the premiums paid are allocated to each taxpayer in proportion to the premiums for each taxpayer’s applicable benchmark plan.
(2) Example. The following example illustrates the rules of this paragraph (h):
(ii) Under paragraph (h)(1) of this section, both A and B may claim premium tax credits. A computes her credit using her household income, a family size of three, and a benchmark plan premium of $12,000. B computes his credit using his household income, a family size of one, and a benchmark plan premium of $6,000.
(iii) In determining whether the amount in paragraph (d)(1)(i) of this section (the premiums for the qualified health plan A and B purchase) is less than the amount in paragraph (d)(1)(ii) of this section (the benchmark plan premium minus the product of household income and the applicable percentage), the $15,000 premiums paid are allocated to A and B in proportion to the premiums for their applicable benchmark plans. Thus, the portion of the premium allocated to A is $10,000 ($15,000 × $12,000/$18,000) and the portion allocated to B is $5,000 ($15,000 × $6,000/$18,000).
(i) [Reserved]
(j) Additional benefits—(1) In general. If a qualified health plan offers benefits in addition to the essential health benefits a qualified health plan must provide under section 1302 of the Affordable Care Act (42 U.S.C. 18022), or a State requires a qualified health plan to cover benefits in addition to these essential health benefits, the portion of the premium for the plan properly allocable to the additional benefits is excluded from the monthly premiums under paragraph (d)(1)(i) or (ii) of this section. Premiums are allocated to additional benefits before determining the applicable benchmark plan under paragraph (f) of this section.
(2) Method of allocation. The portion of the premium properly allocable to additional benefits is determined under guidance issued by the Secretary of Health and Human Services. See section 36B(b)(3)(D).
(3) Examples. The following examples illustrate the rules of this paragraph (j):
(ii) Under this paragraph (j), B’s enrollment premiums and the benchmark plan premium are reduced by the portion of the premium that is allocable to the additional benefits provided under that plan. Therefore, B’s monthly enrollment premiums are reduced to $335 ($370 − $35) and B’s benchmark plan premium is reduced to $400 ($440 − $40). B’s premium assistance amount for a coverage month is $335, the lesser of $335 (B’s enrollment premiums, reduced by the portion of the premium allocable to additional benefits) and $340 (B’s benchmark plan premium, reduced by the portion of the premium allocable to additional benefits ($400), minus B’s $60 contribution amount).
(k) Pediatric dental coverage—(1) In general. For purposes of determining the amount of the monthly premium a taxpayer pays for coverage under paragraph (d)(1)(i) of this section, if an individual enrolls in both a qualified health plan and a plan described in section 1311(d)(2)(B)(ii) of the Affordable Care Act (42 U.S.C. 13031(d)(2)(B)(ii)) (a stand-alone dental plan), the portion of the premium for the stand-alone dental plan that is properly allocable to pediatric dental benefits that are essential benefits required to be provided by a qualified health plan is treated as a premium payable for the individual’s qualified health plan.
(2) Method of allocation. The portion of the premium for a stand-alone dental plan properly allocable to pediatric dental benefits is determined under guidance issued by the Secretary of Health and Human Services.
(3) Example. The following example illustrates the rules of this paragraph (k):
(ii) Under this paragraph (k), the amount C pays for premiums (Amount 1) for purposes of computing the premium assistance amount is increased by the portion of the premium for the stand-alone dental plan allocable to pediatric dental benefits that are essential health benefits. Thus, the amount of the premiums for the plan in which C enrolls is treated as $620 for purposes of computing the amount of the premium tax credit. C’s premium assistance amount for each coverage month is $605 (Amount 2), the lesser of Amount 1 (increased by the premiums allocable to pediatric dental benefits) and Amount 2.
(l) Families including individuals not lawfully present—(1) In general. If one or more individuals for whom a taxpayer is allowed a deduction under section 151 are not lawfully present (within the meaning of § 1.36B-1(g)), the percentage a taxpayer’s household income bears to the Federal poverty line for the taxpayer’s family size for purposes of determining the applicable percentage under paragraph (g) of this section is determined by excluding individuals who are not lawfully present from family size and by determining household income in accordance with paragraph (l)(2) of this section.
(2) Revised household income computation—(i) Statutory method. For purposes of paragraph (l)(1) of this section, household income is equal to the product of the taxpayer’s household income (determined without regard to this paragraph (l)(2)) and a fraction—
(A) The numerator of which is the Federal poverty line for the taxpayer’s family size determined by excluding individuals who are not lawfully present; and
(B) The denominator of which is the Federal poverty line for the taxpayer’s family size determined by including individuals who are not lawfully present.
(ii) Comparable method. The Commissioner may describe a comparable method in additional published guidance, see § 601.601(d)(2) of this chapter.
(m) Applicability date. Paragraph (g)(1) of this section applies to taxable years beginning after December 31, 2013.
(n) Effective/applicability date. (1) Except as provided in paragraphs (n)(2) and (3) of this section, this section applies to taxable years ending after December 31, 2013.
(2) Paragraphs (c)(4), (d)(1) and (d)(2) of this section apply to taxable years beginning after December 31, 2016. Paragraph (f) of this section applies to taxable years beginning after December 31, 2018. Paragraphs (d)(1) and (d)(2) of § 1.36B-3, as contained in 26 CFR part I edition revised as of April 1, 2016, applies to taxable years ending after December 31, 2013, and beginning before January 1, 2017. Paragraph (f) of § 1.36B-3, as contained in 26 CFR part I edition revised as of April 1, 2016, applies to taxable years ending after December 31, 2013, and beginning before January 1, 2019.
(3) Paragraph (d)(1)(i) of this section applies to taxable years beginning after December 31, 2022.
(a) Reconciliation—(1) Coordination of premium tax credit with advance credit payments—(i) In general. A taxpayer must reconcile the amount of credit allowed under section 36B with advance credit payments on the taxpayer’s income tax return for a taxable year. A taxpayer whose premium tax credit for the taxable year exceeds the taxpayer’s advance credit payments may receive the excess as an income tax refund. A taxpayer whose advance credit payments for the taxable year exceed the taxpayer’s premium tax credit owes the excess as an additional income tax liability.
(ii) Allocation rules and responsibility for advance credit payments—(A) In general. A taxpayer must reconcile all advance credit payments for coverage of any member of the taxpayer’s family.
(B) Individuals enrolled by a taxpayer and claimed as a personal exemption deduction by another taxpayer—(1) In general. If a taxpayer (the enrolling taxpayer) enrolls an individual in a qualified health plan and another taxpayer (the claiming taxpayer) claims a personal exemption deduction for the individual (the shifting enrollee), then for purposes of computing each taxpayer’s premium tax credit and reconciling any advance credit payments, the enrollment premiums and advance credit payments for the plan in which the shifting enrollee was enrolled are allocated under this paragraph (a)(1)(ii)(B) according to the allocation percentage described in paragraph (a)(1)(ii)(B)(2) of this section. If advance credit payments are allocated under paragraph (a)(1)(ii)(B)(4) of this section, the claiming taxpayer and enrolling taxpayer must use this same allocation percentage to calculate their § 1.36B-3(d)(1)(ii) adjusted monthly premiums for the applicable benchmark plan (benchmark plan premiums). This paragraph (a)(1)(ii)(B) does not apply to amounts allocated under § 1.36B-3(h) (qualified health plan covering more than one family) or if the shifting enrollee or enrollees are the only individuals enrolled in the qualified health plan. For purposes of this paragraph (a)(1)(ii)(B)(1), a taxpayer who is expected at enrollment in a qualified health plan to be the taxpayer filing an income tax return for the year of coverage with respect to an individual enrolling in the plan has enrolled that individual. For taxable years to which section 151(d)(5) applies, the claiming taxpayer is the taxpayer who properly includes the shifting enrollee in his or her family for the taxable year.
(2) Allocation percentage. The enrolling taxpayer and claiming taxpayer may agree on any allocation percentage between zero and one hundred percent. If the enrolling taxpayer and claiming taxpayer do not agree on an allocation percentage, the percentage is equal to the number of shifting enrollees properly included in the enrolling taxpayer’s family divided by the number of individuals enrolled by the enrolling taxpayer in the same qualified health plan as the shifting enrollee.
(3) Allocating premiums. In computing the premium tax credit, the claiming taxpayer is allocated a portion of the enrollment premiums for the plan in which the shifting enrollee was enrolled equal to the enrollment premiums times the allocation percentage. The enrolling taxpayer is allocated the remainder of the enrollment premiums not allocated to one or more claiming taxpayers.
(4) Allocating advance credit payments. In reconciling any advance credit payments, the claiming taxpayer is allocated a portion of the advance credit payments for the plan in which the shifting enrollee was enrolled equal to the enrolling taxpayer’s advance credit payments for the plan times the allocation percentage. The enrolling taxpayer is allocated the remainder of the advance credit payments not allocated to one or more claiming taxpayers. This paragraph (a)(1)(ii)(B)(4) only applies in situations in which advance credit payments are made for coverage of a shifting enrollee.
(5) Premiums for the applicable benchmark plan. If paragraph (a)(1)(ii)(B)(4) of this section applies, the claiming taxpayer’s benchmark plan premium is the sum of the benchmark plan premium for the claiming taxpayer’s coverage family, excluding the shifting enrollee or enrollees, and the allocable portion. The allocable portion for purposes of this paragraph (a)(1)(ii)(B)(5) is the product of the benchmark plan premium for the enrolling taxpayer’s coverage family if the shifting enrollee was a member of the enrolling taxpayer’s coverage family and the allocation percentage. If the enrolling taxpayer’s coverage family is enrolled in more than one qualified health plan, the allocable portion is determined as if the enrolling taxpayer’s coverage family includes only the coverage family members who enrolled in the same plan as the shifting enrollee or enrollees. The enrolling taxpayer’s benchmark plan premium is the benchmark plan premium for the enrolling taxpayer’s coverage family had the shifting enrollee or enrollees remained a part of the enrolling taxpayer’s coverage family, minus the allocable portion.
(C) Responsibility for advance credit payments for an individual not reported on any taxpayer’s return. If advance credit payments are made for coverage of an individual who is not included in any taxpayer’s family, as defined in § 1.36B-1(d), the taxpayer who attested to the Exchange to the intention to include such individual in the taxpayer’s family as part of the advance credit payment eligibility determination for coverage of the individual must reconcile the advance credit payments.
(iii) Advance credit payment for a month in which an issuer does not provide coverage. For purposes of reconciliation, a taxpayer does not have an advance credit payment for a month if the issuer of the qualified health plan in which the taxpayer or a family member is enrolled does not provide coverage for that month.
(2) Credit computation. The premium assistance credit amount is computed on the taxpayer’s return using the taxpayer’s household income and family size for the taxable year. Thus, the taxpayer’s contribution amount (household income for the taxable year times the applicable percentage) is determined using the taxpayer’s household income and family size at the end of the taxable year. The applicable benchmark plan for each coverage month is determined under § 1.36B-3(f).
(3) Limitation on additional tax—(i) In general. The additional tax imposed under paragraph (a)(1) of this section on a taxpayer whose household income is less than 400 percent of the Federal poverty line is limited to the amounts provided in the table in paragraph (a)(3)(ii) of this section (or successor tables). For taxable years beginning after December 31, 2014, the limitation amounts may be adjusted in published guidance, see § 601.601(d)(2) of this chapter, to reflect changes in the consumer price index.
(ii) Additional tax limitation table.
Household income percentage of Federal poverty line | Limitation amount for taxpayers whose tax is determined under section 1(c) | Limitation amount for all other taxpayers |
---|---|---|
Less than 200% | $300 | $600 |
At least 200% but less than 300% | 750 | 1,500 |
At least 300% but less than 400% | 1,250 | 2,500 |
(iii) Limitation on additional tax for taxpayers who claim a section 162(l) deduction for a qualified health plan—(A) In general. A taxpayer who receives advance credit payments and deducts premiums for a qualified health plan under section 162(l) must use paragraph (a)(3)(iii)(B), and paragraph (a)(3)(iii)(C) or (D), of this section to determine the limitation on additional tax in this paragraph (a)(3) (limitation amount). Taxpayers must make this determination before calculating their section 162(l) deduction and premium tax credit. For additional rules for taxpayers who may claim a deduction under section 162(l) for a qualified health plan for which advance credit payments are made, see § 1.162(l)-1.
(B) Determining the limitation amount. A taxpayer described in paragraph (a)(3)(iii)(A) of this section must use the limitation amount for which the taxpayer qualifies under paragraph (a)(3)(iii)(C) or (D) of this section. The limitation amount determined under this paragraph (a)(3)(iii) replaces the limitation amount that would otherwise be determined under the additional tax limitation table in paragraph (a)(3)(ii) of this section. In applying paragraph (a)(3)(iii)(C) of this section, a taxpayer must first determine whether he or she qualifies for the limitation amount applicable to taxpayers with household income of less than 200 percent of the Federal poverty line for the taxpayer’s family size. If the taxpayer does not qualify to use the limitation amount applicable to taxpayers with household income of less than 200 percent of the Federal poverty line for the taxpayer’s family size, the taxpayer must next determine whether he or she qualifies for the limitation applicable to taxpayers with household income of less than 300 percent of the Federal poverty line for the taxpayer’s family size. If the taxpayer does not qualify to use the limitation amount applicable to taxpayers with household income of less than 300 percent of the Federal poverty line for the taxpayer’s family size, the taxpayer must next determine whether he or she qualifies for the limitation applicable to taxpayers with household income of less than 400 percent of the Federal poverty line for the taxpayer’s family size. If the taxpayer does not qualify to use the limitation amount applicable to taxpayers with household income of less than 200 percent, 300 percent, or 400 percent of the Federal poverty line for the taxpayer’s family size, the limitation on additional tax under section 36B(f)(2)(B) does not apply to the taxpayer.
(C) Requirements. A taxpayer meets the requirements of this paragraph (a)(3)(iii)(C) for a limitation amount if the taxpayer’s household income as a percentage of the Federal poverty line is less than or equal to the maximum household income as a percentage of the Federal poverty line for which that limitation is available. Household income for this purpose is determined by using a section 162(l) deduction equal to the lesser of—
(1) The sum of the specified premiums for the plan not paid through advance credit payments, the limitation amount (determined without regard to paragraph (a)(1)(iii)(C)(2) of this section), and any deduction allowable under section 162(l) for premiums other than specified premiums, and
(2) The earned income from the trade or business with respect to which the health insurance plan is established.
(D) Specified premiums not paid through advance credit payments. For purposes of paragraph (a)(3)(iii)(C) of this section, specified premiums not paid through advance credit payments means specified premiums, as defined in § 1.162(l)-1(a)(2), minus advance credit payments made with respect to the specified premiums.
(E) Examples. For examples illustrating the rules of this paragraph (a)(3)(iii), see Examples 13, 14, and 15 of paragraph (a)(4) of this section.
(4) Examples. The following examples illustrate the rules of this paragraph (a). In each example the taxpayer enrolls in a higher cost qualified health plan than the applicable benchmark plan:
(ii) A’s household income for 2014 is $33,622, which is 301 percent of the Federal poverty line for a family of one (applicable percentage 9.5). Consequently, A’s premium tax credit for 2014 is $2,006 (benchmark plan premium of $5,200 less contribution amount of $3,194 (household income of $33,622 × .095)). Because A’s advance credit payments for 2014 are $2,952 and A’s 2014 credit is $2,006, A has excess advance payments of $946. Under paragraph (a)(1) of this section, A’s tax liability for 2014 is increased by $946. Because A’s household income is between 300 percent and 400 percent of the Federal poverty line, if A’s excess advance payments exceeded $1,250, under the limitation of paragraph (a)(3) of this section, A’s additional tax liability would be limited to that amount.
(ii) In 2014, B and C do not claim L as their dependent (and no taxpayer claims a personal exemption deduction for L). Consequently, B’s and C’s family size for 2014 is three, their household income of $63,388 is 332 percent of the Federal poverty line for a family of three (applicable percentage 9.5), and the annual premium for their applicable benchmark plan is $12,000. Their premium tax credit for 2014 is $5,978 ($12,000 benchmark plan premium less $6,022 contribution amount (household income of $63,388 × .095)). Because B’s and C’s advance credit payments for 2014 are $8,535 and their 2014 credit is $5,978, B and C have excess advance payments of $2,557. B’s and C’s additional tax liability for 2014 under paragraph (a)(1) of this section, however, is limited to $2,500 under paragraph (a)(3) of this section.
(ii) D’s actual household income for 2014 is $44,903, which is 402 percent of the Federal poverty line for a family of one. D is not an applicable taxpayer and may not claim a premium tax credit. Additionally, the repayment limitation of paragraph (a)(3) of this section does not apply. Consequently, D has excess advance payments of $1,486 (the total amount of the advance credit payments in 2014). Under paragraph (a)(1) of this section, D’s tax liability for 2014 is increased by $1,486.
(ii) F begins a new job in August 2014 and is eligible for employer-sponsored minimum essential coverage for the period September through December 2014. F discontinues her Exchange coverage effective November 1, 2014. F’s household income for 2014 is $28,707 (257 percent of the Federal poverty line for a family size of one, applicable percentage 8.25).
(iii) Under § 1.36B-3(a), F’s premium assistance credit amount is the sum of the premium assistance amounts for the coverage months. Under § 1.36B-3(c)(1)(iii), a month in which an individual is eligible for minimum essential coverage other than coverage in the individual market is not a coverage month. Because F is eligible for employer-sponsored minimum essential coverage as of September 1, only the months January through August of 2014 are coverage months.
(iv) If F had 12 coverage months in 2014, F’s premium tax credit would be $2,832 (benchmark plan premium of $5,200 less contribution amount of $2,368 (household income of $28,707 × .0825)). Because F has only eight coverage months in 2014, F’s credit is $1,888 ($2,832/12 × 8). Because F does not discontinue her Exchange coverage until November 1, 2014, F’s advance credit payments for 2014 are $2,460 ($246 × 10). Consequently, F has excess advance payments of $572 ($2,460 less $1,888) and F’s tax liability for 2014 is increased by $572 under paragraph (a)(1) of this section.
(ii) On August 1, 2014, E loses her eligibility for government-sponsored minimum essential coverage. E enrolls in the qualified health plan that covers F for August through December 2014. The annual premium for the applicable benchmark plan is $10,000. The Exchange computes E’s monthly advance credit payments for the period September through December to be $675 as follows: benchmark plan premium of $10,000 less contribution amount of $1,906 (projected household income of $30,260 × .063) = $8,094; $8,094/12 = $675. E’s household income for 2014 is $28,747 (190 percent of the Federal poverty line, applicable percentage 5.84).
(iii) Under § 1.36B-3(c)(1), January through July of 2014 are coverage months for F and August through December are coverage months for E and F. Under paragraph (a)(2) of this section, E must compute her premium tax credit using the premium for the applicable benchmark plan for each coverage month. E’s premium assistance credit amount for 2014 is the sum of the premium assistance amounts for all coverage months. E reconciles her premium tax credit with advance credit payments as follows:
Advance credit payments (Jan. to July) | $1,925 | ($275 × 7) |
Advance credit payments (Aug. to Dec.) | 3,375 | ($675 × 5) |
Total advance credit payments | 5,300 | |
Benchmark plan premium (Jan. to July) | 3,033 | (($5,200/12) × 7) |
Benchmark plan premium (Aug. to Dec.) | 4,167 | (($10,000/12) × 5) |
Total benchmark plan premium | 7,200 | |
Contribution amount (taxable year household income × applicable percentage) | 1,679 | ($28,747 × .0584) |
Credit (total benchmark plan premium less contribution amount) | 5,521 |
(ii) E reconciles her premium tax credit with advance credit payments as follows:
Advance credit payments (March to July) | $1,375 | ($275 × 5) |
Advance credit payments (Aug. to Dec.) | 3,375 | ($675 × 5) |
Total advance credit payments | 4,750 | |
Benchmark plan premium (March to July) | 2,167 | (($5,200/12) × 5) |
Benchmark plan premium (Aug. to Dec.) | 4,167 | (($10,000/12) × 5) |
Total benchmark plan premium | 6,334 | |
Contribution amount for 10 coverage months (taxable year household income × applicable percentage × 10/12) | 1,399 | ($28,747 × .0584 × 10/12) |
Credit (total benchmark plan premium less contribution amount) | 4,935 |
(ii) Under paragraph (a)(1)(iii) of this section, F does not take into account advance credit payments for June or July of 2014 when reconciling the premium tax credit with advance credit payments under paragraph (a)(1) of this section.
(ii) K lives with H for more than half of 2014 and H claims K as a dependent for 2014. G and H agree to an allocation percentage, as described in paragraph (a)(1)(ii)(B)(2) of this section, of 20 percent. Under the agreement, H is allocated 20 percent of the items to be allocated, and G is allocated the remainder of those items.
(iii) If H is eligible for a premium tax credit, H takes into account $2,600 of the premiums for the plan in which K was enrolled ($13,000 x .20) and $2,400 of G’s benchmark plan premium ($12,000 × .20). In addition, H is responsible for reconciling $1,287 ($6,434 × .20) of the advance credit payments for K’s coverage.
(iv) G’s family size for 2014 includes only G and J and G’s household income of $58,900 is 380 percent of the Federal poverty line for a family of two (applicable percentage 9.5). G’s benchmark plan premium for 2014 is $9,600 (the benchmark premium for the plan covering G, J, and K ($12,000), minus the amount allocated to H ($2,400). Consequently, G’s premium tax credit is $4,004 (G’s benchmark plan premium of $9,600 minus G’s contribution amount of $5,596 ($58,900 × .095)). G has an excess advance payment of $1,143 (the excess of the advance credit payments of $5,147 ($6,434 − $1,287 allocated to H) over the premium tax credit of $4,004).
(ii) If H is eligible for a premium tax credit, H takes into account $4,290 of the premiums for the plan in which K was enrolled ($13,000 × .33). H, in computing H’s benchmark plan premium, must include $3,960 of G’s benchmark plan premium ($12,000 x .33). In addition, H is responsible for reconciling $2,123 ($6,434 x .33) of the advance credit payments for K’s coverage.
(iii) G’s benchmark plan premium for 2014 is $8,040 (the benchmark premium for the plan covering G, J, and K ($12,000), minus the amount allocated to H ($3,960). Consequently, G’s premium tax credit is $2,444 (G’s benchmark plan premium of $8,040 minus G’s contribution amount of $5,596 ($58,900 × .095)). G has an excess advance credit payment of $1,867 (the excess of the advance credit payments of $4,311 ($6,434 − $2,123 allocated to H) over the premium tax credit of $2,444).
(ii) Because B received the benefit of advance credit payments and deducts premiums for a qualified health plan under section 162(l), B must determine whether B is allowed a limitation on additional tax under paragraph (a)(3)(iii) of this section. B begins by testing eligibility for the $600 limitation amount for taxpayers with household income at less than 200 percent of the Federal poverty line for the taxpayer’s family size. B determines household income as a percentage of the Federal poverty line by taking a section 162(l) deduction equal to the lesser of $6,600 (the sum of the amount of premiums not paid through advance credit payments, $6,000 ($14,000 − $8,000), and the limitation amount, $600) and $75,000 (the earned income from the trade or business with respect to which the health insurance plan is established). The result is $97,100 ($103,700 − $6,600) or 412 percent of the Federal poverty line for B’s family size. Since 412 percent is not less than 200 percent, B may not use a $600 limitation amount.
(iii) B performs the same calculation for the $1,500 ($103,700 − $7,500 = $96,200 or 408 percent of the Federal poverty line) and $2,500 limitation amounts ($103,700 − $8,500 = $95,200 or 404 percent of the Federal poverty line), the amounts for taxpayers with household income of less than 300 percent or 400 percent, respectively, of the Federal poverty line for the taxpayer’s family size, and determines that B may not use either of those limitation amounts. Because B does not meet the requirements of paragraph (a)(3)(iii) of this section for any of the limitation amounts in section 36B(f)(2)(B), B is not eligible for the limitation on additional tax for excess advance credit payments.
(iv) Although B may not claim a limitation on additional tax for excess advance credit payments, B may still be eligible for a premium tax credit. B would determine eligibility for the premium tax credit, the amount of the premium tax credit, and the section 162(l) deduction using the rules under section 36B and section 162(l), applying no limitation on additional tax.
(ii) Because B received the benefit of advance credit payments and deducts premiums for a qualified health plan under section 162(l), B must determine whether B is allowed a limitation on additional tax under paragraph (a)(3)(iii) of this section. B first determines that B does not meet the requirements of paragraph (a)(3)(iii)(C) of this section for using the $600 or $1,500 limitation amounts, the amounts for taxpayers with household income of less than 200 percent or 300 percent, respectively, of the Federal poverty line for the taxpayer’s family size. That is because B’s household income as a percentage of the Federal poverty line, determined by using a section 162(l) deduction for premiums for the qualified health plan equal to the lesser of the sum of the premiums for the plan not paid through advance credit payments and the limitation amount, and the earned income from the trade or business with respect to which the health insurance plan is established, is more than the maximum household income as a percentage of the Federal poverty line for which that limitation is available (using the $600 limitation, B’s household income would be $72,202 ($78,802−($6,000 + $600)), which is 307 percent of the Federal poverty line for B’s family size; and using the $1,500 limitation, B’s household income would be $71,302 ($78,802−($6,000 + $1,500)), which is 303 percent of the Federal poverty line for B’s family size).
(iii) However, B meets the requirements of paragraph (a)(3)(iii)(C) of this section using the $2,500 limitation amount for taxpayers with household income of less than 400 percent of the Federal poverty line for the taxpayer’s family size. That is because B’s household income as a percentage of the Federal poverty line by taking a section 162(l) deduction equal to the lesser of $8,500 (the sum of the amount of premiums not paid through advance credit payments, $6,000, and the limitation amount, $2,500) and $75,000 (the earned income from the trade or business with respect to which the health insurance plan is established), is $70,302 (299 percent of the Federal poverty line), which is below 400 percent of the Federal poverty line for B’s family size, and is less than the maximum amount for which that limitation is available. Thus, B uses a limitation amount of $2,500 in computing B’s additional tax on excess advance credit payments.
(iv) B may determine the amount of the premium tax credit and the section 162(l) deduction using the rules under section 36B and section 162(l), applying the $2,500 limitation amount determined above.
(ii) Because C received the benefit of advance credit payments and deducts premiums for a qualified health plan under section 162(l), C must determine whether C is allowed a limitation on additional tax under paragraph (a)(3)(iii) of this section. C begins by testing eligibility for the $600 limitation amount for taxpayers with household income at less than 200 percent of the Federal poverty line for the taxpayer’s family size. C determines household income as a percentage of the Federal poverty line by taking a section 162(l) deduction equal to the lesser of $6,600 (the sum of the amount of premiums not paid through advance credit payments, $6,000 ($14,000−$8,000), and the limitation amount, $600), and $3,000 (C’s earned income from the trade or business with respect to which the health insurance plan is established). The result is $36,100 ($39,100−$3,000) or 147 percent of the Federal poverty line for C’s family size. Because 147 percent is less than 200 percent, the limitation amount under paragraph (a)(3)(iii) of this section that C uses in computing C’s additional tax on excess advance credit payments is $600.
(iii) C may determine the amount of the premium tax credit and the section 162(l) deduction using the rules under section 36B and section 162(l), applying the $600 limitation amount determined above.
(b) Changes in filing status—(1) In general. Except as provided in paragraph (b)(2) or (b)(3) of this section, a taxpayer whose marital status changes during the taxable year computes the premium tax credit by using the applicable benchmark plan or plans for the taxpayer’s marital status as of the first day of each coverage month. The taxpayer’s contribution amount (household income for the taxable year times the applicable percentage) is determined using the taxpayer’s household income and family size at the end of the taxable year.
(2) Taxpayers who marry during the taxable year—(i) In general. Taxpayers who marry during and file a joint return for the taxable year may compute the additional tax imposed under paragraph (a)(1) of this section under paragraph (b)(2)(ii) of this section. Only taxpayers who are unmarried at the beginning of the taxable year and are married (within the meaning of section 7703) at the end of the taxable year, at least one of whom receives advance credit payments, may use this alternative computation.
(ii) Alternative computation of additional tax liability—(A) In general. The additional tax liability determined under this paragraph (b)(2)(ii) is equal to the excess of the taxpayers’ advance credit payments for the taxable year over the amount of the alternative marriage-year credit. The alternative marriage-year credit is the sum of both taxpayers’ alternative premium assistance amounts for the pre-marriage months and the premium assistance amounts for the marriage months. This paragraph (b)(2)(ii) may not be used to increase the additional premium tax credit computed under paragraph (a)(1)(i) of this section.
(B) Alternative premium assistance amounts for pre-marriage months. Taxpayers compute the alternative premium assistance amounts for each taxpayer for each full or partial month the taxpayers are unmarried as described in paragraph (a)(2) of this section, except that each taxpayer treats the amount of household income as one-half of the actual household income for the taxable year and treats family size as the number of individuals in the taxpayer’s family prior to the marriage. The taxpayers may include a dependent of the taxpayers for the taxable year in either taxpayer’s family size for the pre-marriage months.
(C) Premium assistance amounts for marriage months. Taxpayers compute the premium assistance amounts for each full month the taxpayers are married as described in paragraph (a)(2) of this section.
(3) Taxpayers not married to each other at the end of the taxable year. Taxpayers who are married (within the meaning of section 7703) to each other during a taxable year but legally separate under a decree of divorce or of separate maintenance during the taxable year, and who are enrolled in the same qualified health plan at any time during the taxable year must allocate the benchmark plan premiums, the enrollment premiums, and the advance credit payments for the period the taxpayers are married during the taxable year. Taxpayers must also allocate these items if one of the taxpayers has a dependent enrolled in the same plan as the taxpayer’s former spouse or enrolled in the same plan as a dependent of the taxpayer’s former spouse. The taxpayers may allocate these items to each former spouse in any proportion but must allocate all items in the same proportion. If the taxpayers do not agree on an allocation that is reported to the IRS in accordance with the relevant forms and instructions, 50 percent of: The benchmark plan premiums; the enrollment premiums; and the advance credit payments for the married period, is allocated to each taxpayer. If for a period a plan covers only one of the taxpayers and no dependents, only one of the taxpayers and one or more dependents of that same taxpayer, or only one or more dependents of one of the taxpayers, then the benchmark plan premiums, the enrollment premiums, and the advance credit payments for that period are allocated entirely to that taxpayer.
(4) Taxpayers filing returns as married filing separately or head of household—(i) Allocation of advance credit payments. Except as provided in § 1.36B-2(b)(2)(ii), the premium tax credit is allowed to married (within the meaning of section 7703) taxpayers only if they file joint returns. See § 1.36B-2(b)(2)(i). Taxpayers who receive advance credit payments as married taxpayers and who do not file a joint return must allocate the advance credit payments for coverage under a qualified health plan equally to each taxpayer for any period the plan covers and in which advance credit payments are made for both taxpayers, only one of the taxpayers and one or more dependents of the other taxpayer, or one or more dependents of both taxpayers. If, for a period a plan covers, advance credit payments are made for only one of the taxpayers and no dependents, only one of the taxpayers and one or more dependents of that same taxpayer, or only one or more dependents of one of the taxpayers, the advance credit payments for that period are allocated entirely to that taxpayer. If one or both of the taxpayers is an applicable taxpayer eligible for a premium tax credit for the taxable year, the premium tax credit is computed by allocating the enrollment premiums under paragraph (b)(4)(ii) of this section. The repayment limitation described in paragraph (a)(3) of this section applies to each taxpayer based on the household income and family size reported on that taxpayer’s return. This paragraph (b)(4) also applies to taxpayers who receive advance credit payments as married taxpayers and file a tax return using the head of household filing status.
(ii) Allocation of premiums. If taxpayers who are married within the meaning of section 7703, without regard to section 7703(b), do not file a joint return, 50 percent of the enrollment premiums are allocated to each taxpayer. However, all of the enrollment premiums are allocated to only one of the taxpayers for a period in which a qualified health plan covers only that taxpayer and no dependents, only that taxpayer and one or more dependents of that taxpayer, or only one or more dependents of that taxpayer.
(5) Examples. The following examples illustrate the provisions of this paragraph (b). In each example the taxpayer enrolls in a higher cost qualified health plan than the applicable benchmark plan:
(ii) Q is a single taxpayer with two dependents. In 2013 the Exchange for the rating area where Q resides determines that Q’s 2014 household income will be $35,000 (183 percent of the Federal poverty line, applicable percentage 5.52). Q enrolls in a qualified health plan. The premium for the applicable benchmark plan is $10,000. Q’s monthly advance credit payment is $672, computed as follows: $10,000 benchmark plan premium minus contribution amount of $1,932 ($35,000 × .0552) equals $8,068 (total advance credit); $8,068/12 = $672.
(iii) P and Q marry on July 17, 2014 and enroll in a single policy for a qualified health plan covering four family members, effective August 1, 2014. The premium for the applicable benchmark plan is $14,000. Based on household income of $75,000 and a family size of four (325 percent of the Federal poverty line, applicable percentage 9.5), the Exchange approves advance credit payments of $573 per month, computed as follows: $14,000 benchmark plan premium minus contribution amount of $7,125 ($75,000 × .095) equals $6,875 (total advance credit); $6,875/12 = $573.
(iv) P and Q file a joint return for 2014 and report $75,000 in household income and a family size of four. P and Q compute their credit at reconciliation under paragraph (b)(1) of this section. They use the premiums for the applicable benchmark plans that apply for the months married and the months not married, and their contribution amount is based on their Federal poverty line percentage at the end of the taxable year. P and Q reconcile their premium tax credit with advance credit payments as follows:
Advance payments for P (Jan. to July) | $819 |
Advance payments for Q (Jan. to July) | 4,704 |
Advance payments for P and Q (Aug. to Dec.) | 2,865 |
Total advance payments | 8,388 |
Benchmark plan premium for P (Jan. to July) | 3,033 |
Benchmark plan premium for Q (Jan. to July) | 5,833 |
Benchmark plan premium for P and Q (Aug. to Dec.) | 5,833 |
Total benchmark plan premium | 14,699 |
Contribution amount (taxable year household income × applicable percentage) | 7,125 |
Credit (total benchmark plan premium less contribution amount) | 7,574 |
Additional tax | 814 |
(ii) P and Q compute the alternative marriage-year credit as follows:
Benchmark plan premium for P (Jan. to July) | $3,033 | (($5,200/12) × 7) |
Contribution amount ( | 2,078 | ($37,500 × .095 × 7/12) |
Alternative premium assistance amount for P’s pre-marriage months | 955 | ($3,033−$2,078) |
Benchmark plan premium for Q (Jan. to July) | 5,833 | (($10,000/12) × 7) |
Contribution amount ( | 1,339 | ($37,500 × .0612 × 7/12) |
Alternative premium assistance amount for Q’s pre-marriage months | 4,494 | ($5,833−$1,339) |
Benchmark plan premium for P and Q (Aug. to Dec.) | 5,833 | (($14,000/12 × 5) |
Contribution amount (taxable year household income × applicable percentage × 5/12) | 2,969 | ($75,000 × .095 × 5/12) |
Premium assistance amount for marriage months | 2,864 | ($5,833−$2,969) |
(iii) P and Q reconcile their premium tax credit with advance credit payments by determining the excess of their advance credit payments ($8,388) over their alternative marriage-year credit ($8,313). P and Q must increase their tax liability by $75 under paragraph (a)(1) of this section.
(ii) Taxpayer S is single with no dependents. In 2013, the Exchange for the rating area where S resides determines that S’s 2014 household income will be $20,000 (179 percent of the Federal poverty line, applicable percentage 5.33). S enrolls in a qualified health plan. The premium for the applicable benchmark plan is $5,200. S’s monthly advance credit payment is $345, computed as follows: $5,200 benchmark plan premium minus contribution amount of $1,066 ($20,000 × .0533) = $4,134 (total advance credit); $4,134/12 = $345.
(iii) R and S marry in September 2014 and enroll in a single policy for a qualified health plan covering them both, beginning October 1, 2014. The premium for the applicable benchmark plan is $10,000. Based on household income of $60,000 and a family size of two (397 percent of the Federal poverty line, applicable percentage 9.5), R’s and S’s monthly advance credit payment is $358, computed as follows: $10,000 benchmark plan premium minus contribution amount of $5,700 ($60,000 × .095) = $4,300; $4,300/12 = $358. R’s and S’s advance credit payments for 2014 are $5,232, computed as follows:
Advance payments for R (Jan. to Sept.) | $1,053 | ($117 × 9) |
Advance payments for S (Jan. to Sept.) | 3,105 | ($345 × 9) |
Advance payments for R and S (Oct. to Dec.) | 1,074 | ($358 × 3) |
Total advance payments | 5,232 |
(v) R and S compute their alternative marriage-year credit as follows:
Benchmark plan premium for R (Jan. to Sept.) | $3,900 | (($5,200/12) × 9) |
Contribution amount (( | 2,053 | ($31,000 × .0883 × 9/12) |
Premium assistance amount for R’s pre-marriage months | 1,847 | ($3,900 − $2,053) |
Benchmark plan premium for S (Jan. to Sept.) | 3,900 | (($5,200/12) × 9) |
Contribution amount (( | 2,053 | ($31,000 × .0883 × 9/12) |
Premium assistance amount for S’s pre-marriage months | 1,847 | ($3,900−$2,053) |
0 |
(vi) R and S reconcile their premium tax credit with advance credit payments by determining the excess of their advance credit payments ($5,232) over their alternative marriage-year credit ($3,694). R and S must increase their tax liability by $1,538 under paragraph (a)(1) of this section.
(ii) Because R’s and S’s premium tax credit of $3,484 exceeds their advance credit payments of $2,707, R and S are allowed an additional credit of $777. Although R and S marry in 2014, paragraph (b)(2) of this section (the alternative computation of additional tax for taxpayers who marry during the taxable year) does not apply because they do not owe additional tax for 2014.
(ii) V and W divorce on June 17, 2014, and obtain separate qualified health plans beginning July 1, 2014. V enrolls based on household income of $60,000 and a family size of three (314 percent of the Federal poverty line, applicable percentage 9.5). The premium for the applicable benchmark plan is $10,000. The Exchange approves advance credit payments of $358 per month, computed as follows: $10,000 benchmark plan premium minus V’s contribution amount of $5,700 ($60,000 × .095) equals $4,300 (total advance credit); $4,300/12 = $358.
(iii) W enrolls based on household income of $16,420 and a family size of one (147 percent of the Federal poverty line, applicable percentage 3.82). The premium for the applicable benchmark plan is $5,200. The Exchange approves advance credit payments of $381 per month, computed as follows: $5,200 benchmark plan premium minus W’s contribution amount of $627 ($16,420 × .0382) equals $4,573 (total advance credit); $4,573/12 = $381. V and W do not agree on an allocation of the premium for the applicable benchmark plan, the premiums for the plan in which they enroll, and the advance credit payments for the period they were married in the taxable year.
(iv) V and W each compute their credit at reconciliation under paragraph (b)(1) of this section, using the premiums for the applicable benchmark plans that apply to them for the months married and the months not married, and the contribution amount based on their Federal poverty line percentages at the end of the taxable year. Under paragraph (b)(3) of this section, because V and W do not agree on an allocation, V and W must equally allocate the benchmark plan premium ($7,050) and the advance credit payments ($3,438) for the six-month period January through June 2014 when they are married and enrolled in the same qualified health plan. Thus, V and W each are allocated $3,525 of the benchmark plan premium ($7,050/2) and $1,719 of the advance credit payments ($3,438/2) for January through June.
(v) V reports on his 2014 tax return $60,000 in household income and family size of three. W reports on her 2014 tax return $16,420 in household income and family size of one. V and W reconcile their premium tax credit with advance credit payments as follows:
V | W | |
---|---|---|
Allocated advance payments (Jan. to June) | $1,719 | $1,719 |
Actual advance payments (July to Dec.) | 2,148 | 2,286 |
Total advance payments | 3,867 | 4,005 |
Allocated benchmark plan premium (Jan. to June) | 3,525 | 3,525 |
Actual benchmark plan premium (July to Dec.) | 5,000 | 2,600 |
Total benchmark plan premium | 8,525 | 6,125 |
Contribution amount (taxable year household income × applicable percentage) | 5,700 | 627 |
Credit (total benchmark plan premium less contribution amount) | 2,825 | 5,498 |
Additional credit | 1,493 | |
Additional tax | 1,042 |
V | W | |
---|---|---|
Allocated advance payments (Jan. to June) | $2,716 | $722 |
Actual advance payments (July to Dec.) | 2,148 | 2,286 |
Total advance payments | 4,864 | 3,008 |
Allocated benchmark plan premium (Jan. to June) | 5,570 | 1,481 |
Actual benchmark plan premium (July to Dec.) | 5,000 | 2,600 |
Total benchmark plan premium | 10,570 | 4,081 |
Contribution amount (taxable year household income × applicable percentage) | 5,700 | 627 |
Credit (total benchmark plan premium less contribution amount) | 4,870 | 3,454 |
Additional credit | 6 | 446 |
(ii) X and Y file income tax returns for 2014 using a married filing separately filing status. X reports household income of $60,000 and a family size of three (314 percent of the Federal poverty line). Y reports household income of $16,420 and a family size of one (147 percent of the Federal poverty line).
(iii) Because X and Y are married but do not file a joint return for 2014, X and Y are not applicable taxpayers and are not allowed a premium tax credit for 2014. See § 1.36B-2(b)(2). Under paragraph (b)(4) of this section, half of the advance credit payments ($6,880/2 = $3,440) is allocated to X and half is allocated to Y for purposes of determining their excess advance payments. The repayment limitation described in paragraph (a)(3) of this section applies to X and Y based on the household income and family size reported on each return. Consequently, X’s tax liability for 2014 is increased by $2,500 and Y’s tax liability for 2014 is increased by $600.
(ii) X must reconcile the amount of credit with advance credit payments under paragraph (a) of this section. The premium for the applicable benchmark plan covering X and his two dependents is $9,800. X’s premium tax credit is computed as follows: $9,800 benchmark plan premium minus X’s contribution amount of $5,700 ($60,000 × .095) equals $4,100.
(iii) Under paragraph (b)(4) of this section, half of the advance payments ($6,880/2 = $3,440) is allocated to X and half is allocated to Y. Thus, X is entitled to $660 additional premium tax credit ($4,100 − $3,440). Y has $3,440 excess advance payments, which is limited to $600 under paragraph (a)(3) of this section.
(ii) A’s family size for 2014 for purposes of computing the premium tax credit is one, and A is the only member of her coverage family. Thus, A’s benchmark plan for all months of 2014 is the second lowest cost silver plan offered by the Exchange for A’s rating area that covers A. A’s household income includes only A’s modified adjusted gross income. Under paragraph (b)(4)(ii) of this section, A takes into account $5,000 ($10,000 x .50) of the premiums for the plan in which she was enrolled in determining her premium tax credit. Further, A must reconcile $3,250 ($6,500 x .50) of the advance credit payments for her coverage under paragraph (b)(4)(i) of this section.
(c) Applicability dates. Paragraphs (a)(1)(ii), (a)(3)(iii), (a)(4), Examples 4, 10, 11, 12, 13, 14, and 15, (b)(3), (b)(4), and (b)(5), Examples 9 and 10 apply to taxable years beginning after December 31, 2013. The last sentence of paragraph (a)(1)(ii)(B)(1), paragraph (a)(1)(ii)(B)(2), and paragraph (a)(1)(ii)(C) of this section apply to taxable years ending on or after December 31, 2020.
§ 1.36B-5 Information reporting by Exchanges.
(a) In general. An Exchange must report to the Internal Revenue Service (IRS) information required by section 36B(f)(3) and this section relating to individual market qualified health plans in which individuals enroll through the Exchange. No reporting is required under this section for enrollment in plans through the Small Business Health Options Exchange.
(b) Individual filing a return. For purposes of this section, the terms tax filer and responsible adult describe the individual who is expected to be the taxpayer filing an income tax return for the year of coverage with respect to individuals enrolling in a qualified health plan. A tax filer is an individual on behalf of whom advance payments of the premium tax credit are made. A responsible adult is an individual on behalf of whom advance payments of the premium tax credit are not made. An individual may be a tax filer or responsible adult whether or not enrolled in coverage. If more than one family (within the meaning of § 1.36B-1(d)) enrolls in the same qualified health plan, there is a tax filer or responsible adult for each family.
(c) Information required to be reported—(1) Information reported annually. An Exchange must report to the IRS the following information for each qualified health plan—
(i) The name, address, and taxpayer identification number (TIN), or date of birth if a TIN is not available, of the tax filer or responsible adult;
(ii) The name and TIN, or date of birth if a TIN is not available, of a tax filer’s spouse;
(iii) The amount of the advance credit payments paid for coverage under the plan each month;
(iv) For plans for which advance credit payments are made, the premium (excluding the premium allocated to benefits in excess of essential health benefits, see § 1.36B-3(j)) for the applicable benchmark plan for purposes of computing advance credit payments;
(v) Except as provided in paragraph (c)(3)(ii) of this section, for plans for which advance credit payments are not made, the premium (excluding the premium allocated to benefits in excess of essential health benefits, see § 1.36B-3(j)) for the applicable benchmark plan that would apply to all individuals enrolled in the qualified health plan if advance credit payments were made for the coverage;
(vi) The name and TIN, or date of birth if a TIN is not available, and dates of coverage for each individual covered under the plan;
(vii) The coverage start and end dates of the qualified health plan;
(viii) The monthly premium for the plan in which the individuals enroll, however—
(A) The premium allocated to benefits in excess of essential health benefits is excluded, see § 1.36B-3(j);
(B) The premium for a stand-alone dental plan allocated to pediatric dental benefits is added, see § 1.36B-3(k), but if a family (within the meaning of § 1.36B-1(d)) is enrolled in more than one qualified health plan, the pediatric dental premium is added to the premium for only one qualified health plan; and
(C) The amount is not reduced for advance credit payments;
(ix) The name of the qualified health plan issuer;
(x) The Exchange-assigned policy identification number;
(xi) The Exchange’s unique identifier; and
(xii) Any other information specified by forms or instructions or in published guidance, see § 601.601(d) of this chapter.
(2) Information reported monthly. For each calendar month, an Exchange must report to the IRS for each qualified health plan, the information described in paragraph (c)(1) of this section and the following information—
(i) For plans for which advance credit payments are made—
(A) The names, TINs, or dates of birth if no TIN is available, of the individuals enrolled in the qualified health plan who are expected to be the tax filer’s dependent; and
(B) Information on employment (to the extent this information is provided to the Exchange) consisting of—
(1) The name, address, and EIN of each employer of the tax filer, the tax filer’s spouse, and each individual covered by the plan; and
(2) An indication of whether an employer offered affordable minimum essential coverage that provided minimum value, and, if so, the amount of the employee’s required contribution for self-only coverage;
(ii) The unique identifying number the Exchange uses to report data that enables the IRS to associate the data with the proper account from month to month;
(iii) The issuer’s employer identification number (EIN); and
(iv) Any other information specified by forms or instructions or in published guidance, see § 601.601(d) of this chapter.
(3) Special rules for information reported—(i) Multiple families enrolled in a single qualified health plan. An Exchange must report the information specified in paragraphs (c)(1) and (c)(2) of this section for each family (within the meaning of § 1.36B-1(d)) enrolled in a qualified health plan, including families submitting a single application or enrolled in a single qualified health plan. If advance credit payments are made for coverage under the plan, the enrollment premiums reported to each family under paragraph (c)(1)(viii) of this section are the premiums allocated to the family under § 1.36B-3(h) (allocating enrollment premiums to each taxpayer in proportion to the premiums for each taxpayer’s applicable benchmark plan).
(ii) Alternative to reporting applicable benchmark plan. An Exchange satisfies the requirement in paragraph (c)(1)(v) of this section if, on or before January 1 of each year after 2014, the Exchange provides a reasonable method that a responsible adult may use to determine the premium (after adjusting for benefits in excess of essential health benefits) for the applicable benchmark plan that applies to the responsible adult’s coverage family for the prior calendar year for purposes of determining the premium tax credit on the tax return.
(iii) Partial month of coverage.—(A) In general. Except as provided in paragraph (c)(3)(iii)(B) of this section, if an individual is enrolled in a qualified health plan after the first day of a month, the amount reported for that month under paragraphs (c)(1)(iv), (c)(1)(v), and (c)(1)(viii) of this section is $0.
(B) Certain mid-month enrollments. For information reporting that is due on or after January 1, 2019, if an individual’s qualified health plan is terminated before the last day of a month, or if an individual is enrolled in coverage after the first day of a month and the coverage is effective on the date of the individual’s birth, adoption, or placement for adoption or in foster care, or on the effective date of a court order, the amount reported under paragraphs (c)(1)(iv) and (c)(1)(v) of this section is the premium for the applicable benchmark plan for a full month of coverage (excluding the premium allocated to benefits in excess of essential health benefits), and the amount reported under paragraph (c)(1)(viii) of this section is the enrollment premium for the month, reduced by any amounts that were refunded.
(4) Exemptions. For each calendar month, an Exchange must report to the IRS the name and TIN, or date of birth if a TIN is not available, of each individual for whom the Exchange has granted an exemption from coverage under section 5000A(e) and the related regulations, the months for which the exemption is in effect, and the exemption certificate number.
(d) Time for reporting—(1) Annual reporting. An Exchange must submit to the IRS the annual report required under paragraph (c)(1) of this section on or before January 31 of the year following the calendar year of coverage.
(2) Monthly reporting—(i) In general. Except as provided in paragraph (d)(2)(ii) of this section, an Exchange must submit to the IRS the monthly reports required under paragraphs (c)(2) and (c)(4) of this section on or before the 15th day following each month of coverage.
(ii) Initial monthly reporting in 2014. Exchanges must submit to the IRS the initial monthly report required under paragraphs (c)(2) and (c)(4) of this section on a date that the Commissioner may establish in other guidance, see § 601.601(d) of this section, but no earlier than June 15, 2014. The initial report must include cumulative information for enrollments for the period January 1, 2014, through the last day of the month preceding the month for submitting the initial monthly report.
(3) Corrections to information reported. In general, an Exchange must correct erroneous or outdated monthly-reported information in the next monthly report. If the information must be corrected after the final monthly submission on January 15 following the coverage year, corrections should be submitted by the 15th day of the month following the month in which the incorrect information is identified. However, no monthly report correction is permitted after April 15 following the year of coverage. Errors on the annual report must be corrected and reported to the IRS and to the individual recipient identified in paragraph (f) of this section as soon as possible.
(e) Electronic reporting. An Exchange must submit the reports to the IRS required under this section in electronic format. The information reported monthly will be submitted to the IRS through the Department of Health and Human Services.
(f) Annual statement to be furnished to individuals—(1) In general. An Exchange must furnish to each tax filer or responsible adult (the recipient for purposes of paragraphs (f) and (g) of this section) a written statement showing—
(i) The name and address of the recipient and
(ii) The information described in paragraph (c)(1) of this section for the previous calendar year.
(2) Form of statements. A statement required under this paragraph (f) may be made by furnishing to the recipient identified in the annual report either a copy of the report filed with the IRS or a substitute statement. A substitute statement must include the information required to be shown on the report filed with the IRS and must comply with requirements in published guidance (see § 601.601(d)(2) of this chapter) relating to substitute statements. A reporting entity may use an IRS truncated taxpayer identification number as the identification number for an individual in lieu of the identification number appearing on the corresponding information report filed with the IRS.
(3) Time and manner for furnishing statements. An Exchange must furnish the statements required under this paragraph (f) on or before January 31 of the year following the calendar year of coverage. If mailed, the statement must be sent to the recipient’s last known permanent address or, if no permanent address is known, to the recipient’s temporary address. For purposes of this paragraph (f)(3), an Exchange’s first class mailing to the last known permanent address, or if no permanent address is known, the temporary address, discharges the Exchange’s requirement to furnish the statement. An Exchange may furnish the statement electronically in accordance with paragraph (g) of this section.
(g) Electronic furnishing of statements—(1) In general. An Exchange required to furnish a statement under paragraph (f) of this section may furnish the statement to the recipient in an electronic format in lieu of a paper format. An Exchange that meets the requirements of paragraphs (g)(2) through (g)(7) of this section is treated as furnishing the statement in a timely manner.
(2) Consent—(i) In general. A recipient must have affirmatively consented to receive the statement in an electronic format. The consent may be made electronically in any manner that reasonably demonstrates that the recipient is able to access the statement in the electronic format in which it will be furnished. Alternatively, the consent may be made in a paper document that is confirmed electronically.
(ii) Withdrawal of consent. The consent requirement of this paragraph (g)(2) is not satisfied if the recipient withdraws the consent and the withdrawal takes effect before the statement is furnished. An Exchange may provide that the withdrawal of consent takes effect either on the date the Exchange receives it or on another date no more than 60 days later. The Exchange may provide that a request by the recipient for a paper statement will be treated as a withdrawal of consent to receive the statement in an electronic format. If the Exchange furnishes a statement after the withdrawal of consent takes effect, the recipient has not consented to receive the statement in electronic format.
(iii) Change in hardware or software requirements. If a change in the hardware or software required to access the statement creates a material risk that a recipient will not be able to access a statement, an Exchange must, prior to changing the hardware or software, notify the recipient. The notice must describe the revised hardware and software required to access the statement and inform the recipient that a new consent to receive the statement in the revised electronic format must be provided to the Exchange. After implementing the revised hardware and software, the Exchange must obtain a new consent or confirmation of consent from the recipient to receive the statement electronically.
(iv) Examples. The following examples illustrate the rules of this paragraph (g)(2):
(3) Required disclosures—(i) In general. Prior to, or at the time of, a recipient’s consent, an Exchange must provide to the recipient a clear and conspicuous disclosure statement containing each of the disclosures described in paragraphs (g)(3)(ii) through (g)(3)(viii) of this section.
(ii) Paper statement. An Exchange must inform the recipient that the statement will be furnished on paper if the recipient does not consent to receive it electronically.
(iii) Scope and duration of consent. An Exchange must inform the recipient of the scope and duration of the consent. For example, the Exchange must inform the recipient whether the consent applies to each statement required to be furnished after the consent is given until it is withdrawn or only to the first statement required to be furnished following the consent.
(iv) Post-consent request for a paper statement. An Exchange must inform the recipient of any procedure for obtaining a paper copy of the recipient’s statement after giving the consent described in paragraph (g)(2)(i) of this section and whether a request for a paper statement will be treated as a withdrawal of consent.
(v) Withdrawal of consent. An Exchange must inform the recipient that—
(A) The recipient may withdraw consent by writing (electronically or on paper) to the person or department whose name, mailing address, telephone number, and email address is provided in the disclosure statement;
(B) An Exchange will confirm the withdrawal and the date on which it takes effect in writing (either electronically or on paper); and
(C) A withdrawal of consent does not apply to a statement that was furnished electronically in the manner described in this paragraph (g) before the date on which the withdrawal of consent takes effect.
(vi) Notice of termination. An Exchange must inform the recipient of the conditions under which the Exchange will cease furnishing statements electronically to the recipient.
(vii) Updating information. An Exchange must inform the recipient of the procedures for updating the information needed to contact the recipient and notify the recipient of any change in the Exchange’s contact information.
(viii) Hardware and software requirements. An Exchange must provide the recipient with a description of the hardware and software required to access, print, and retain the statement, and the date when the statement will no longer be available on the Web site. The Exchange must advise the recipient that the statement may be required to be printed and attached to a Federal, State, or local income tax return.
(4) Format. The electronic version of the statement must contain all required information and comply with applicable published guidance (see § 601.601(d) of this chapter) relating to substitute statements to recipients.
(5) Notice—(i) In general. If a statement is furnished on a Web site, the Exchange must notify the recipient. The notice may be delivered by mail, electronic mail, or in person. The notice must provide instructions on how to access and print the statement and include the following statement in capital letters, “IMPORTANT TAX RETURN DOCUMENT AVAILABLE.” If the notice is provided by electronic mail, this statement must be on the subject line of the electronic mail.
(ii) Undeliverable electronic address. If an electronic notice described in paragraph (g)(5)(i) of this section is returned as undeliverable, and the Exchange cannot obtain the correct electronic address from the Exchange’s records or from the recipient, the Exchange must furnish the notice by mail or in person within 30 days after the electronic notice is returned.
(iii) Corrected statement. An Exchange must furnish a corrected statement to the recipient electronically if the original statement was furnished electronically. If the original statement was furnished through a Web site posting, the Exchange must notify the recipient that it has posted the corrected statement on the Web site in the manner described in paragraph (g)(5)(i) of this section within 30 days of the posting. The corrected statement or the notice must be furnished by mail or in person if—
(A) An electronic notice of the Web site posting of an original statement or the corrected statement was returned as undeliverable; and
(B) The recipient has not provided a new email address.
(6) Access period. Statements furnished on a Web site must be retained on the Web site through October 15 of the year following the calendar year to which the statements relate (or the first business day after October 15, if October 15 falls on a Saturday, Sunday, or legal holiday). The furnisher must maintain access to corrected statements that are posted on the Web site through October 15 of the year following the calendar year to which the statements relate (or the first business day after October 15, if October 15 falls on a Saturday, Sunday, or legal holiday) or the date 90 days after the corrected forms are posted, whichever is later.
(7) Paper statements after withdrawal of consent. An Exchange must furnish a paper statement if a recipient withdraws consent to receive a statement electronically and the withdrawal takes effect before the statement is furnished. A paper statement furnished under this paragraph (g)(7) after the statement due date is timely if furnished within 30 days after the date the Exchange receives the withdrawal of consent.
(h) Effective/applicability date. Except for the last sentence of paragraph (c)(3)(i) of this section and paragraph (c)(3)(iii) of this section, this section applies to taxable years ending after December 31, 2013. The last sentence of paragraph (c)(3)(i) of this section and paragraph (c)(3)(iii) of this section apply to taxable years beginning after December 31, 2018. Paragraph (c)(3) of § 1.36B-5 as contained in 26 CFR part I edition revised as of April 1, 2016, applies to information reporting for taxable years ending after December 31, 2013, and beginning before January 1, 2019.
§ 1.36B-6 Minimum value.
(a) In general—(1) Employees. An eligible employer-sponsored plan provides minimum value (MV) for an employee of the employer offering the coverage only if—
(i) The plan’s MV percentage, as defined in paragraph (c) of this section, is at least 60 percent based on the plan’s share of the total allowed costs of benefits provided to the employee; and
(ii) The plan provides substantial coverage of inpatient hospital services and physician services.
(2) Related individuals—(i) In general. An eligible employer-sponsored plan provides MV for an individual who may enroll in the plan because of a relationship to an employee of the employer offering the coverage (a related individual) only if—
(A) The plan’s MV percentage, as defined in paragraph (c) of this section, is at least 60 percent based on the plan’s share of the total allowed costs of benefits provided to the related individual; and
(B) The plan provides substantial coverage of inpatient hospital services and physician services.
(ii) Plans providing MV to employees. If an eligible employer-sponsored plan provides MV to an employee under paragraph (a)(1) of this section, the plan also provides MV for related individuals if—
(A) The scope of benefits is the same for the employee and related individuals; and
(B) Cost sharing (including deductibles, co-payments, coinsurance, and out-of-pocket maximums) under the plan is the same for the employee and related individuals under the tier of coverage that would, if elected, include the employee and all related individuals (disregarding any differences in deductibles or out-of-pocket maximums that are attributable to a different tier of coverage, such as self plus one versus family coverage).
(b) MV standard population. [Reserved]
(c) MV percentage—(1) In general. [Reserved]
(2) Wellness program incentives—(i) In general. Nondiscriminatory wellness program incentives offered by an eligible employer-sponsored plan that affect deductibles, copayments, or other cost-sharing are treated as earned in determining the plan’s MV percentage if the incentives relate exclusively to tobacco use. Wellness program incentives that do not relate to tobacco use or that include a component unrelated to tobacco use are treated as not earned for this purpose. For purposes of this section, the term wellness program incentive has the same meaning as the term reward in § 54.9802-1(f)(1)(i) of this chapter.
(ii) Example. The following example illustrates the rules of this paragraph (c)(2):
(ii) Under paragraph (c)(2)(i) of this section, only the incentives related to tobacco use are considered in determining the plan’s MV percentage. C is treated as having earned the $300 incentive for attending a smoking cessation course regardless of whether C actually attends the course. Thus, the deductible for determining for the MV percentage for both Employees B and C is $3,700. The $200 incentive for completing cholesterol screening is disregarded.
(3) Employer contributions to health savings accounts. Employer contributions for the current plan year to health savings accounts that are offered with an eligible employer-sponsored plan are taken into account for that plan year towards the plan’s MV percentage.
(4) Employer contributions to health reimbursement arrangements. Amounts newly made available for the current plan year under a health reimbursement arrangement that would be integrated within the meaning of Notice 2013-54 (2013-40 IRB 287), see § 601.601(d) of this chapter, with an eligible employer-sponsored plan for an employee enrolled in the plan are taken into account for that plan year towards the plan’s MV percentage if the amounts may be used to reduce only cost-sharing for covered medical expenses. A health reimbursement arrangement counts toward a plan’s MV percentage only if the health reimbursement arrangement and the eligible employer-sponsored plan are offered by the same employer. Employer contributions to a health reimbursement arrangement count for a plan year towards the plan’s MV percentage only to the extent the amount of the annual contribution is required under the terms of the plan or otherwise determinable within a reasonable time before the employee must decide whether to enroll in the eligible employer-sponsored plan.
(5) Expected spending adjustments for health savings accounts and health reimbursement arrangements. [Reserved]
(d) Methods for determining MV. [Reserved]
(e) Scope of essential health benefits and adjustment for benefits not included in MV Calculator. [Reserved]
(f) Actuarial certification. [Reserved]
(1) In general. [Reserved]
(2) Membership in American Academy of Actuaries. [Reserved]
(3) Actuarial analysis. [Reserved]
(4) Use of MV Calculator. [Reserved]
(g) Effective/applicability date—in general. (1) Except as provided in paragraph (g)(2) of this section, this section applies for taxable years ending after December 31, 2013.
(2) Exceptions. (i) Paragraph (a)(1)(ii) of this section applies for plan years beginning after November 3, 2014; and
(ii) Paragraph (a)(2) of this section applies to taxable years beginning after December 31, 2022.
§ 1.37-1 General rules for the credit for the elderly.
(a) In general. In the case of an individual, section 37 provides a credit against the tax imposed by chapter 1 of the Internal Revenue Code of 1954. This section and §§ 1.37-2 and 1.37-3 provide guidance in the computation of the credit for the elderly provided under section 37 for taxable years beginning after 1975. For rules relating to the computation of the retirement income credit provided under section 37 for taxable years beginning before 1976, see 26 CFR 1.37-1 through 1.37-5 (Rev. as of April 1, 1980). Note that section 403 of the Tax Reduction and Simplification Act of 1977 provides that a taxpayer may elect to compute the credit under section 37 for the taxpayer’s first taxable year beginning in 1976 in accordance with the rules applicable to taxable years beginning before 1976.
(b) Limitation on the amount of the credit. The credit allowed by section 37 for a taxable year shall not exceed the tax imposed by chapter 1 of the Code for the taxable year (reduced, in the case of a taxable year beginning before 1979, by the general tax credit allowed by section 42).
(c) Married couples must file joint returns. If the taxpayer is married at the close of the taxable year, the credit provided by section 37 shall be allowed only if the taxpayer and the taxpayer’s spouse file a joint return for the taxable year. The preceding sentence shall not apply in the case of a husband and wife who are not members of the same household at any time during the taxable year. For the determination of marital status, see §§ 143 and 1.143-1.
(d) Nonresident aliens ineligible. No credit is allowed under section 37 to any individual for any taxable year during which that individual is at any time a nonresident alien unless the individual is treated, by reason of an election under section 6013 (g) or (h), as a resident of the United States for that taxable year.
§ 1.37-2 Credit for individuals age 65 or over.
(a) In general. This section illustrates the computation of the credit for the elderly in the case of an individual who has attained the age of 65 before the close of the taxable year. This section shall not apply to an individual for any taxable year for which the individual makes the election described in section 37(e)(2) and paragraph (b) of § 1.37-3.
(b) Computation of credit. The credit for the elderly for an individual to whom this section applies equals 15 percent of the individual’s “section 37 amount” for the taxable year. An individual’s “section 37 amount” for a taxable year is the initial amount determined under section 37(b)(2), reduced as provided in section 37(b)(3) and (c)(1).
(c) Examples. The computation of the credit for the elderly for individuals to whom this section applies may be illustrated by the following examples:
Initial amount under section 37(b)(2) | $2,500 | |
Reductions required by section 37 (b)(3) and (c)(1): | ||
Social security payments | $1,450 | |
One-half the excess of adjusted gross income over $7,500 | 250 | 1,700 |
Section 37 amount | 800 | |
15 pct. of $800 | $120 |
Initial amount under section 37(b)(2) | $3,750 | |
Reductions required by section 37 (b)(3): | ||
Railroad retirement pension | $1,550 | |
Social Security payments | 1,200 | 2,750 |
Section 37 amount | 1,000 | |
15 pct. of $1,000 | 150 | |
Limitation based upon amount of tax (derived from table reflecting allowance of general tax credit) | $139 |
§ 1.37-3 Credit for individuals under age 65 who have public retirement system income.
(a) In general. This section provides rules for the computation of the credit for the elderly under section 37(e) in the case of an individual who has not attained the age of 65 before the close of the taxable year and whose gross income for the taxable year includes retirement income within the meaning of paragraph (d)(1)(ii) of this section (i.e., under a public retirement system). If such an individual is married within the meaning of section 143 at the close of the taxable year and the spouse of the individual has attained the age of 65 before the close of the taxable year, this section shall apply to the individual for the taxable year only if both spouses make the election described in paragraph (b) of this section. If both spouses make the election described in paragraph (b) of this section for the taxable year, the credit of each spouse shall be determined under the rules of this section. See paragraph (f)(2) of this section for a limitation on the effects of community property laws in making determinations and computations under section 37(e) and this section.
(b) Election by certain married taxpayers. If a married individual under age 65 at the close of the taxable year has retirement income and the spouse of that individual has attained the age of 65 before the close of the taxable year, both spouses may elect to compute the credit provided by section 37 under the rules of section 37(e) and this section. The spouses shall signify the election on the return (or amended return) for the taxable year in the manner prescribed in the instructions accompanying the return. The election may be made at any time before the expiration of the period of limitation for filing claim for credit or return for the taxable year. The election may be revoked without the consent of the Commissioner at any time before the expiration of that period by filing an amended return.
(c) Computation of credit. The credit of an individual under section 37(e) and this section equals 15 percent of the individual’s credit base for the taxable year. The credit base of an individual for a taxable year is the lesser of—
(1) The retirement income of the individual for the taxable year, or
(2) The amount determined under section 37(e)(5), as modified by section 37(e) (6) and (7).
(d) Retirement income—(1) General rule—(i) For individuals 65 or over. Section 37(e)(4)(A) enumerates the kinds of income which may be treated as the retirement income of an individual who has attained the age of 65 before the close of the taxable year. They include income from pensions and annuities, interest, rents, dividends, certain bonds received under a qualified bond purchase plan, and certain individual retirement accounts or annuities.
(ii) For individuals under 65. In the case of an individual who has not attained the age of 65 before the close of the taxable year, retirement income consists only of income from pensions and annuities (including disability annuity payments) under a public retirement system which arises from services performed by that individual or by a present or former spouse of that individual. The term “public retirement system” means a pension, annuity, or retirement, or similar fund or system established by the United States, a State, a possession of the United States, any political subdivision of any of the foregoing, or the District of Columbia.
(2) Rents. For purposes of section 37(e)(4)(A)(iii), income from rents shall be the gross amount received, not reduced by depreciation or other expenses, except that beneficiaries of a trust or estate shall treat as retirement income only their proportionate shares, of the taxable rents of the trust or estate. In the case of an amount received for board and lodging, only the portion of the amount received for lodging is income from rents.
(3) Disability annuity payments received by individual under age 65. Disability annuity payments received under a public retirement system by an individual under age 65 at the close of the taxable year shall not be treated as retirement income unless the payments are for periods after the date on which the individual reached minimum retirement age, that is, the age at which the individual would be eligible to receive a pension or annuity without regard to disability, and any of the following conditions is satisfied—
(i) The individual is precluded from seeking the benefits of section 105(d) (relating to certain disability payments) for that taxable year by reason of an irrevocable election;
(ii) The individual was not permanently and totally disabled at the time of retirement (and was not permanently and totally disabled either on January 1, 1976, or on January 1, 1977, if the individual retired before the later date on disability or under circumstances which entitled the individual to retire on disability); or
(iii) The payments are for periods after the individual reached mandatory retirement age.
(4) Compensation of personal services rendered during taxable year. Retirement income does not include any amount representing compensation for personal services rendered during the taxable year. For this purpose, amounts received as a pension shall not be treated as representing compensation for personal services rendered during the taxable year if the period of service during the taxable year is not substantial when compared with the total years of service. For example, an individual on the calendar year basis retires on November 30 after 5 years of service and receives a pension during the remainder of his taxable year. The pension is not treated as representing compensation for personal services rendered during such taxable year merely because it is paid by reason of the services of the individual for a period of 5 years which includes a portion of the taxable year.
(5) Amounts not includible in gross income. Retirement income does not include any amount not includible in the gross income of the individual for the taxable year. For example, if a portion of an annuity is excluded from gross income under section 72, relating to annuities, that portion of the annuity is not retirement income; similarly, the portion of dividend income excluded from gross income under section 116, relating to the partial exclusion of dividends received by individuals is not retirement income.
(e) Earned income—(1) In general. The term “earned income” in section 37(e)(5)(B) generally has the same meaning as in section 911(b), except that earned income does not include any amount received as a pension or annuity. See section 911(b) and the regulations thereunder. Section 911(b) provides, in general, that earned income includes wages, salaries, professional fees, and other amounts received as compensation for personal services rendered.
(2) Earned income from self-employment. For purposes of section 37(e)(5)(B), the earned income of a taxpayer from self-employment in a trade or business shall not exceed—
(i) The taxpayer’s share of the net profits from the trade or business if capital is not a material income-producing factor in that trade or business; or
(ii) Thirty percent of the taxpayer’s share of the net profits from the trade or business if capital is a material income-producing factor in that trade or business.
(3) Disability annuity payments received by individuals under age 65. Disability annuity payments received under a public retirement system by an individual under age 65 at the close of the taxable year shall be treated as earned income for purposes of section 37(e)(5)(B) unless the payments are treated as retirement income under paragraph (d)(3) of this section.
(f) Computation of credit under section 37(e) in the case of joint returns—(1) In general. In the case of a joint return of husband and wife, the credit base of each spouse under section 37(e) is computed separately. The spouses then combine their credit bases and compute a single credit. The limitation in section 37(c)(2) and paragraph (b) of § 1.37-1 on the amount of the credit is determined by reference to the joint tax liability of the spouses. Thus, regardless of whether a spouse would be liable for the tax imposed by chapter 1 of the Code if the joint return had not been filed, the credit base of that spouse is taken into account in computing the credit.
(2) Community property laws. For taxable years beginning after 1977, married individuals filing joint returns shall disregard community property laws in making any determination or computation required under section 37(e) or this section. Each item of income is attributed in full to the spouse whose income it would have been in the absence of community property laws. Thus, if a 67-year old individual files a joint return with a 62-year old spouse for 1979 and the only income of the couple is from a public pension of the older spouse, that public pension is attributed in full to the older spouse for purposes of section 37(e) even though the applicable community property law may treat one-half of the pension as the income of the 62-year old spouse. Since the younger spouse consequently has no retirement income within the meaning of paragraph (d) of this section, the couple may not make the election described in paragraph (b) of this section.
(g) Examples. The computation of the credit for the elderly under section 37(e) and this section is illustrated by the following examples:
Maximum retirement income level under section 37(e)(5) | $2,500 | |
Earned income offset under section 37(e)(5)(B)(ii): | ||
Earned income in excess of $1,700 | $950 | |
One-half of earned income in excess of $1,200, but not in excess of $1,700 | 250 | 1,200 |
Amount determined under section 37(e)(5) | 1,300 | |
Retirement income | 2,400 | |
Credit for the elderly (15 pct. of $1,300) | 195 |
Credit base of H: | ||
Amount allocated to H under section 37(e)(6) | $2,150 | |
Reductions required by section 37(e)(5): | ||
Social Security payments | $1,400 | |
One-half of excess of earnings over $1,200 | 50 | 1,450 |
Amount determined under section 37(e)(5) | 700 | |
Retirement income | 6,000 | |
Credit base of H | 700 | |
Credit base of W: | ||
Amount allocated to W under section 37(e)(6) | $1,600 | |
Reduction required by section 37(e)(5)(B): | ||
One-half of excess of earnings over $1,200 | $200 | |
Amount determined under section 37(e)(5) | 1,400 | |
Retirement income | 1,400 | |
Credit base of W | 1,400 | |
Computation of credit: | ||
Credit base of H | 700 | |
Credit base of W | 1,400 | |
Combined credit base | 2,100 | |
Credit for the elderly (15 pct. of $2,100) | 315 |
(b) Subject to the limitation of section 37(c)(2) and paragraph (b) of § 1.37-1, H’s credit for the elderly is $157.50, computed as follows:
Maximum retirement income level under section 37(e)(7) | $1,875 | |
Reductions required by section 37(e)(5): | ||
Social security payments | $700 | |
One-half of excess of earnings over $1,200 (taking into account one-half of combined earnings of $2,900) | 125 | 825 |
Amount determined under section 37(e)(5) | 1,050 | |
Retirement income | 3,700 | |
Credit of H (15 pct. of $1,050) | 157.50 |
Maximum retirement income level under section 37(e)(7) | $1,875 | |
Reductions required by section 37(e)(5): | ||
Social security payments | $700 | |
One-half of excess of earnings over $1,200 | 125 | 825 |
Amount determined under section 37(e)(5) | 1,050 | |
Retirement income (limited to W’s share of public pension) | 700 | |
Credit of W (15 pct. of $700) | 105 |
§ 1.38-1 Investment in certain depreciable property.
Regulations under sections 46 through 50 are prescribed under the authority granted the Secretary by section 38(b) to prescribe regulations as may be necessary to carry out the purposes of section 38 and subpart B, part IV, subchapter A, chapter 1 of the Code.
§ 1.40-1 Questions and answers relating to the meaning of the term “qualified mixture” in section 40(b)(1).
Q-1. What is a “qualified mixture” within the meaning of section 40(b)(1)?
A-1. A “qualified mixture” is a mixture of alcohol and gasoline or of alcohol and special fuel which (1) is sold by the taxpayer producing such mixture to any person for use as a fuel, or (2) is used as a fuel by the taxpayer producing such mixture.
Q-2. Must alcohol be present in a product in order for that product to be considered a mixture of alcohol and either gasoline or a special fuel?
A-2. No. A product is considered to be a mixture of alcohol and gasoline or of alcohol and a special fuel if the product is derived from alcohol and either gasoline or a special fuel even if the alcohol is chemically transformed in producing the product so that the alcohol is no longer present as a separate chemical in the final product, provided that there is no significant loss in the energy content of the alcohol. Thus, a product may be considered to be “mixture of alcohol and gasoline or of alcohol and a special fuel” within the meaning of section 40(b)(1)(B) if such product is produced in a chemical reaction between alcohol and either gasoline or a special fuel. Similarly a product may be considered to be a “mixture of alcohol and gasoline or of alcohol and a special fuel” if such product is produced by blending a chemical compound derived from alcohol with either gasoline or a special fuel.
Thus, for example, a blend of gasoline and ethyl tertiary butyl ether (ETBE), a compound derived from ethanol (a qualified alcohol), in a chemical reaction in which there is no significant loss in the energy content of the ethanol, is considered for purposes of section 40(b)(1)(B) to be a mixture of gasoline and the ethanol used to produce the ETBE, even though the ethanol is chemically transformed in the production of ETBE and is not present in the final product.
§ 1.41-0 Table of contents.
This section lists the table of contents for §§ 1.41-1 through 1.41-9.
(a) Amount of credit.
(b) Introduction to regulations under section 41.
(a) Trade or business requirement.
(1) In general.
(2) New business.
(3) Research performed for others.
(i) Taxpayer not entitled to results.
(ii) Taxpayer entitled to results.
(4) Partnerships.
(i) In general.
(ii) Special rule for certain partnerships and joint ventures.
(b) Supplies and personal property used in the conduct of qualified research.
(1) In general.
(2) Certain utility charges.
(i) In general.
(ii) Extraordinary expenditures.
(3) Right to use personal property.
(4) Use of personal property in taxable years beginning after December 31, 1985.
(c) Qualified services.
(1) Engaging in qualified research.
(2) Direct supervision.
(3) Direct support.
(d) Wages paid for qualified services.
(1) In general.
(2) “Substantially all.”
(e) Contract research expenses.
(1) In general.
(2) Performance of qualified research.
(3) “On behalf of.”
(4) Prepaid amounts.
(5) Examples.
(a) New taxpayers.
(b) Special rules for short taxable years.
(1) Short credit year.
(2) Short taxable year preceding credit year.
(3) Short taxable year in determining fixed-base percentage.
(c) Definition of gross receipts.
(1) In general.
(2) Amounts excluded.
(3) Foreign corporations.
(d) Consistency requirement.
(1) In general.
(2) Illustrations.
(e) Effective date.
(a) Qualified research.
(1) General rule.
(2) Requirements of section 41(d)(1).
(3) Undertaken for the purpose of discovering information.
(i) In general.
(ii) Application of the discovering information requirement.
(iii) Patent safe harbor.
(4) Technological in nature.
(5) Process of experimentation.
(i) In general.
(ii) Qualified purpose.
(6) Substantially all requirement.
(7) Use of computers and information technology.
(8) Illustrations.
(b) Application of requirements for qualified research.
(1) In general.
(2) Shrinking-back rule.
(3) Illustration.
(c) Excluded activities.
(1) In general.
(2) Research after commercial production.
(i) In general.
(ii) Certain additional activities related to the business component.
(iii) Activities related to production process or technique.
(iv) Clinical testing.
(3) Adaptation of existing business components.
(4) Duplication of existing business component.
(5) Surveys, studies, research relating to management functions, etc.
(6) Internal use software.
(i) General rule.
(ii) Inapplicability of the high threshold of innovation test.
(iii) Software developed primarily for internal use.
(iv) Software not developed primarily for internal use.
(v) Time and manner of determination.
(vi) Software developed for both internal use and to enable interaction with third parties (dual function software).
(vii) High threshold of innovation test.
(viii) Illustrations.
(7) Activities outside the United States, Puerto Rico, and other possessions.
(i) In general.
(ii) Apportionment of in-house research expenses.
(iii) Apportionment of contract research expenses.
(8) Research in the social sciences, etc.
(9) Research funded by any grant, contract, or otherwise.
(10) Illustrations.
(d) Recordkeeping for the research credit.
(e) Effective dates.
(a) Controlled groups of corporations; trades or businesses under common control.
(1) In general.
(2) Consolidated groups.
(3) Definitions.
(b) Computation of the group credit.
(1) In general.
(2) Start-up companies.
(c) Allocation of the group credit.
(d) Special rules for consolidated groups.
(1) In general.
(2) Start-up company status.
(3) Special rule for allocation of group credit among consolidated group members.
(e) Examples.
(f) For taxable years beginning before January 1, 1990.
(g) Tax accounting periods used.
(1) In general.
(2) Special rule when timing of research is manipulated.
(h) Membership during taxable year in more than one group.
(i) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease payments.
(5) Payment for supplies.
(j) Effective/applicability dates.
(1) In general.
(2) Consolidated group rule.
(3) Taxable years ending after June 9, 2011.
(4) Taxable years beginning after December 31, 2011.
(5) Taxable years ending before January 1, 2012.
(a) Allocations.
(1) Corporation making an election under subchapter S.
(i) Pass-through, for taxable years beginning after December 31, 1982, in the case of an S corporation.
(ii) Pass-through, for taxable years beginning before January 1, 1983, in the case of a subchapter S corporation.
(2) Pass-through in the case of an estate or trust.
(3) Pass-through in the case of a partnership.
(i) In general.
(ii) Certain expenditures by joint ventures.
(4) Year in which taken into account.
(5) Credit allowed subject to limitation.
(b) Adjustments for certain acquisitions and dispositions—Meaning of terms.
(c) Special rule for pass-through of credit.
(d) Carryback and carryover of unused credits.
(a) Determination of credit.
(b) Election.
(1) In general.
(2) Time and manner of election.
(3) Revocation.
(4) Special rules for controlled groups.
(i) In general.
(ii) Designated member.
(5) Effective/applicability dates.
(a) Determination of credit.
(b) Election.
(1) In general.
(2) Time and manner of election.
(3) Revocation.
(4) Special rules for controlled groups.
(i) In general.
(ii) Designated member.
(c) Special rules.
(1) Qualified research expenditures (QREs) required in all years.
(2) Section 41(c)(6) applicability.
(3) Short taxable years.
(i) General rule.
(ii) Limited exception.
(4) Controlled groups.
(d) Effective/applicability dates.
§ 1.41-1 Credit for increasing research activities.
(a) Amount of credit. The amount of a taxpayer’s credit is determined under section 41(a). For taxable years beginning after June 30, 1996, and at the election of the taxpayer, the portion of the credit determined under section 41(a)(1) may be calculated using the alternative incremental credit set forth in section 41(c)(4). For taxable years ending after December 31, 2006, and at the election of the taxpayer, the portion of the credit determined under section 41(a)(1) may be calculated using either the alternative incremental credit set forth in section 41(c)(4), or the alternative simplified credit set forth in section 41(c)(5).
(b) Introduction to regulations under section 41. (1) Sections 1.41-2 through 1.41-8 and 1.41-3A through 1.41-5A address only certain provisions of section 41. The following table identifies the provisions of section 41 that are addressed, and lists each provision with the section of the regulations in which it is covered.
Section of the regulation | Section of the Internal Revenue Code |
---|---|
§ 1.41-2 | 41(b). |
§ 1.41-3 | 41(c). |
§ 1.41-4 | 41(d). |
§ 1.41-5 | 41(e). |
§ 1.41-6 | 41(f). |
§ 1.41-7 | 41(f). 41(g). |
§ 1.41-8 | 41(c). |
§ 1.41-3A | 41(c) (taxable years beginning before January 1, 1990). |
§ 1.41-4A | 41(d) (taxable years beginning before January 1, 1986). |
§ 1.41-5A | 41(e) (taxable years beginning before January 1, 1987). |
(2) Section 1.41-3A also addresses the special rule in section 221(d)(2) of the Economic Recovery Tax Act of 1981 relating to taxable years overlapping the effective dates of section 41. Section 41 was formerly designated as sections 30 and 44F. Sections 1.41-0 through 1.41-8 and 1.41-0A through 1.41-5A refer to these sections as section 41 for conformity purposes. Whether section 41, former section 30, or former section 44F applies to a particular expenditure depends upon when the expenditure was paid or incurred.
§ 1.41-2 Qualified research expenses.
(a) Trade or business requirement—(1) In general. An in-house research expense of the taxpayer or a contract research expense of the taxpayer is a qualified research expense only if the expense is paid or incurred by the taxpayer in carrying on a trade or business of the taxpayer. The phrase “in carrying on a trade or business” has the same meaning for purposes of section 41(b)(1) as it has for purposes of section 162; thus, expenses paid or incurred in connection with a trade or business within the meaning of section 174(a) (relating to the deduction for research and experimental expenses) are not necessarily paid or incurred in carrying on a trade or business for purposes of section 41. A research expense must relate to a particular trade or business being carried on by the taxpayer at the time the expense is paid or incurred in order to be a qualified research expense. For purposes of section 41, a contract research expense of the taxpayer is not a qualified research expense if the product or result of the research is intended to be transferred to another in return for license or royalty payments and the taxpayer does not use the product of the research in the taxpayer’s trade or business.
(2) New business. Expenses paid or incurred prior to commencing a new business (as distinguished from expanding an existing business) may be paid or incurred in connection with a trade or business but are not paid or incurred in carrying on a trade or business. Thus, research expenses paid or incurred by a taxpayer in developing a product the sale of which would constitute a new trade or business for the taxpayer are not paid or incurred in carrying on a trade or business.
(3) Research performed for others—(i) Taxpayer not entitled to results. If the taxpayer performs research on behalf of another person and retains no substantial rights in the research, that research shall not be taken into account by the taxpayer for purposes of section 41. See § 1.41-4A(d)(2).
(ii) Taxpayer entitled to results. If the taxpayer in carrying on a trade or business performs research on behalf of other persons but retains substantial rights in the research, the taxpayer shall take otherwise qualified expenses for that research into account for purposes of section 41 to the extent provided in § 1.41-4A(d)(3).
(4) Partnerships—(i) In general. An in-house research expense or a contract research expense paid or incurred by a partnership is a qualified research expense of the partnership if the expense is paid or incurred by the partnership in carrying on a trade or business of the partnership, determined at the partnership level without regard to the trade or business of any partner.
(ii) Special rule for certain partnerships and joint ventures. (A) If a partnership or a joint venture (taxable as a partnership) is not carrying on the trade or business to which the research relates, then the general rule in paragraph (a)(4)(i) of this section would not allow any of such expenditures to qualify as qualified research expenses.
(B) Notwithstanding paragraph (a)(4)(ii)(A) of this section, if all the partners or venturers are entitled to make independent use of the results of the research, this paragraph (a)(4)(ii) may allow a portion of such expenditures to be treated as qualified research expenditures by certain partners or venturers.
(C) First, in order to determine the amount of credit that may be claimed by certain partners or venturers, the amount of qualified research expenditures of the partnership or joint venture is determined (assuming for this purpose that the partnership or joint venture is carrying on the trade or business to which the research relates).
(D) Second, this amount is reduced by the proportionate share of such expenses allocable to those partners or venturers who would not be able to claim such expenses as qualified research expenditures if they had paid or incurred such expenses directly. For this purpose such partners’ or venturers’ proportionate share of such expenses shall be determined on the basis of such partners’ or venturers’ share of partnership items of income or gain (excluding gain allocated under section 704(c)) which results in the largest proportionate share. Where a partner’s or venturer’s share of partnership items of income or gain (excluding gain allocated under section 704(c)) may vary during the period such partner or venturer is a partner or venturer in such partnership or joint venture, such share shall be the highest share such partner or venturer may receive.
(E) Third, the remaining amount of qualified research expenses is allocated among those partners or venturers who would have been entitled to claim a credit for such expenses if they had paid or incurred the research expenses in their own trade or business, in the relative proportions that such partners or venturers share deductions for expenses under section 174 for the taxable year that such expenses are paid or incurred.
(F) For purposes of section 41, research expenditures to which this paragraph (a)(4)(ii) applies shall be treated as paid or incurred directly by such partners or venturers. See § 1.41-7(a)(3)(ii) for special rules regarding these expenses.
(iii) The following examples illustrate the application of the principles contained in paragraph (a)(4)(ii) of this section.
(b) Supplies and personal property used in the conduct of qualified research—(1) In general. Supplies and personal property (except to the extent provided in paragraph (b)(4) of this section) are used in the conduct of qualified research if they are used in the performance of qualified services (as defined in section 41(b)(2)(B), but without regard to the last sentence thereof) by an employee of the taxpayer (or by a person acting in a capacity similar to that of an employee of the taxpayer; see example (6) of § 1.41-2(e)(5)). Expenditures for supplies or for the use of personal property that are indirect research expenditures or general and administrative expenses do not qualify as inhouse research expenses.
(2) Certain utility charges—(i) In general. In general, amounts paid or incurred for utilities such as water, electricity, and natural gas used in the building in which qualified research is performed are treated as expenditures for general and administrative expenses.
(ii) Extraordinary expenditures. To the extent the taxpayer can establish that the special character of the qualified research required additional extraordinary expenditures for utilities, the additional expenditures shall be treated as amounts paid or incurred for supplies used in the conduct of qualified research. For example, amounts paid for electricity used for general laboratory lighting are treated as general and administrative expenses, but amounts paid for electricity used in operating high energy equipment for qualified research (such as laser or nuclear research) may be treated as expenditures for supplies used in the conduct of qualified research to the extent the taxpayer can establish that the special character of the research required an extraordinary additional expenditure for electricity.
(3) Right to use personal property. The determination of whether an amount is paid to or incurred for another person for the right to use personal property in the conduct of qualified research shall be made without regard to the characterization of the transaction as a lease under section 168(f)(8) (as that section read before it was repealed by the Tax Reform Act of 1986). See § 5c.168(f)(8)-1(b).
(4) Use of personal property in taxable years beginning after December 31, 1985. For taxable years beginning after December 31, 1985, amounts paid or incurred for the use of personal property are not qualified research expenses, except for any amount paid or incurred to another person for the right to use (time-sharing) computers in the conduct of qualified research. The computer must be owned and operated by someone other than the taxpayer, located off the taxpayer’s premises, and the taxpayer must not be the primary user of the computer.
(c) Qualified services—(1) Engaging in qualified research. The term “engaging in qualified research” as used in section 41(b)(2)(B) means the actual conduct of qualified research (as in the case of a scientist conducting laboratory experiments).
(2) Direct supervision. The term “direct supervision” as used in section 41(b)(2)(B) means the immediate supervision (first-line management) of qualified research (as in the case of a research scientist who directly supervises laboratory experiments, but who may not actually perform experiments). “Direct supervision” does not include supervision by a higher-level manager to whom first-line managers report, even if that manager is a qualified research scientist.
(3) Direct support. The term “direct support” as used in section 41(b)(2)(B) means services in the direct support of either—
(i) Persons engaging in actual conduct of qualified research, or
(ii) Persons who are directly supervising persons engaging in the actual conduct of qualified research. For example, direct support of research includes the services of a secretary for typing reports describing laboratory results derived from qualified research, of a laboratory worker for cleaning equipment used in qualified research, of a clerk for compiling research data, and of a machinist for machining a part of an experimental model used in qualified research. Direct support of research activities does not include general administrative services, or other services only indirectly of benefit to research activities. For example, services of payroll personnel in preparing salary checks of laboratory scientists, of an accountant for accounting for research expenses, of a janitor for general cleaning of a research laboratory, or of officers engaged in supervising financial or personnel matters do not qualify as direct support of research. This is true whether general administrative personnel are part of the research department or in a separate department. Direct support does not include supervision. Supervisory services constitute “qualified services” only to the extent provided in paragraph (c)(2) of this section.
(d) Wages paid for qualified services—(1) In general. Wages paid to or incurred for an employee constitute in-house research expenses only to the extent the wages were paid or incurred for qualified services performed by the employee. If an employee has performed both qualified services and nonqualified services, only the amount of wages allocated to the performance of qualified services constitutes an in-house research expense. In the absence of another method of allocation that the taxpayer can demonstrate to be more appropriate, the amount of in-house research expense shall be determined by multiplying the total amount of wages paid to or incurred for the employee during the taxable year by the ratio of the total time actually spent by the employee in the performance of qualified services for the taxpayer to the total time spent by the employee in the performance of all services for the taxpayer during the taxable year.
(2) “Substantially all.” Notwithstanding paragraph (d)(1) of this section, if substantially all of the services performed by an employee for the taxpayer during the taxable year consist of services meeting the requirements of section 41(b)(2)(B) (i) or (ii), then the term “qualified services” means all of the services performed by the employee for the taxpayer during the taxable year. Services meeting the requirements of section 41(b)(2)(B) (i) or (ii) constitute substantially all of the services performed by the employee during a taxable year only if the wages allocated (on the basis used for purposes of paragraph (d)(1) of this section) to services meeting the requirements of section 41(b)(2)(B) (i) or (ii) constitute at least 80 percent of the wages paid to or incurred by the taxpayer for the employee during the taxable year.
(e) Contract research expenses—(1) In general. A contract research expense is 65 percent of any expense paid or incurred in carrying on a trade or business to any person other than an employee of the taxpayer for the performance on behalf of the taxpayer of—
(i) Qualified research as defined in § 1.41-4 or 1.41-4A, whichever is applicable, or
(ii) Services which, if performed by employees of the taxpayer, would constitute qualified services within the meaning of section 41(b)(2)(B).
(2) Performance of qualified research. An expense is paid or incurred for the performance of qualified research only to the extent that it is paid or incurred pursuant to an agreement that—
(i) Is entered into prior to the performance of the qualified research,
(ii) Provides that research be performed on behalf of the taxpayer, and
(iii) Requires the taxpayer to bear the expense even if the research is not successful.
(3) “On behalf of.” Qualified research is performed on behalf of the taxpayer if the taxpayer has a right to the research results. Qualified research can be performed on behalf of the taxpayer notwithstanding the fact that the taxpayer does not have exclusive rights to the results.
(4) Prepaid amounts. Notwithstanding paragraph (e)(1) of this section, if any contract research expense paid or incurred during any taxable year is attributable to qualified research to be conducted after the close of such taxable year, the expense so attributable shall be treated for purposes of section 41(b)(1)(B) as paid or incurred during the period during which the qualified research is conducted.
(5) Examples. The following examples illustrate provisions contained in paragraphs (e) (1) through (4) of this section.
Labor | $90x |
Supplies | 20x |
Depreciation on equipment | 50x |
Overhead | 40x |
Total | 200x |
§ 1.41-3 Base amount for taxable years beginning on or after January 3, 2001.
(a) New taxpayers. If, with respect to any credit year, the taxpayer has not been in existence for any previous taxable year, the average annual gross receipts of the taxpayer for the four taxable years preceding the credit year shall be zero. If, with respect to any credit year, the taxpayer has been in existence for at least one previous taxable year, but has not been in existence for four taxable years preceding the taxable year, then the average annual gross receipts of the taxpayer for the four taxable years preceding the credit year shall be the average annual gross receipts for the number of taxable years preceding the credit year for which the taxpayer has been in existence.
(b) Special rules for short taxable years—(1) Short credit year. If a credit year is a short taxable year, then the base amount determined under section 41(c)(1) (but not section 41(c)(2)) shall be modified by multiplying that amount by the number of months in the short taxable year and dividing the result by 12.
(2) Short taxable year preceding credit year. If one or more of the four taxable years preceding the credit year is a short taxable year, then the gross receipts for such year are deemed to be equal to the gross receipts actually derived in that year multiplied by 12 and divided by the number of months in that year.
(3) Short taxable year in determining fixed-base percentage. No adjustment shall be made on account of a short taxable year to the computation of a taxpayer’s fixed-base percentage.
(c) Definition of gross receipts—(1) In general. For purposes of section 41, gross receipts means the total amount, as determined under the taxpayer’s method of accounting, derived by the taxpayer from all its activities and from all sources (e.g., revenues derived from the sale of inventory before reduction for cost of goods sold).
(2) Amounts excluded. For purposes of this paragraph (c), gross receipts do not include amounts representing—
(i) Returns or allowances;
(ii) Receipts from the sale or exchange of capital assets, as defined in section 1221;
(iii) Repayments of loans or similar instruments (e.g., a repayment of the principal amount of a loan held by a commercial lender);
(iv) Receipts from a sale or exchange not in the ordinary course of business, such as the sale of an entire trade or business or the sale of property used in a trade or business as defined under section 1221(2);
(v) Amounts received with respect to sales tax or other similar state and local taxes if, under the applicable state or local law, the tax is legally imposed on the purchaser of the good or service, and the taxpayer merely collects and remits the tax to the taxing authority; and
(vi) Amounts received by a taxpayer in a taxable year that precedes the first taxable year in which the taxpayer derives more than $25,000 in gross receipts other than investment income. For purposes of this paragraph (c)(2)(vi), investment income is interest or distributions with respect to stock (other than the stock of a 20-percent owned corporation as defined in section 243(c)(2).
(3) Foreign corporations. For purposes of section 41, in the case of a foreign corporation, gross receipts include only gross receipts that are effectively connected with the conduct of a trade or business within the United States, the Commonwealth of Puerto Rico, or other possessions of the United States. See section 864(c) and applicable regulations thereunder for the definition of effectively connected income.
(d) Consistency requirement—(1) In general. In computing the credit for increasing research activities for taxable years beginning after December 31, 1989, qualified research expenses and gross receipts taken into account in computing a taxpayer’s fixed-base percentage and a taxpayer’s base amount must be determined on a basis consistent with the definition of qualified research expenses and gross receipts for the credit year, without regard to the law in effect for the taxable years taken into account in computing the fixed-base percentage or the base amount. This consistency requirement applies even if the period for filing a claim for credit or refund has expired for any taxable year taken into account in computing the fixed-base percentage or the base amount.
(2) Illustrations. The following examples illustrate the application of the consistency rule of paragraph (d)(1) of this section:
(ii) During the fixed-base period, X reported the following amounts as qualified research expenses on its Form 6765:
1984 | $100x |
1985 | 120x |
1986 | 150x |
1987 | 180x |
1988 | 170x |
Total | 720x |
(e) Effective date. The rules in paragraphs (c) and (d) of this section are applicable for taxable years beginning on or after the date final regulations are published in the
§ 1.41-4 Qualified research for expenditures paid or incurred in taxable years ending on or after December 31, 2003.
(a) Qualified research—(1) General rule. Research activities related to the development or improvement of a business component constitute qualified research only if the research activities meet all of the requirements of section 41(d)(1) and this section, and are not otherwise excluded under section 41(d)(3)(B) or (d)(4), or this section.
(2) Requirements of section 41(d)(1). Research constitutes qualified research only if it is research—
(i) With respect to which expenditures may be treated as expenses under section 174, see § 1.174-2;
(ii) That is undertaken for the purpose of discovering information that is technological in nature, and the application of which is intended to be useful in the development of a new or improved business component of the taxpayer; and
(iii) Substantially all of the activities of which constitute elements of a process of experimentation that relates to a qualified purpose.
(3) Undertaken for the purpose of discovering information—(i) In general. For purposes of section 41(d) and this section, research must be undertaken for the purpose of discovering information that is technological in nature. Research is undertaken for the purpose of discovering information if it is intended to eliminate uncertainty concerning the development or improvement of a business component. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the business component, or the appropriate design of the business component.
(ii) Application of the discovering information requirement. A determination that research is undertaken for the purpose of discovering information that is technological in nature does not require the taxpayer be seeking to obtain information that exceeds, expands or refines the common knowledge of skilled professionals in the particular field of science or engineering in which the taxpayer is performing the research. In addition, a determination that research is undertaken for the purpose of discovering information that is technological in nature does not require that the taxpayer succeed in developing a new or improved business component.
(iii) Patent safe harbor. For purposes of section 41(d) and paragraph (a)(3)(i) of this section, the issuance of a patent by the Patent and Trademark Office under the provisions of 35 U.S.C. 151 (other than a patent for design issued under the provisions of 35 U.S.C. 171) is conclusive evidence that a taxpayer has discovered information that is technological in nature that is intended to eliminate uncertainty concerning the development or improvement of a business component. However, the issuance of such a patent is not a precondition for credit availability.
(4) Technological in nature. For purposes of section 41(d) and this section, information is technological in nature if the process of experimentation used to discover such information fundamentally relies on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement.
(5) Process of experimentation—(i) In general. For purposes of section 41(d) and this section, a process of experimentation is a process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. A process of experimentation must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science and involves the identification of uncertainty concerning the development or improvement of a business component, the identification of one or more alternatives intended to eliminate that uncertainty, and the identification and the conduct of a process of evaluating the alternatives (through, for example, modeling, simulation, or a systematic trial and error methodology). A process of experimentation must be an evaluative process and generally should be capable of evaluating more than one alternative. A taxpayer may undertake a process of experimentation if there is no uncertainty concerning the taxpayer’s capability or method of achieving the desired result so long as the appropriate design of the desired result is uncertain as of the beginning of the taxpayer’s research activities. Uncertainty concerning the development or improvement of the business component (e.g., its appropriate design) does not establish that all activities undertaken to achieve that new or improved business component constitute a process of experimentation.
(ii) Qualified purpose. For purposes of section 41(d) and this section, a process of experimentation is undertaken for a qualified purpose if it relates to a new or improved function, performance, reliability or quality of the business component. Research will not be treated as conducted for a qualified purpose if it relates to style, taste, cosmetic, or seasonal design factors.
(6) Substantially all requirement. In order for activities to constitute qualified research under section 41(d)(1), substantially all of the activities must constitute elements of a process of experimentation that relates to a qualified purpose. The substantially all requirement of section 41(d)(1)(C) and paragraph (a)(2)(iii) of this section is satisfied only if 80 percent or more of a taxpayer’s research activities, measured on a cost or other consistently applied reasonable basis (and without regard to section 1.41-2(d)(2)), constitute elements of a process of experimentation for a purpose described in section 41(d)(3). Accordingly, if 80 percent (or more) of a taxpayer’s research activities with respect to a business component constitute elements of a process of experimentation for a purpose described in section 41(d)(3), the substantially all requirement is satisfied even if the remaining 20 percent (or less) of a taxpayer’s research activities with respect to the business component do not constitute elements of a process of experimentation for a purpose described in section 41(d)(3), so long as these remaining research activities satisfy the requirements of section 41(d)(1)(A) and are not otherwise excluded under section 41(d)(4). The substantially all requirement is applied separately to each business component.
(7) Use of computers and information technology. The employment of computers or information technology, or the reliance on principles of computer science or information technology to store, collect, manipulate, translate, disseminate, produce, distribute, or process data or information, and similar uses of computers and information technology does not itself establish that qualified research has been undertaken.
(8) Illustrations. The following examples illustrate the application of paragraph (a)(5) of this section:
(ii) Conclusion. X’s activities to change the color of its blue widget to green are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section because substantially all of X’s activities are not undertaken for a qualified purpose. All of X’s research activities are related to style, taste, cosmetic, or seasonal design factors.
(ii) Conclusion. X’s activities to modify its painting process are a separate business component under section 41(d)(2)(A). X’s activities to modify its painting process to change the color of its blue widget to green are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the modification of its painting process. Rather, the manufacturer of the paint machines eliminated X’s uncertainty regarding the modification of its painting process. X’s activities to test the nozzles to determine if the nozzles work as specified by the manufacturer of the paint spraying machines are in the nature of routine or ordinary testing or inspection for quality control.
(ii) Conclusion. X’s activities to modify its current production line by developing the new shredding blade meet the requirements of qualified research as set forth in paragraph (a)(2) of this section. Substantially all of X’s activities constitute elements of a process of experimentation because X evaluated alternatives to achieve a result where the method of achieving that result, and the appropriate design of that result, were uncertain as of the beginning of the taxpayer’s research activities. X identified uncertainties related to the development of a business component, and identified alternatives intended to eliminate these uncertainties. Furthermore, X’s process of evaluating identified alternatives was technological in nature, and was undertaken to eliminate the uncertainties.
(ii) Conclusion. In general, if eighty percent or more of a taxpayer’s research activities measured on a cost or other consistently applied reasonable basis constitute elements of a process of experimentation for a qualified purpose under section 41(d)(3)(A) and paragraph (a)(5)(ii) of this section, then the substantially all requirement of section 41(d)(1)(C) and paragraph (a)(2)(iii) of this section is satisfied. Substantially all of X’s activities constitute elements of a process of experimentation because X evaluated alternatives to achieve a result where the method of achieving that result, and the appropriate design of that result, were uncertain as of the beginning of X’s research activities. X identified uncertainties related to the improvement of a business component and identified alternatives intended to eliminate these uncertainties. Furthermore, X’s process of evaluating the identified alternatives was technological in nature and was undertaken to eliminate the uncertainties. Because substantially all (in this example, eighty-five percent) of X’s activities to update its current model vehicle constitute elements of a process of experimentation for a qualified purpose described in section 41(d)(3)(A), all of X’s activities to update its current model vehicle meet the requirements of qualified research as set forth in paragraph (a)(2) of this section, provided that X’s remaining activities (in this example, fifteen percent of X’s total activities) satisfy the requirements of section 41(d)(1)(A) and are not otherwise excluded under section 41(d)(4).
(ii) Conclusion. X’s activities to select the software are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the development of a business component. X’s evaluation of products available from vendors is not a process of experimentation.
(ii) Conclusion. X’s activities related to selecting the commercial software vendor with the object-oriented functions it wanted, and then selecting which functions to use, are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. In addition, incorporating the selected object-oriented functions into the new web application software being developed by X did not involve conducting a process of evaluating alternatives in order to eliminate uncertainty regarding the development of software. X’s evaluation of products available from vendors and selection of software functions are not a process of experimentation.
(ii) Conclusion. X’s activities to develop the software are activities relating to the development of a separate business component under section 41(d)(2)(A). X’s activities to develop the load distribution function are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating different load distribution alternatives in order to eliminate uncertainty regarding the development of software. X’s selection of a separate server and a round robin distribution algorithm is not a process of experimentation.
(ii) Conclusion. X’s activities to develop software are activities to develop a separate business component under section 41(d)(2)(A). X’s activities involving the design, evaluation, and systematic testing of several new load balancing algorithms meet the requirements as set forth in paragraph (a)(5) of this section. X’s activities constitute elements of a process of experimentation because X identified uncertainties related to the development of a business component, identified alternatives intended to eliminate those uncertainties, and evaluated one or more alternatives to achieve a result where the appropriate design was uncertain at the beginning of X’s research activities.
(ii) Conclusion. X’s activities related to the ERP software including the data transfer are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the development of software. X’s activities in choosing between available templates, reports, and other standard programs and conducting data transfer are not elements of a process of experimentation.
(ii) Conclusion. Substantially all of X’s activities with respect to this ERP project do not satisfy the requirements for a process of experimentation. However, when the shrinking-back rule is applied, a subset of X’s activities do satisfy the requirements for a process of experimentation. X’s activities to develop the data caching software and keeping the data on the legacy and ERP systems synchronized meet the requirements of qualified research as set forth in paragraph (a)(2) of this section. Substantially all of X’s activities to develop the specialized data caching and synchronization software constitute elements of a process of experimentation because X identified uncertainties related to the development of a business component, identified alternatives intended to eliminate those uncertainties, and evaluated alternatives to achieve a result where the appropriate design of that result was uncertain as of the beginning of the taxpayer’s research activities.
(b) Application of requirements for qualified research—(1) In general. The requirements for qualified research in section 41(d)(1) and paragraph (a) of this section, must be applied separately to each business component, as defined in section 41(d)(2)(B). In cases involving development of both a product and a manufacturing or other commercial production process for the product, research activities relating to development of the process are not qualified research unless the requirements of section 41(d) and this section are met for the research activities relating to the process without taking into account the research activities relating to development of the product. Similarly, research activities relating to development of the product are not qualified research unless the requirements of section 41(d) and this section are met for the research activities relating to the product without taking into account the research activities relating to development of the manufacturing or other commercial production process.
(2) Shrinking-back rule. The requirements of section 41(d) and paragraph (a) of this section are to be applied first at the level of the discrete business component, that is, the product, process, computer software, technique, formula, or invention to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer. If these requirements are not met at that level, then they apply at the most significant subset of elements of the product, process, computer software, technique, formula, or invention to be held for sale, lease, or license. This shrinking back of the product is to continue until either a subset of elements of the product that satisfies the requirements is reached, or the most basic element of the product is reached and such element fails to satisfy the test. This shrinking-back rule is applied only if a taxpayer does not satisfy the requirements of section 41(d)(1) and paragraph (a)(2) of this section with respect to the overall business component. The shrinking-back rule is not itself applied as a reason to exclude research activities from credit eligibility.
(3) Illustration. The following example illustrates the application of this paragraph (b):
(c) Excluded activities—(1) In general. Qualified research does not include any activity described in section 41(d)(4) and paragraph (c) of this section.
(2) Research after commercial production—(i) In general. Activities conducted after the beginning of commercial production of a business component are not qualified research. Activities are conducted after the beginning of commercial production of a business component if such activities are conducted after the component is developed to the point where it is ready for commercial sale or use, or meets the basic functional and economic requirements of the taxpayer for the component’s sale or use.
(ii) Certain additional activities related to the business component. The following activities are deemed to occur after the beginning of commercial production of a business component—
(A) Preproduction planning for a finished business component;
(B) Tooling-up for production;
(C) Trial production runs;
(D) Trouble shooting involving detecting faults in production equipment or processes;
(E) Accumulating data relating to production processes; and
(F) Debugging flaws in a business component.
(iii) Activities related to production process or technique. In cases involving development of both a product and a manufacturing or other commercial production process for the product, the exclusion described in section 41(d)(4)(A) and paragraphs (c)(2)(i) and (ii) of this section applies separately for the activities relating to the development of the product and the activities relating to the development of the process. For example, even after a product meets the taxpayer’s basic functional and economic requirements, activities relating to the development of the manufacturing process still may constitute qualified research, provided that the development of the process itself separately satisfies the requirements of section 41(d) and this section, and the activities are conducted before the process meets the taxpayer’s basic functional and economic requirements or is ready for commercial use.
(iv) Clinical testing. Clinical testing of a pharmaceutical product prior to its commercial production in the United States is not treated as occurring after the beginning of commercial production even if the product is commercially available in other countries. Additional clinical testing of a pharmaceutical product after a product has been approved for a specific therapeutic use by the Food and Drug Administration and is ready for commercial production and sale is not treated as occurring after the beginning of commercial production if such clinical testing is undertaken to establish new functional uses, characteristics, indications, combinations, dosages, or delivery forms for the product. A functional use, characteristic, indication, combination, dosage, or delivery form shall be considered new only if such functional use, characteristic, indication, combination, dosage, or delivery form must be approved by the Food and Drug Administration.
(3) Adaptation of existing business components. Activities relating to adapting an existing business component to a particular customer’s requirement or need are not qualified research. This exclusion does not apply merely because a business component is intended for a specific customer.
(4) Duplication of existing business component. Activities relating to reproducing an existing business component (in whole or in part) from a physical examination of the business component itself or from plans, blueprints, detailed specifications, or publicly available information about the business component are not qualified research. This exclusion does not apply merely because the taxpayer examines an existing business component in the course of developing its own business component.
(5) Surveys, studies, research relating to management functions, etc. Qualified research does not include activities relating to—
(i) Efficiency surveys;
(ii) Management functions or techniques, including such items as preparation of financial data and analysis, development of employee training programs and management organization plans, and management-based changes in production processes (such as rearranging work stations on an assembly line);
(iii) Market research, testing, or development (including advertising or promotions);
(iv) Routine data collections; or
(v) Routine or ordinary testing or inspections for quality control.
(6) Internal use software—(i) General rule. Research with respect to software that is developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use is eligible for the research credit only if—
(A) The research with respect to the software satisfies the requirements of section 41(d)(1);
(B) The research with respect to the software is not otherwise excluded under section 41(d)(4) (other than section 41(d)(4)(E)); and
(C) The software satisfies the high threshold of innovation test of paragraph (c)(6)(vii) of this section.
(ii) Inapplicability of the high threshold of innovation test. This paragraph (c)(6) does not apply to the following:
(A) Software developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer for use in an activity that constitutes qualified research (other than the development of the internal use software itself);
(B) Software developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer for use in a production process to which the requirements of section 41(d)(1) are met; and
(C) A new or improved package of software and hardware developed together by the taxpayer as a single product (or to the costs to modify an acquired software and hardware package), of which the software is an integral part, that is used directly by the taxpayer in providing services in its trade or business. In these cases, eligibility for the research credit is to be determined by examining the combined hardware-software product as a single product.
(iii) Software developed primarily for internal use—(A) In general. Except as otherwise provided in paragraph (c)(6)(vi) of this section, software is developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use if the software is developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business. Software that the taxpayer develops primarily for a related party’s internal use will be considered internal use software. A related party is any corporation, trade or business, or other person that is treated as a single taxpayer with the taxpayer pursuant to section 41(f).
(B) General and administrative functions. General and administrative functions are:
(1) Financial management. Financial management functions are functions that involve the financial management of the taxpayer and the supporting recordkeeping. Financial management functions include, but are not limited to, functions such as accounts payable, accounts receivable, inventory management, budgeting, cash management, cost accounting, disbursements, economic analysis and forecasting, financial reporting, finance, fixed asset accounting, general ledger bookkeeping, internal audit, management accounting, risk management, strategic business planning, and tax.
(2) Human resources management. Human resources management functions are functions that manage the taxpayer’s workforce. Human resources management functions include, but are not limited to, functions such as recruiting, hiring, training, assigning personnel, and maintaining personnel records, payroll, and benefits.
(3) Support services. Support services are other functions that support the day- to-day operations of the taxpayer. Support services include, but are not limited to, functions such as data processing, facility services (for example, grounds keeping, housekeeping, janitorial, and logistics), graphic services, marketing, legal services, government compliance services, printing and publication services, and security services (for example, video surveillance and physical asset protection from fire and theft).
(iv) Software not developed primarily for internal use. Software is not developed primarily for the taxpayer’s internal use if it is not developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business, such as—
(A) Software developed to be commercially sold, leased, licensed, or otherwise marketed to third parties; or
(B) Software developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.
(v) Time and manner of determination. For purposes of paragraphs (c)(6)(iii) and (iv) of this section, whether software is developed primarily for internal use or not developed primarily for internal use depends on the intent of the taxpayer and the facts and circumstances at the beginning of the software development. For example, software will not be considered internal use software solely because it is used internally for purposes of testing prior to commercial sale, lease, or license. If a taxpayer originally develops software primarily for internal use, but later makes improvements to the software with the intent to hold the improved software to be sold, leased, licensed, or otherwise marketed to third parties, or to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system using the improved software, the improvements will be considered separate from the existing software and will not be considered developed primarily for internal use. Alternatively, if a taxpayer originally develops software to be sold, leased, licensed, or otherwise marketed to third parties, or to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system, but later makes improvements to the software with the intent to use the software in general and administrative functions, the improvements will be considered separate from the existing software and will be considered developed primarily for internal use.
(vi) Software developed for both internal use and to enable interaction with third parties (dual function software)—(A) Presumption of development primarily for internal use. Unless paragraph (c)(6)(vi)(B) or (C) of this section applies, software developed by (or for the benefit of) the taxpayer both for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business and to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system (dual function software) is presumed to be developed primarily for a taxpayer’s internal use.
(B) Identification of a subset of elements of software that only enables interaction with third parties. To the extent that a taxpayer can identify a subset of elements of dual function software that only enables a taxpayer to interact with third parties or allows third parties to initiate functions or review data (third party subset), the presumption under paragraph (c)(6)(vi)(A) of this section does not apply to such third party subset, and such third party subset is not developed primarily for internal use as described under paragraph (c)(6)(iv)(B) of this section.
(C) Safe harbor for expenditures related to software developed for both internal use and to enable interaction with third parties. If, after the application of paragraph (c)(6)(vi)(B) of this section, there remains dual function software or a subset of elements of dual function software (dual function subset), a taxpayer may include 25 percent of the qualified research expenditures of such dual function software or dual function subset in computing the amount of the taxpayer’s credit. This paragraph (c)(6)(vi)(C) applies only if the taxpayer’s research activities related to the development or improvement of the dual function software or dual function subset constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the dual function software or dual function subset’s use by third parties or by the taxpayer to interact with third parties is reasonably anticipated to constitute at least 10 percent of the dual function software or the dual function subset’s use. An objective, reasonable method within the taxpayer’s industry must be used to estimate the dual function software or dual function subset’s use by third parties or by the taxpayer to interact with third parties. An objective, reasonable method may include, but is not limited to, processing time, amount of data transfer, and number of software user interface screens.
(D) Time and manner of determination. A taxpayer must apply this paragraph (c)(6)(vi) based on the intent of the taxpayer and the facts and circumstances at the beginning of the software development.
(E) Third party. For purposes of paragraphs (c)(6)(iv), (v), and (vi) of this section, the term third party means any corporation, trade or business, or other person that is not treated as a single taxpayer with the taxpayer pursuant to section 41(f). Additionally, for purposes of paragraph (c)(6)(iv)(B) of this section, third parties do not include any persons that use the software to support the general and administrative functions of the taxpayer.
(vii) High threshold of innovation test—(A) In general. Software satisfies this paragraph (c)(6)(vii) only if the taxpayer can establish that—
(1) The software is innovative;
(2) The software development involves significant economic risk; and
(3) The software is not commercially available for use by the taxpayer in that the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the requirements of paragraphs (c)(6)(vii)(A)(1) and (2) of this section.
(B) Innovative. Software is innovative if the software would result in a reduction in cost or improvement in speed or other measurable improvement, that is substantial and economically significant, if the development is or would have been successful. This is a measurable objective standard, not a determination of the unique or novel nature of the software or the software development process.
(C) Significant economic risk. The software development involves significant economic risk if the taxpayer commits substantial resources to the development and if there is substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period. The term “substantial uncertainty” requires a higher level of uncertainty and technical risk than that required for business components that are not internal use software. This standard does not require technical uncertainty regarding whether the final result can ever be achieved, but rather whether the final result can be achieved within a timeframe that will allow the substantial resources committed to the development to be recovered within a reasonable period. Technical risk arises from uncertainty that is technological in nature, as defined in paragraph (a)(4) of this section, and substantial uncertainty must exist at the beginning of the taxpayer’s activities.
(D) Application of high threshold of innovation test. The high threshold of innovation test of paragraph (c)(6)(vii) of this section takes into account only the results anticipated to be attributable to the development of new or improved software at the beginning of the software development independent of the effect of any modifications to related hardware or other software. The implementation of existing technology by itself is not evidence of innovation, but the use of existing technology in new ways could be evidence of a high threshold of innovation if it resolves substantial uncertainty as defined in paragraph (c)(6)(vii)(C) of this section.
(viii) Illustrations. The following examples illustrate provisions contained in this paragraph (c)(6). No inference should be drawn from these examples concerning the application of section 41(d)(1) and paragraph (a) of this section to these facts.
(ii) Conclusion. The telecommunications software that interfaces directly with the hardware is part of a package of software and hardware developed together by the taxpayer that is used by the taxpayer in providing services in its trade or business. Accordingly, this paragraph (c)(6) does not apply to the software that interfaces directly with the hardware as described in paragraph (c)(6)(ii)(C) of this section, and eligibility for the research credit is determined by examining the combined software-hardware product as a single product.
(ii) Conclusion. The software is developed for use in a general and administrative function because reserve valuation is a financial management function under paragraph (c)(6)(iii)(B)(1) of this section. Accordingly, the software is internal use software because it is developed for use in a general and administrative function.
(ii) Conclusion. The employee access software module is developed for use in a general and administrative function because employee access software is a human resources management function under paragraph (c)(6)(iii)(B)(2) of this section. Accordingly, the software module is internal use software because it is developed for use in a general and administrative function.
(ii) Conclusion. The software is developed for use in a general and administrative function because the software was developed to be used by X for marketing which is a support services function under paragraph (c)(6)(iii)(B)(3) of this section. Accordingly, the software is internal use software because it is developed for use in a general and administrative function.
(ii) Conclusion. The financial systems, human resource systems, inventory and sales systems are general and administrative functions under paragraph (c)(6)(iii)(B) of this section. Accordingly, the Developed Software is internal use software because it is developed for use in general and administrative functions.
(ii) Conclusion. Under paragraph (c)(6)(vi)(E) of this section, X’s vendors are not third parties for purposes of paragraph (c)(6)(iv) of this section. While X’s software was developed to allow vendors to initiate functions or review data on the taxpayer’s system, the software is not excluded from internal use software as set forth in paragraph (c)(6)(iv)(B) of this section because the software was developed to allow vendors to use the software to support X’s inventory management, which is a general and administrative function of X.
(ii) Conclusion. The software is not developed primarily for internal use because it is not developed for use in a general and administrative function. X developed the software to allow third parties to initiate functions or review data on the taxpayer’s system as provided under paragraph (c)(6)(iv)(B) of this section.
(ii) Conclusion. The software for uploading and modifying photographs is not developed primarily for internal use because it is not developed for use in X’s general and administrative functions under paragraph (c)(6)(iii)(A) of this section. The users and the advertisers are third parties for purposes of paragraph (c)(6)(iv) of this section. Furthermore, both the software for uploading and modifying photographs and the advertising software are not internal use software under paragraph (c)(6)(iv)(B) of this section because at the beginning of the development X developed the software with the intention of enabling X to interact with third parties or to allow third parties to initiate functions on X’s system.
(ii) Conclusion. The software is not developed primarily for internal use because it is not developed for use in a general and administrative function. X developed the software to be commercially sold, leased, licensed, or otherwise marketed to third parties under paragraph (c)(6)(iv)(A) of this section.
(ii) Conclusion. Support services, which include facility services, are general and administrative functions under paragraph (c)(6)(iii)(B) of this section. Accordingly, the original software is developed for use in general and administrative functions and is, therefore, developed primarily for internal use. However, the improvements to the software are not developed primarily for internal use because the improved software was not developed for use in a general and administrative function. X developed the improved software to be commercially sold, leased, licensed, or otherwise marketed to third parties under paragraphs (c)(6)(iv)(A) and (c)(6)(v) of this section.
(ii) Conclusion. The software developed by X is dual function software. Because X is able to identify a third party subset, the third party subset is not presumed to be internal use software under paragraph (c)(6)(vi)(A) of this section. If X’s research activities related to the third party subset constitute qualified research under section 41(d), and the allocable expenditures are qualified research expenditures under section 41(b), $25,000 of the software research expenditures allocable to the third party subset may be included in computing the amount of X’s credit, pursuant to paragraph (c)(6)(vi)(B) of this section. If, after the application of paragraph (c)(6)(vi)(B) of this section, there remains a dual function subset, X may determine whether paragraph (c)(6)(vi)(C) of this section applies.
(ii) Conclusion. The software developed by X is dual function software. The software is presumed to be developed primarily for internal use under paragraph (c)(6)(vi)(A) of this section. Although X is unable to identify a third party subset, X reasonably anticipates that the dual function software’s use by third parties will be at least 10% of the dual function software’s use. If X’s research activities related to the development or improvement of the dual function software constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the allocable expenditures are qualified research expenditures under section 41(b), X may include $12,500 (25% of $50,000) of the software research expenditures of the dual function software in computing the amount of X’s credit pursuant to paragraph (c)(6)(vi)(C) of this section.
(ii) Conclusion. The software developed by X is dual function software. The software is presumed to be developed primarily for X’s internal use under paragraph (c)(6)(vi)(A) of this section. X is unable to identify a third party subset, and X reasonably anticipates that the dual function software’s use by third parties will be less than 10% of the dual function software’s use. X may only include the software research expenditures of the dual function software in computing the amount of X’s credit if the software satisfies the high threshold of innovation test of paragraph (c)(6)(vii) of this section and X’s research activities related to the development or improvement of the dual function software constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the allocable expenditures are qualified research expenditures under section 41(b).
(ii) Conclusion. The software developed by X is dual function software. Because X is able to identify a third party subset, such third party subset (Subset A) is not presumed to be internal use software under paragraph (c)(6)(vi)(A) of this section. If X’s research activities related to the development or improvement of Subset A constitute qualified research under section 41(d), and the allocable expenditures are qualified research expenditures under section 41(b), the $25,000 of the software research expenditures allocable to Subset A may be included in computing the amount of X’s credit pursuant to paragraph (c)(6)(vi)(B) of this section. Although X is unable to identify a third party subset of Subset B, 15% of Subset B’s use is reasonably anticipated to be attributable to the use of Subset B by third parties. If X’s research activities related to the development or improvement of Subset B constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the allocable expenditures are qualified research expenditures under section 41(b), X may include $6,250 (25% × $25,000) of the software research expenditures of Subset B in computing the amount of X’s credit, pursuant to paragraph (c)(6)(vi)(C) of this section.
(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. However, the software satisfies the high threshold of innovation test set forth in paragraph (c)(6)(vii) of this section. The software was intended to be innovative in that it would provide a reduction in cost or improvement in speed that is substantial and economically significant. In addition, X’s development activities involved significant economic risk in that X committed substantial resources to the development and there was substantial uncertainty, because of technical risk, that the resources would be recovered within a reasonable period. Finally, at the time X undertook the development of the system, software meeting X’s requirements was not commercially available for use by X.
(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. X’s activities do not satisfy the high threshold of innovation test of paragraph (c)(6)(vii) of this section. Although the software meets the requirements of paragraphs (c)(6)(vii)(A)(1) and (3) of this section, X’s development activities did not involve significant economic risk under paragraph (c)(6)(vii)(A)(2) of this section. X did not have substantial uncertainty, because of technical risk, that the resources committed to the project would be recovered within a reasonable period.
(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. However, the software satisfies the high threshold of innovation test as set forth in paragraph (c)(6)(vii) of this section. The software was intended to be innovative because it would provide a reduction in cost or improvement in speed that is substantial and economically significant. In addition, X’s development activities involved significant economic risk in that X committed substantial resources to the development and there was substantial uncertainty that because of technical risk, such resources would be recovered within a reasonable period. Finally, at the time X undertook the development of the system, software meeting X’s requirements was not commercially available for use by X.
(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. X’s activities do not satisfy the high threshold of innovation test of paragraph (c)(6)(vii) of this section. Although the software meets the requirements of paragraphs (c)(6)(vii)(A)(1) and (3) of this section, X’s development activities did not involve significant economic risk under paragraph (c)(6)(vii)(A)(2) of this section. X did not have substantial uncertainty, because of technical risk, that the resources committed to the project would be recovered within a reasonable period.
(7) Activities outside the United States, Puerto Rico, and other possessions—(i) In general. Research conducted outside the United States, as defined in section 7701(a)(9), the Commonwealth of Puerto Rico and other possessions of the United States does not constitute qualified research.
(ii) Apportionment of in-house research expenses. In-house research expenses paid or incurred for qualified services performed both in the United States, the Commonwealth of Puerto Rico and other possessions of the United States and outside the United States, the Commonwealth of Puerto Rico and other possessions of the United States must be apportioned between the services performed in the United States, the Commonwealth of Puerto Rico and other possessions of the United States and the services performed outside the United States, the Commonwealth of Puerto Rico and other possessions of the United States. Only those in-house research expenses apportioned to the services performed within the United States, the Commonwealth of Puerto Rico and other possessions of the United States are eligible to be treated as qualified research expenses, unless the in-house research expenses are wages and the 80 percent rule of § 1.41-2(d)(2) applies.
(iii) Apportionment of contract research expenses. If contract research is performed partly in the United States, the Commonwealth of Puerto Rico and other possessions of the United States and partly outside the United States, the Commonwealth of Puerto Rico and other possessions of the United States, only 65 percent (or 75 percent in the case of amounts paid to qualified research consortia) of the portion of the contract amount that is attributable to the research activity performed in the United States, the Commonwealth of Puerto Rico and other possessions of the United States may qualify as a contract research expense (even if 80 percent or more of the contract amount is for research performed in the United States, the Commonwealth of Puerto Rico and other possessions of the United States).
(8) Research in the social sciences, etc. Qualified research does not include research in the social sciences (including economics, business management, and behavioral sciences), arts, or humanities.
(9) Research funded by any grant, contract, or otherwise. Qualified research does not include any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity). To determine the extent to which research is so funded, § 1.41-4A(d) applies.
(10) Illustrations. The following examples illustrate provisions contained in paragraphs (c)(1) through (9) (excepting paragraphs (c)(6) of this section) of this section. No inference should be drawn from these examples concerning the application of section 41(d)(1) and paragraph (a) of this section to these facts. The examples are as follows:
(ii) Conclusion. X’s research with respect to the design of the new belts to be used in its manufacturing of the new tire may be qualified research under section 41(d)(1) and paragraph (a) of this section. However, X’s expenses to implement the new belts, including the costs to manufacture, install, and test the belts were incurred after the belts met the taxpayer’s functional and economic requirements and are excluded as research after commercial production under section 41(d)(4)(A) and paragraph (c)(2) of this section.
(ii) Conclusion. X’s activities to develop a new or improved widget are not excluded from the definition of qualified research under section 41(d)(4)(A) and paragraph (c)(2) of this section. X’s activities relating to the development of a new or improved widget constitute a new research project to develop a new business component. X’s research activities relating to the development of the new or improved widget, a new business component, are not considered to be activities conducted after the beginning of commercial production under section 41(d)(4)(A) and paragraph (c)(2) of this section.
(ii) Conclusion. Because X’s activities represent activities to adapt an existing software program to a particular customer’s requirement or need, X’s activities are excluded from the definition of qualified research under section 41(d)(4)(B) and paragraph (c)(3) of this section.
(ii) Conclusion. Because X’s activities are excluded from the definition of qualified research under section 41(d)(4)(B) and paragraph (c)(3) of this section, C’s payments to X are not for qualified research and are not considered to be contract research expenses under section 41(b)(3)(A).
(ii) Conclusion. Because C’s employees’ activities to adapt the core software program to C’s requirements are excluded from the definition of qualified research under section 41(d)(4)(B) and paragraph (c)(3) of this section, the wages C paid to its employees do not constitute in-house research expenses under section 41(b)(2)(A).
(ii) Conclusion. X’s activities to manufacture rail cars for B are excluded from the definition of qualified research. The rail car sold to B was not a new business component, but merely an adaptation of an existing business component that did not require a process of experimentation. Thus, X’s activities to manufacture rail cars for B are excluded from the definition of qualified research under section 41(d)(4)(B) and paragraph (c)(3) of this section because X’s activities represent activities to adapt an existing business component to a particular customer’s requirement or need.
(ii) Conclusion. X’s research activities to determine how to modify X’s robotic equipment for its manufacturing process are not excluded from the definition of qualified research under section 41(d)(4)(B) and paragraph (c)(3) of this section, provided that X’s research activities satisfy the requirements of section 41(d)(1).
(ii) Conclusion. X’s activities in analyzing and reproducing ingredients A and B involve duplication of existing business components and are excluded from the definition of qualified research under section 41(d)(4)(C) and paragraph (c)(4) of this section. X’s experimentation activities to develop potential alternative formulations of the additive do not involve duplication of an existing business component and are not excluded from the definition of qualified research under section 41(d)(4)(C) and paragraph (c)(4) of this section.
(ii) Conclusion. X’s activities in developing and implementing the new management structure are excluded from the definition of qualified research under section 41(d)(4)(D) and paragraph (c)(5) of this section. Qualified research does not include activities relating to management functions or techniques including management organization plans and management-based changes in production processes.
(ii) Conclusion. X’s activities related to the new product represent research in the social sciences (including economics and business management) and are thus excluded from the definition of qualified research under section 41(d)(4)(G) and paragraph (c)(8) of this section.
(d) Recordkeeping for the research credit. A taxpayer claiming a credit under section 41 must retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit. For the rules governing record retention, see § 1.6001-1. To facilitate compliance and administration, the IRS and taxpayers may agree to guidelines for the keeping of specific records for purposes of substantiating research credits.
(e) Effective/applicability dates. Other than paragraph (c)(6) of this section, this section is applicable for taxable years ending on or after December 31, 2003. Paragraph (c)(6) of this section is applicable for taxable years beginning on or after October 4, 2016. For any taxable year that both ends on or after January 20, 2015 and begins before October 4, 2016, the IRS will not challenge return positions consistent with all of paragraph (c)(6) of this section or all of paragraph (c)(6) of this section as contained in the Internal Revenue Bulletin (IRB) 2015-5 (see www.irs.gov/pub/irs-irbs/irb15-05.pdf). For taxable years ending before January 20, 2015, taxpayers may choose to follow either all of § 1.41-4(c)(6) as contained in 26 CFR part 1 (revised as of April 1, 2003) and IRB 2001-5 (see www.irs.gov/pub/irs-irbs/irb01-05.pdf) or all of § 1.41-4(c)(6) as contained in IRB 2002-4 (see www.irs.gov/pub/irs-irbs/irb02-04.pdf).
§ 1.41-4A Qualified research for taxable years beginning before January 1, 1986.
(a) General rule. Except as otherwise provided in section 30(d) (as that section read before amendment by the Tax Reform Act of 1986) and in this section, the term “qualified research” means research, expenditures for which would be research and experimental expenditures within the meaning of section 174. Expenditures that are ineligible for the section 174 deduction elections are not expenditures for qualified research. For example, expenditures for the acquisition of land or depreciable property used in research, and mineral exploration costs described in section 174(d), are not expenditures for qualified research.
(b) Activities outside the United States—(1) In-house research. In-house research conducted outside the United States (as defined in section 7701(a)(9)) cannot constitute qualified research. Thus, wages paid to an employee scientist for services performed in a laboratory in the United States and in a test station in Antarctica must be apportioned between the services performed within the United States and the services performed outside the United States, and only the wages apportioned to the services conducted within the United States are qualified research expenses unless the 80 percent rule of § 1.41-2(d)(2) applies.
(2) Contract research. If contract research is performed partly within the United States and partly without, only 65 percent of the portion of the contract amount that is attributable to the research performed within the United States can qualify as contract research expense (even if 80 percent or more of the contract amount was for research performed in the United States).
(c) Social sciences or humanities. Qualified research does not include research in the social sciences or humanities. For purposes of section 30(d)(2) (as that section read before amendment by the Tax Reform Act of 1986) and of this section, the phrase “research in the social sciences or humanities” encompasses all areas of research other than research in a field of laboratory science (such as physics or biochemistry), engineering or technology. Examples of research in the social sciences or humanities include the development of a new life insurance contract, a new economic model or theory, a new accounting procedure or a new cookbook.
(d) Research funded by any grant, contract, or otherwise—(1) In general. Research does not constitute qualified research to the extent it is funded by any grant, contract, or otherwise by another person (including any governmental entity). All agreements (not only research contracts) entered into between the taxpayer performing the research and other persons shall be considered in determining the extent to which the research is funded. Amounts payable under any agreement that are contingent on the success of the research and thus considered to be paid for the product or result of the research (see § 1.41-2(e)(2)) are not treated as funding. For special rules regarding funding between commonly controlled businesses, see § 1.41-6(e).
(2) Research in which taxpayer retains no rights. If a taxpayer performing research for another person retains no substantial rights in research under the agreement providing for the research, the research is treated as fully funded for purposes of section 41(d)(4)(H), and no expenses paid or incurred by the taxpayer in performing the research are qualified research expenses. For example, if the taxpayer performs research under an agreement that confers on another person the exclusive right to exploit the results of the research, the taxpayer is not performing qualified research because the research is treated as fully funded under this paragraph (d)(2). Incidental benefits to the taxpayer from performance of the research (for example, increased experience in a field of research) do not constitute substantial rights in the research. If a taxpayer performing research for another person retains no substantial rights in the research and if the payments to the researcher are contingent upon the success of the research, neither the performer nor the person paying for the research is entitled to treat any portion of the expenditures as qualified research expenditures.
(3) Research in which the taxpayer retains substantial rights—(i) In general. If a taxpayer performing research for another person retains substantial rights in the research under the agreement providing for the research, the research is funded to the extent of the payments (and fair market value of any property) to which the taxpayer becomes entitled by performing the research. A taxpayer does not retain substantial rights in the research if the taxpayer must pay for the right to use the results of the research. Except as otherwise provided in paragraph (d)(3)(ii) of this section, the taxpayer shall reduce the amount paid or incurred by the taxpayer for the research that would, but for section 41(d)(4)(H), constitute qualified research expenses of the taxpayer by the amount of funding determined under the preceding sentence.
(ii) Pro rata allocation. If the taxpayer can establish to the satisfaction of the district director—
(A) The total amount of research expenses,
(B) That the total amount of research expenses exceed the funding, and
(C) That the otherwise qualified research expenses (that is, the expenses which would be qualified research expenses if there were no funding) exceed 65 percent of the funding, then the taxpayer may allocate the funding pro rata to nonqualified and otherwise qualified research expenses, rather than allocating it 100 percent to otherwise qualified research expenses (as provided in paragraph (d)(3)(i) of this section). In no event, however, shall less than 65 percent of the funding be applied against the otherwise qualified research expenses.
(iii) Project-by-project determination. The provisions of this paragraph (d)(3) shall be applied separately to each research project undertaken by the taxpayer.
(4) Independent research and development under the Federal Acquisition Regulations System and similar provisions. The Federal Acquisition Regulations System and similar rules and regulations relating to contracts (fixed price, cost plus, etc.) with government entities provide for allocation of certain “independent research and development costs” and “bid and proposal costs” of a contractor to contracts entered into with that contractor. In general, any “independent research and development costs” and “bid and proposal costs” paid to a taxpayer by reason of such a contract shall not be treated as funding the underlying research activities except to the extent the “independent research and development costs” and “bid and proposal costs” are properly severable from the contract. See § 1.451-3(e); see also section 804(d)(2) of the Tax Reform Act of 1986.
(5) Funding determinable only in subsequent taxable year. If at the time the taxpayer files its return for a taxable year, it is impossible to determine to what extent particular research performed by the taxpayer during that year may be funded, then the taxpayer shall treat the research as completely funded for purposes of completing that return. When the amount of funding is finally determined, the taxpayer should amend the return and any interim returns to reflect the proper amount of funding.
(6) Examples. The following examples illustrate the application of the principles contained in this paragraph.
In-house research expenses | $100x |
Outside research: | |
(Amount B paid to third parties for research, 65 percent of which ($26x) is treated as a contract research expense of B) | 40x |
Overhead and other expenses | 10x |
Total | 150x |
§ 1.41-5 Basic research for taxable years beginning after December 31, 1986. [Reserved]
§ 1.41-5A Basic research for taxable years beginning before January 1, 1987.
(a) In general. The amount expended for basic research within the meaning of section 30(e) (before amended by the Tax Reform Act of 1986) equals the sum of money plus the taxpayer’s basis in tangible property (other than land) transferred for use in the performance of basic research.
(b) Trade or business requirement. Any amount treated as a contract research expense under section 30(e) (before amendment by the Tax Reform Act of 1986) shall be deemed to have been paid or incurred in carrying on a trade or business, if the corporation that paid or incurred the expenses is actually engaged in carrying on some trade or business.
(c) Prepaid amounts—(1) In general. If any basic research expense paid or incurred during any taxable year is attributable to research to be conducted after the close of such taxable year, the expense so attributable shall be treated for purposes of section 30(b)(1)(B) (before amendment by the Tax Reform Act of 1986) as paid or incurred during the period in which the basic research is conducted.
(2) Transfers of property. In the case of transfers of property to be used in the performance of basic research, the research in which that property is to be used shall be considered to be conducted ratably over a period beginning on the day the property is first so used and continuing for the number of years provided with respect to property of that class under section 168(c)(2) (before amendment by the Tax Reform Act of 1986). For example, if an item of property which is 3-year property under section 168(c) is transferred to a university for basic research on January 12, 1983, and is first so used by the university on March 1, 1983, then the research in which that property is used is considered to be conducted ratably from March 1, 1983, through February 28, 1986.
(d) Written research agreement—(1) In general. A written research agreement must be entered into prior to the performance of the basic research.
(2) Agreement between a corporation and a qualified organization after June 30, 1983—(i) In general. A written research agreement between a corporation and a qualified organization (including a qualified fund) entered into after June 30, 1983, shall provide that the organization shall inform the corporation within 60 days after the close of each taxable year of the corporation what amount of funds provided by the corporation pursuant to the agreement was expended on basic research during the taxable year of the corporation. In determining amounts expended on basic research, the qualified organization shall take into account the exclusions specified in section 30(e)(3) (before amendment by the Tax Reform Act of 1986) and in paragraph (e) of this section.
(ii) Transfers of property. In the case of transfers of property to be used in basic research, the agreement shall provide that substantially all use of the property is to be for basic research, as defined in section 30(e)(3) (before amendment by the Tax Reform Act of 1986).
(3) Agreement between a qualified fund and a qualified educational organization after June 30, 1983. A written research agreement between a qualified fund and a qualified educational organization (see section 30(e)(4)(B)(iii) (before amendment by the Tax Reform Act of 1986)) entered into after June 30, 1983, shall provide that the qualified educational organization shall furnish sufficient information to the qualified fund to enable the qualified fund to comply with the written research agreements it has entered into with grantor corporations, including the requirement set forth in paragraph (d)(2) of this section.
(e) Exclusions—(1) Research conducted outside the United States. If a taxpayer pays or incurs an amount for basic research to be performed partly within the United States and partly without, only 65 percent of the portion of the amount attributable to research performed within the United States can be treated as a contract research expense (even if 80 percent or more of the contract amount was for basic research performed in the United States).
(2) Research in the social sciences or humanities. Basic research does not include research in the social sciences or humanities, within the meaning of § 1.41-4A(c).
(f) Procedure for making an election to be treated as a qualified fund. In order to make an election to be treated as a qualified fund within the meaning of section 30(e)(4)(B)(iii) (before amendment by the Tax Reform Act of 1986) or as an organization described in section 41(e)(6)(D), the organization shall file with the Internal Revenue Service center with which it files its annual return a statement that—
(1) Sets out the name, address, and taxpayer identification number of the electing organization (the “taxpayer”) and of the organization that established and maintains the electing organization (the “controlling organization”),
(2) Identifies the election as an election under section 41(e)(6)(D) of the Code,
(3) Affirms that the controlling organization and the taxpayer are section 501(c)(3) organizations,
(4) Provides that the taxpayer elects to be treated as a private foundation for all Code purposes other than section 4940,
(5) Affirms that the taxpayer satisfies the requirement of section 41(e)(6)(D)(iii), and
(6) Specifies the date on which the election is to become effective.
§ 1.41-6 Aggregation of expenditures.
(a) Controlled group of corporations; trades or businesses under common control—(1) In general. To determine the amount of research credit (if any) allowable to a trade or business that at the end of its taxable year is a member of a controlled group, a taxpayer must—
(i) Compute the group credit in the manner described in paragraph (b) of this section; and
(ii) Allocate the group credit among the members of the group in the manner described in paragraph (c) of this section.
(2) Consolidated groups. For special rules relating to consolidated groups, see paragraph (d) of this section.
(3) Definitions. For purposes of this section—
(i) Consolidated group has the meaning set forth in § 1.1502-1(h).
(ii) Controlled group and group mean a controlled group of corporations, as defined in section 41(f)(5), or a group of trades or businesses under common control. For rules for determining whether trades or businesses are under common control, see § 1.52-1 (b) through (g).
(iii) Credit year means the taxable year for which the member is computing the credit.
(iv) Group credit means the research credit (if any) allowable to a controlled group.
(v) Trade or business means a sole proprietorship, a partnership, a trust, an estate, or a corporation that is carrying on a trade or business (within the meaning of section 162). Any corporation that is a member of a commonly controlled group shall be deemed to be carrying on a trade or business if any other member of that group is carrying on any trade or business.
(b) Computation of the group credit—(1) In general. All members of a controlled group are treated as a single taxpayer for purposes of computing the research credit. The group credit is compute2d by applying all of the section 41 computational rules on an aggregate basis. All members of a controlled group must use the same method of computation: The method described in section 41(a)(1), the alternative incremental credit (AIRC) method described in section 41(c)(4) (available for years beginning on or before December 31, 2008), or the alternative simplified credit (ASC) method described in section 41(c)(5), in computing the group credit for a credit year.
(2) Start-up companies—(i) In general. For purposes of computing the group credit, a controlled group is treated as a start-up company for purposes of section 41(c)(3)(B)(i) if—
(A) There was no taxable year beginning before January 1, 1984, in which a member of the group had gross receipts and either the same member or another member also had qualified research expenditures (QREs); or
(B) There were fewer than three taxable years beginning after December 31, 1983, and before January 1, 1989, in which a member of the group had gross receipts and either the same member or another member also had QREs.
(ii) Example. The following example illustrates the principles of paragraph (b)(2)(i) of this section:
(iii) First taxable year after December 31, 1993, for which the controlled group had QREs. In the case of a controlled group that is treated as a start-up company under section 41(c)(3)(B)(i) and paragraph (b)(2)(i) of this section, for purposes of determining the group’s fixed-base percentage under section 41(c)(3)(B)(ii), the first taxable year after December 31, 1993, for which the group has QREs is the first taxable year in which at least one member of the group has QREs.
(iv) Example. The following example illustrates the principles of paragraph (b)(2)(iii) of this section:
(c) Allocation of the group credit. The group credit is allocated to each member of the controlled group on a proportionate basis to its share of the aggregate of the qualified research expenses, basic research payments, and amounts paid or incurred to energy research consortiums taken into account for the taxable year by such controlled group for purposes of the credit. For purposes of paragraphs (c), (d), and (e) of this section, qualified research expenses, basic research payments, and amounts paid or incurred to energy research consortiums are collectively referred to as QREs.
(d) Special rules for consolidated groups—(1) In general. For purposes of applying paragraph (c) of this section, members of a consolidated group who are members of a controlled group are treated as a single member of the controlled group.
(2) Start-up company status. A consolidated group’s status as a start-up company and the first taxable year after December 31, 1993, for which a consolidated group has QREs are determined in accordance with the principles of paragraph (b)(2) of this section.
(3) Special rule for allocation of group credit among consolidated group members. The portion of the group credit that is allocated to a consolidated group is allocated to each member of the consolidated group on a proportionate basis to its share of the aggregate of the QREs taken into account for the taxable year by such consolidated group for purposes of the credit.
(e) Examples. The following examples illustrate the provisions of paragraphs (c) and (d) of this section.
(f) For taxable years beginning before January 1, 1990. For taxable years beginning before January 1, 1990, see § 1.41-6 as contained in 26 CFR part 1, revised April 1, 2005.
(g) Tax accounting periods used—(1) In general. The credit allowable to a member of a controlled group is that member’s share of the group credit computed as of the end of that member’s taxable year. In computing the group credit for a group whose members have different taxable years, a member generally should treat the taxable year of another member that ends with or within the credit year of the computing member as the credit year of that other member. For example, Q, R, and S are members of a controlled group of corporations. Both Q and R are calendar year taxpayers. S files a return using a fiscal year ending June 30. For purposes of computing the group credit at the end of Q’s and R’s taxable year on December 31, S’s fiscal year ending June 30, which ends within Q’s and R’s taxable year, is treated as S’s credit year.
(2) Special rule when timing of research is manipulated. If the timing of research by members using different tax accounting periods is manipulated to generate a credit in excess of the amount that would be allowable if all members of the group used the same tax accounting period, then the appropriate Internal Revenue Service official in the operating division that has examination jurisdiction of the return may require each member of the group to calculate the credit in the current taxable year and all future years as if all members of the group had the same taxable year and base period as the computing member.
(h) Membership during taxable year in more than one group. A trade or business may be a member of only one group for a taxable year. If, without application of this paragraph, a business would be a member of more than one group at the end of its taxable year, the business shall be treated as a member of the group in which it was included for its preceding taxable year. If the business was not included for its preceding taxable year in any group in which it could be included as of the end of its taxable year, the business shall designate in its timely filed (including extensions) return the group in which it is being included. If the return for a taxable year is due before July 1, 1983, the business may designate its group membership through an amended return for that year filed on or before June 30, 1983. If the business does not so designate, then the appropriate Internal Revenue Service official in the operating division that has examination jurisdiction of the return will determine the group in which the business is to be included.
(i) Intra-group transactions—(1) In general. Because all members of a group under common control are treated as a single taxpayer for purposes of determining the research credit, transfers between members of the group are generally disregarded.
(2) In-house research expenses. If one member of a group performs qualified research on behalf of another member, the member performing the research shall include in its QREs any in-house research expenses for that work and shall not treat any amount received or accrued as funding the research. Conversely, the member for whom the research is performed shall not treat any part of any amount paid or incurred as a contract research expense. For purposes of determining whether the in-house research for that work is qualified research, the member performing the research shall be treated as carrying on any trade or business carried on by the member on whose behalf the research is performed.
(3) Contract research expenses. If a member of a group pays or incurs contract research expenses to a person outside the group in carrying on the member’s trade or business, that member shall include those expenses as QREs. However, if the expenses are not paid or incurred in carrying on any trade or business of that member, those expenses may be taken into account as contract research expenses by another member of the group provided that the other member—
(i) Reimburses the member paying or incurring the expenses; and
(ii) Carries on a trade or business to which the research relates.
(4) Lease payments. The amount paid or incurred to another member of the group for the lease of personal property owned by a member of the group is not taken into account for purposes of section 41. Amounts paid or incurred to another member of the group for the lease of personal property owned by a person outside the group shall be taken into account as in-house research expenses for purposes of section 41 only to the extent of the lesser of—
(i) The amount paid or incurred to the other member; or
(ii) The amount of the lease expenses paid to the person outside the group.
(5) Payment for supplies. Amounts paid or incurred to another member of the group for supplies shall be taken into account as in-house research expenses for purposes of section 41 only to the extent of the lesser of—
(i) The amount paid or incurred to the other member; or
(ii) The amount of the other member’s basis in the supplies.
(j) Effective/applicability dates—(1) In general. Except for paragraph (d) of this section, these regulations are applicable for taxable years ending on or after May 24, 2005. Generally, a taxpayer may use any reasonable method of computing and allocating the credit (including use of the consolidated group rule contained in paragraph (d) of this section) for taxable years ending before May 24, 2005. However, paragraph (b) of this section, relating to the computation of the group credit, and paragraph (c) of this section, relating to the allocation of the group credit, (applied without regard to paragraph (d) of this section) will apply to taxable years ending on or after December 29, 1999, if the members of a controlled group, as a whole, claimed more than 100 percent of the amount that would be allowable under paragraph (b) of this section. In the case of a controlled group whose members have different taxable years and whose members use inconsistent methods of allocation, the members of the controlled group shall be deemed to have, as a whole, claimed more than 100 percent of the amount that would be allowable under paragraph (b) of this section.
(2) Consolidated group rule. Paragraph (d) of this section is applicable for taxable years ending on or after November 9, 2006. For taxable years ending on or after May 24, 2005, and before November 9, 2006, see § 1.41-6T(d) as contained in 26 CFR part 1, revised April 1, 2006.
(3) Taxable years ending after June 9, 2011. Paragraphs (b)(1), (c)(2), and (e) of this section are applicable for taxable years ending after June 9, 2011. For taxable years ending on or before June 9, 2011, see §§ 1.41-6T and 1.41-6 as contained in 26 CFR part 1, revised April 1, 2011.
(4) Taxable years beginning after December 31, 2011. Paragraphs (c), (d)(1) and (3), (e), and (j)(4) and (5) of this section apply to taxable years beginning on or after April 2, 2018. For taxable years ending before April 2, 2018, see § 1.41-6T as contained in 26 CFR part 1, as revised April 1, 2017.
(5) Taxable years beginning before January 1, 2012. See § 1.41-6 as contained in 26 CFR part 1, revised April 1, 2014.
§ 1.41-7 Special rules.
(a) Allocations—(1) Corporation making an election under subchapter S—(i) Pass-through, for taxable years beginning after December 31, 1982, in the case of an S corporation. In the case of an S corporation (as defined in section 1361) the amount of research credit computed for the corporation shall be allocated to the shareholders according to the provisions of section 1366 and section 1377.
(ii) Pass-through, for taxable years beginning before January 1, 1983, in the case of a subchapter S corporation. In the case of an electing small business corporation (as defined in section 1371 as that section read before the amendments made by the subchapter S Revision Act of 1982), the amount of the research credit computed for the corporation for any taxable year shall be apportioned pro rata among the persons who are shareholders of the corporation on the last day of the corporation’s taxable year.
(2) Pass-through in the case of an estate or trust. In the case of an estate or trust, the amount of the research credit computed for the estate or trust for any taxable year shall be apportioned among the estate or trust and the beneficiaries on the basis of the income of the estate or trust allocable to each.
(3) Pass-through in the case of a partnership—(i) In general. In the case of a partnership, the research credit computed for the partnership for any taxable year shall be apportioned among the persons who are partners during the taxable year in accordance with section 704 and the regulations thereunder. See, for example, § 1.704-1(b)(4)(ii). Because the research credit is an expenditure-based credit, the credit is to be allocated among the partners in the same proportion as section 174 expenditures are allocated for the year.
(ii) Certain expenditures by joint ventures. Research expenses to which § 1.41-2(a)(4)(ii) applies shall be apportioned among the persons who are partners during the taxable year in accordance with the provisions of that section. For purposes of section 41, these expenses shall be treated as paid or incurred directly by the partners rather than by the partnership. Thus, the partnership shall disregard these expenses in computing the credit to be apportioned under paragraph (a)(3)(i) of this section, and in making the computations under section 41 each partner shall aggregate its distributive share of these expenses with other research expenses of the partner. The limitation on the amount of the credit set out in section 41(g) and in paragraph (c) of this section shall not apply because the credit is computed by the partner, not the partnership.
(4) Year in which taken into account. An amount apportioned to a person under this paragraph shall be taken into account by the person in the taxable year of such person which or within which the taxable year of the corporation, estate, trust, or partnership (as the case may be) ends.
(5) Credit allowed subject to limitation. The credit allowable to any person to whom any amount has been apportioned under paragraph (a)(1), (2) or (3)(i) of this section is subject to section 41(g) and sections 38 and 39 of the Code, if applicable.
(b) Adjustments for certain acquisitions and dispositions—Meaning of terms. For the meaning of “acquisition,” “separate unit,” and “major portion,” see paragraph (b) of § 1.52-2. An “acquisition” includes an incorporation or a liquidation.
(c) Special rule for pass-through of credit. The special rule contained in section 41(g) for the pass-through of the credit in the case of an individual who owns an interest in an unincorporated trade or business, is a partner in a partnership, is a beneficiary of an estate or trust, or is a shareholder in an S corporation shall be applied in accordance with the principles set forth in § 1.53-3.
(d) Carryback and carryover of unused credits. The taxpayer to whom the credit is passed through under paragraph (c) of this section shall not be prevented from applying the unused portion in a carryback or carryover year merely because the entity that earned the credit changes its form of conducting business.
§ 1.41-8 Alternative incremental credit applicable for taxable years beginning on or before December 31, 2008.
(a) Determination of credit. At the election of the taxpayer, the credit determined under section 41(a)(1) equals the amount determined under section 41(c)(4).
(b) Election—(1) In general. A taxpayer may elect to apply the provisions of the alternative incremental research credit (AIRC) in section 41(c)(4) for any taxable year of the taxpayer beginning after June 30, 1996. If a taxpayer makes an election under section 41(c)(4), the election applies to the taxable year for which made and all subsequent taxable years unless revoked in the manner prescribed in paragraph (b)(3) of this section.
(2) Time and manner of election. An election under section 41(c)(4) is made by completing the portion of Form 6765, “Credit for Increasing Research Activities,” (or successor form) relating to the election of the AIRC, and attaching the completed form to the taxpayer’s timely filed (including extensions) original return for the taxable year to which the election applies. An election under section 41(c)(4) may not be made on an amended return. An extension of time to make an election under section 41(c)(4) will not be granted under § 301.9100-3 of this chapter.
(3) Revocation. An election under this section may not be revoked except with the consent of the Commissioner. A taxpayer is deemed to have requested, and to have been granted, the consent of the Commissioner to revoke an election under section 41(c)(4) if the taxpayer completes the portion of Form 6765, “Credit For Increasing Research Activities,” (or successor form) relating to the amount determined under section 41(a)(1) (the regular credit) or the alternative simplified credit (ASC) and attaches the completed form to the taxpayer’s timely filed (including extensions) original return for the year to which the revocation applies. An election under section 41(c)(4) may not be revoked on an amended return. An extension of time to revoke an election under section 41(c)(4) will not be granted under § 301.9100-3 of this chapter.
(4) Special rules for controlled groups—(i) In general. In the case of a controlled group of corporations, all the members of which are not included on a single consolidated return, an election (or revocation) must be made by the designated member by satisfying the requirements of paragraph (b)(2) or (b)(3) of this section (whichever applies), and such election (or revocation) by the designated member shall be binding on all the members of the group for the credit year to which the election (or revocation) relates. If the designated member fails to timely make (or revoke) an election, each member of the group must compute the group credit using the method used to compute the group credit for the immediately preceding credit year.
(ii) Designated member. For purposes of this paragraph (b)(4), for any credit year, the term designated member means that member of the group that is allocated the greatest amount of the group credit under § 1.41-6(c) based on the amount of credit reported on the taxpayer’s timely filed (including extensions) original Federal income tax return (even if that member subsequently is determined not to be the designated member). If the members of a group compute the group credit using different methods (the method described in section 41(a)(1), the AIRC method of section 41(c)(4) (available for years beginning on or before December 31, 2008), or the ASC method of section 41(c)(5)) and at least two members of the group qualify as the designated member, then the term designated member means that member that computes the group credit using the method that yields the greatest group credit. For example, A, B, C, and D are members of a controlled group but are not members of a consolidated group. For the 2008 taxable year (the credit year), the group credit using the method described in section 41(a)(1) is $10x. Under this method, A would be allocated $5x of the group credit, which would be the largest share of the group credit under this method. For the credit year, the group credit using the AIRC method is $15x. Under the AIRC method, B would be allocated $5x of the group credit, which is the largest share of the group credit computed using the AIRC method. For the credit year, the group credit using the ASC method is $10x. Under the ASC method, C would be allocated $5x of the group credit, which is the largest share of the group credit computed using the ASC method. Because the group credit is greatest using the AIRC method and B is allocated the greatest amount of credit under that method, B is the designated member. Therefore, if B makes a section 41(c)(4) election on its original timely filed return for the credit year, that election is binding on all members of the group for the credit year.
(5) Effective/applicability dates. This section is applicable for taxable years ending after June 9, 2011. For taxable years ending on or before June 9, 2011, see §§ 1.41-8 and 1.41-8T, as contained in 26 CFR part 1, revised April 1, 2011.
§ 1.41-9 Alternative simplified credit.
(a) Determination of credit. At the election of the taxpayer, the credit determined under section 41(a)(1) equals the amount determined under section 41(c)(5).
(b) Election—(1) In general. A taxpayer may elect to apply the provisions of the alternative simplified credit (ASC) in section 41(c)(5) for any taxable year of the taxpayer ending after December 31, 2006. If a taxpayer makes an election under section 41(c)(5), the election applies to the taxable year for which made and all subsequent taxable years unless revoked in the manner prescribed in paragraph (b)(3) of this section.
(2) Time and manner of election. A taxpayer makes an election under section 41(c)(5) by completing the portion of Form 6765, “Credit for Increasing Research Activities,” (or successor form) relating to the election of the ASC, and attaching the completed form to the taxpayer’s timely filed (including extensions) original return for the taxable year to which the election applies. A taxpayer may make an election under section 41(c)(5) for a tax year on an amended return, but only if the taxpayer has not previously claimed a section 41(a)(1) credit on its original return or an amended return for that tax year, and only if that tax year is not closed by the period of limitations on assessment under section 6501(a). An extension of time to make an election under section 41(c)(5) will not be granted under § 301.9100-3 of this chapter. A taxpayer that is a member of a controlled group in a tax year may not make an election under section 41(c)(5) for that tax year on an amended return if any member of the controlled group for that tax year previously claimed the research credit under section 41(a)(1) using a method other than the ASC on an original or amended return for that tax year. See paragraph (b)(4) of this section for additional rules concerning controlled groups. See also § 1.41-6(b)(1) requiring that all members of the controlled group use the same method of computation.
(3) Revocation. An election under this section may not be revoked except with the consent of the Commissioner. A taxpayer is deemed to have requested, and to have been granted, the consent of the Commissioner to revoke an election under section 41(c)(5) if the taxpayer completes the portion of Form 6765 (or successor form) relating to the credit determined under section 41(a)(1) (the regular credit) or the alternative incremental credit (AIRC) and attaches the completed form to the taxpayer’s timely filed (including extensions) original return for the year to which the revocation applies. An election under section 41(c)(5) may not be revoked on an amended return. An extension of time to revoke an election under section 41(c)(5) will not be granted under § 301.9100-3 of this chapter.
(4) Special rules for controlled groups—(i) In general. In the case of a controlled group of corporations, all the members of which are not included on a single consolidated return, an election (or revocation) must be made by the designated member by satisfying the requirements of paragraphs (b)(2) or (b)(3) of this section (whichever applies), and such election (or revocation) by the designated member shall be binding on all the members of the group for the credit year to which the election (or revocation) relates. If the designated member fails to timely make (or revoke) an election, each member of the group must compute the group credit using the method used to compute the group credit for the immediately preceding credit year.
(ii) Designated member. For purposes of this paragraph (b)(4), for any credit year, the term designated member means that member of the group that is allocated the greatest amount of the group credit under § 1.41-6(c) based on the amount of credit reported on the taxpayer’s timely filed (including extensions) original Federal income tax return (even if that member subsequently is determined not to be the designated member). If the members of a group compute the group credit using different methods (the method described in section 41(a)(1), the AIRC method of section 41(c)(4), or the ASC method of section 41(c)(5)) and at least two members of the group qualify as the designated member, then the term designated member means that member that computes the group credit using the method that yields the greatest group credit. For example, A, B, C, and D are members of a controlled group but are not members of a consolidated group. For the 2011 taxable year (the credit year), the group credit using the method described in section 41(a)(1) is $10x. Under this method, A would be allocated $5x of the group credit, which would be the largest share of the group credit under this method. For the credit year, the group credit using the ASC method is $15x. Under the ASC method, C would be allocated $5x of the group credit, which is the largest share of the group credit computed using the ASC method. Because the group credit is greatest using the ASC method and C is allocated the greatest amount of credit under that method, C is the designated member. Therefore, if C makes a section 41(c)(5) election on its timely filed (including extensions) original return for the credit year, that election is binding on all members of the group for the credit year.
(c) Special rules—(1) Qualified research expenses (QREs) required in all years. Unless a taxpayer has QREs in each of the three taxable years preceding the taxable year for which the credit is being determined, the credit equals that percentage of the QREs for the taxable year provided by section 41(c)(5)(B)(ii).
(2) Section 41(c)(6) applicability. QREs for the three taxable years preceding the credit year must be determined on a basis consistent with the definition of QREs for the credit year, without regard to the law in effect for the three taxable years preceding the credit year. This consistency requirement applies even if the period for filing a claim for credit or refund has expired for any of the three taxable years preceding the credit year.
(3) Short taxable years—(i) General rule. If one or more of the three taxable years preceding the credit year is a short taxable year, then the QREs for such year are deemed to be equal to the QREs actually paid or incurred in that year multiplied by 365 and divided by the number of days in that year. If a credit year is a short taxable year, then the average QREs for the three taxable years preceding the credit year are modified by multiplying that amount by the number of days in the short taxable year and dividing the result by 365.
(ii) Limited exception. Returns filed for taxable years ending after December 31, 2006, and before June 9, 2011, and for which the period of limitations has not expired, may be amended to apply the daily calculation for short taxable years provided in paragraph (3)(i) of this section in lieu of the monthly calculation for short taxable years provided in § 1.41-9T(c)(4).
(4) Controlled groups. For purposes of computing the group credit under § 1.41-6, a controlled group must apply the rules of this paragraph (c) on an aggregate basis. For example, if the controlled group has QREs in each of the three taxable years preceding the taxable year for which the credit is being determined, the controlled group applies the credit computation provided by section 41(c)(5)(A) rather than section 41(c)(5)(B)(ii).
(d) Effective/applicability dates. This section is applicable for taxable years ending after June 9, 2011. For taxable years ending on or before June 9, 2011, see § 1.41-9T as contained in 26 CFR part 1, revised April 1, 2011. Paragraph (b)(2) of this section applies to elections with respect to taxable years ending on or after February 27, 2015. For taxable years ending before February 27, 2015, see § 1.41-9T as contained in 26 CFR part 1, revised April 1, 2015.
§ 1.42-0 Table of contents.
This section lists the paragraphs contained in §§ 1.42-1 through 1.42-19 and § 1.42-1T.
(a) through (g) [Reserved]
(h) Filing of forms.
(i) [Reserved]
(j) Effective dates.
(a) In general.
(1) Determination of amount of low-income housing credit.
(2) Limitation on low-income housing credit allowed.
(b) The State housing credit ceiling.
(c) Apportionment of State housing credit ceiling among State and local housing credit agencies.
(1) In general.
(2) Primary apportionment.
(3) States with 1 or more constitutional home rule cities.
(i) In general.
(ii) Amount of apportionment to a constitutional home rule city.
(iii) Effect of apportionment to constitutional home rule cities on apportionment to other housing credit agencies.
(iv) Treatment of governmental authority within constitutional home rule city.
(4) Apportionment to local housing credit agencies.
(i) In general.
(ii) Change in apportionment during a calendar year.
(iii) Exchanges of apportionments.
(iv) Written records of apportionments.
(5) Set-aside apportionments for projects involving a qualified nonprofit organization.
(i) In general.
(ii) Projects involving a qualified nonprofit organization.
(6) Expiration of unused apportionments.
(d) Housing credit allocation made by State and local housing credit agencies.
(1) In general.
(2) Amount of a housing credit allocation.
(3) Counting housing credit allocations against an agency’s aggregate housing credit dollar amount.
(4) Rules for when applications for housing credit allocations exceed an agency’s aggregate housing credit dollar amount.
(5) Reduced or additional housing credit allocations.
(i) In general.
(ii) Examples.
(6) No carryover of unused aggregate housing credit dollar amount.
(7) Effect of housing credit allocations in excess of an agency’s aggregate housing credit dollar amount.
(8) Time and manner for making housing credit allocations.
(i) Time.
(ii) Manner.
(iii) Certification.
(iv) Fee.
(v) No continuing agency responsibility.
(e) Housing credit allocation taken into account by owner of a qualified low-income building.
(1) Time and manner for taking housing credit allocation into account.
(2) First-year convention limitation on housing credit allocation taken into account.
(3) Use of excess housing credit allocation for increases in qualified basis.
(i) In general.
(ii) Example.
(4) Separate housing credit allocations for new buildings and increases in qualified basis.
(5) Acquisition of building for which a prior housing credit allocation has been made.
(6) Multiple housing credit allocations.
(f) Exception to housing credit allocation requirement.
(1) Tax-exempt bond financing.
(i) In general.
(ii) Determining use of bond proceeds.
(iii) Example.
(g) Termination of authority to make housing credit allocation.
(1) In general.
(2) Carryover of unused 1989 apportionment.
(3) Expiration of exception for tax-exempt bond financed projects.
(h) [Reserved]
(i) Transitional rules.
(a) Low-income housing credit for existing building
(b) Waiver of 10-year holding period requirement
(c) Waiver requirements
(1) Federally-assisted building
(2) Federal mortgage funds at risk
(3) Statement by the Department of Housing and Urban Development or the Farmers’ Home Administration
(4) No prior credit allowed
(d) Application for waiver
(1) Time and manner
(2) Information required
(3) Other rules
(4) Effective date of waiver
(5) Attachment to return
(e) Effective date of regulations
(a) Treatment under sections 42(i) and 42(b).
(b) Effective date.
(a) Inapplicability to section 42.
(b) Limitation.
(c) Effective date.
(a) Compliance monitoring requirement.
(1) In general.
(2) Requirements for a monitoring procedure.
(i) In general.
(ii) Order and form.
(iii) [Reserved]
(b) Recordkeeping and record retention provisions.
(1) Recordkeeping provision.
(2) Record retention provision.
(3) Inspection record retention provision.
(c) Certification and review provisions.
(1) Certification.
(2) Review.
(ii)-(iii) [Reserved]
(3) [Reserved]
(4) Exception for certain buildings.
(i) In general.
(ii) Agreement and review.
(iii) Example.
(5) Agency reports of compliance monitoring activities.
(d) Inspection provision.
(1) In general.
(2) Inspection standard.
(3) Exception from inspection provision.
(4) Delegation.
(e) Notification-of-noncompliance provisions.
(1) In general.
(2) Notice to owner.
(3) Notice to Internal Revenue Service.
(i) In general.
(ii) Agency retention of records.
(4) Correction period.
(f) Delegation of authority.
(1) Agencies permitted to delegate compliance monitoring functions.
(i) In general.
(ii) Limitations.
(2) Agencies permitted to delegate compliance monitoring functions to another Agency.
(g) Liability.
(h) Effective/applicability dates.
(1) In general.
(2) [Reserved]
(a) Carryover allocations.
(1) In general.
(2) 10 percent basis requirement.
(i) Allocation made before July 1.
(ii) Allocation made after June 30.
(b) Carryover-allocation basis.
(1) In general.
(2) Limitations.
(i) Taxpayer must have basis in land or depreciable property related to the project.
(ii) High cost areas.
(iii) Amounts not treated as paid or incurred.
(iv) Fees.
(3) Reasonably expected basis.
(4) Examples.
(c) Verification of basis by Agency.
(1) Verification requirement.
(2) Manner of verification.
(3) Time of verification.
(i) Allocations made before July 1.
(ii) Allocations made after June 30.
(d) Requirements for making carryover allocations.
(1) In general.
(2) Requirements for allocation.
(3) Special rules for project-based allocations.
(i) In general.
(ii) Requirement of section 42(h)(1)(F)(1)(III).
(4) Recordkeeping requirements.
(i) Taxpayer.
(ii) Agency.
(5) Separate procedure for election of appropriate percentage month.
(e) Special rules.
(1) Treatment of partnerships and other flow-through entities.
(2) Transferees.
(a) Election under section 42(b)(2)(A)(ii)(I) to use the appropriate percentage for the month of a binding agreement.
(1) In general.
(2) Effect on state housing credit ceiling.
(3) Time and manner of making election.
(4) Multiple agreements.
(i) Rescinded agreements.
(ii) Increases in credit.
(5) Amount allocated.
(6) Procedures.
(i) Taxpayer.
(ii) Agency.
(7) Examples.
(b) Election under section 42(b)(2)(A)(ii)(II) to use the appropriate percentage for the month tax-exempt bonds are issued.
(1) Time and manner of making election.
(2) Bonds issued in more than one month.
(3) Limitations on appropriate percentage.
(4) Procedures.
(i) Taxpayer.
(ii) Agency.
(a) General rule.
(b) Limitations.
(c) Treatment of units not for use by the general public.
(a) Inclusion of utility allowances in gross rent.
(b) Applicable utility allowances.
(1) Buildings assisted by the Rural Housing Service.
(2) Buildings with Rural Housing Service assisted tenants.
(3) Buildings regulated by the Department of Housing and Urban Development.
(4) Other buildings.
(i) Tenants receiving HUD rental assistance.
(ii) Other tenants.
(A) General rule.
(B) Utility company estimate.
(C) Agency estimate.
(D) HUD Utility Schedule Model.
(E) Energy consumption model.
(c) Changes in applicable utility allowance.
(1) In general.
(2) Annual review.
(d) Record retention.
(e) Actual consumption submetering arrangements.
(1) Definition.
(2) Administrative fees.
(a) General rule.
(b) Services that are optional.
(1) General rule.
(2) Continual or frequent services.
(3) Required services.
(i) General rule.
(ii) Exceptions.
(A) Supportive services.
(B) Specific project exception.
(a) Effective dates.
(1) In general.
(2) Community Renewal Tax Relief Act of 2000.
(i) In general.
(3) Electronic filing simplification changes.
(4) Utility allowances.
(5) Additional effective dates affecting utility allowances.
(b) Prior periods.
(c) Carryover allocations.
(a) Publication of guidance.
(b) Correcting administrative errors and omissions.
(1) In general.
(2) Administrative errors and omissions described.
(3) Procedures for correcting administrative errors or omissions.
(i) In general.
(ii) Specific procedures.
(iii) Secretary’s prior approval required.
(iv) Requesting the Secretary’s approval.
(v) Agreement to conditions.
(vi) Secretary’s automatic approval.
(vii) How Agency corrects errors or omissions subject to automatic approval.
(viii) Other approval procedures.
(c) Examples.
(d) Effective date.
(a) State housing credit ceiling.
(1) In general.
(2) Cost-of-living adjustment.
(i) General rule.
(ii) Rounding.
(b) The unused carryforward component.
(c) The population component.
(d) The returned credit component.
(1) In general.
(2) Limitations and special rules.
(i) General limitations.
(ii) Credit period limitation.
(iii) Three-month rule for returned credit.
(iv) Returns of credit.
(A) Building not qualified within required time period.
(B) Noncompliance with terms of the allocation.
(C) Mutual consent.
(D) Amount not necessary for financial feasibility.
(3) Manner of returning credit.
(i) Taxpayer notification.
(ii) Internal Revenue Service notification.
(e) The national pool component.
(f) When the State housing credit ceiling is determined.
(g) Stacking order.
(h) Nonprofit set-aside.
(1) Determination of set-aside.
(2) Allocation rules.
(i) National Pool.
(1) In general.
(2) Unused housing credit carryover.
(3) Qualified State.
(i) In general.
(ii) Exceptions.
(A) De minimis amount.
(B) Other circumstances.
(iii) Time and manner for making request.
(4) Formula for determining the National Pool.
(j) Coordination between Agencies.
(k) Example.
(l) Effective dates.
(1) In general.
(2) Community Renewal Tax Relief Act of 2000 changes.
(a) Definitions.
(b) General section 42(g)(2)(D)(i) rule.
(c) Exceptions.
(1) In general.
(2) Rental of next available unit in case of the average income test.
(i) Basic rule.
(ii) No requirement to comply with the next available unit rule in a specific order.
(iii) Deep rent skewed projects.
(iv) Limitation.
(d) Effect of current resident moving within building.
(e) Available unit rule applies separately to each building in a project.
(f) Result of noncompliance with available unit rule.
(g) Relationship to tax-exempt bond provisions.
(h) Examples.
(i) Applicability dates.
(1) In general.
(2) Applicability dates under the average income test.
(a) In general.
(b) Grants do not include certain rental assistance payments.
(c) Qualifying rental assistance program.
(d) Effective date.
(a) Requirements.
(1) In general [Reserved].
(2) Selection criteria [Reserved].
(3) Agency evaluation.
(4) Timing of Agency evaluation.
(i) In general.
(ii) Time limit for placed-in-service evaluation.
(5) Special rule for final determinations and certifications.
(6) Bond-financed projects.
(b) Effective date.
(a) Extended low-income housing commitment.
(1) In general.
(i) Extended use period.
(ii) Termination of extended use period.
(iii) Other non-acceptance.
(iv) Eviction, gross rent increase concerning existing low-income tenants not permitted.
(2) Exception.
(b) Definitions.
(c) Qualified contract purchase price formula.
(1) In general.
(i) Initial determination.
(ii) Mandatory adjustment by the buyer and owner.
(iii) Optional adjustment by the Agency and owner.
(2) Low-income portion amount.
(3) Outstanding indebtedness.
(4) Adjusted investor equity.
(i) Application of cost-of-living factor.
(ii) Unadjusted investor equity.
(iii) Qualified-contract cost-of-living adjustment.
(iv) General rule.
(v) Provision by the Commissioner of the qualified-contract cost-of-living adjustment.
(vi) Methodology.
(vii) Example.
(5) Other capital contributions.
(6) Cash distributions.
(i) In general.
(ii) Excess proceeds.
(iii) Anti-abuse rule.
(d) Administrative discretion and responsibilities of the Agency.
(1) In general.
(2) Actual offer.
(3) Debarment of certain appraisers.
(e) Effective/applicability date.
(a) Average income set-aside.
(b) Definition of low-income unit and qualified group of units.
(1) Definition of low-income unit.
(2) Definition of qualified group of units.
(3) Identification of qualified groups of units.
(i) Average income set-aside test.
(ii) Applicable fraction determinations.
(iii) Identification of units.
(c) Procedures.
(1)-(2) [Reserved]
(3) Designation of imputed income limitations.
(i) Timing of designation.
(ii) 10-percent increments.
(iii) Continuity.
(iv) [Reserved]
(4) [Reserved]
(d) Changing a unit’s designated imputed income limitation.
(1) Permitted changes.
(i) Federally permitted changes.
(ii) Housing credit agency (Agency)-permitted changes.
(iii) Certain laws.
(iv) Tenant movement.
(v) Restoring compliance with average income requirements.
(2) [Reserved]
(e) Examples.
(f) Applicability dates.
(1) General rule.
(2) Designations of occupied units.
(3) Applicability of this section to taxable years beginning before January 1, 2023.
§ 1.42-0T Table of contents.
This section lists the paragraphs contained in §§ 1.42-5T and 1.42-10T.
§ 1.42-1 Limitation on low-income housing credit allowed with respect to qualified low-income buildings receiving housing credit allocations from a State or local housing credit agency.
(a)-(g) [Reserved]. For further guidance, see § 1.42-1T(a) through (g).
(h) Filing of forms. Unless otherwise provided in forms or instructions, a completed Form 8586, “Low-Income Housing Credit,” (or any successor form) must be filed with the owner’s Federal income tax return for each taxable year the owner of a qualified low-income building is claiming the low-income housing credit under section 42(a). Unless otherwise provided in forms or instructions, a completed Form 8609, “Low-Income Housing Credit Allocation and Certification,” (or any successor form) must be filed by the building owner with the IRS. The requirements for completing and filing Forms 8586 and 8609 are addressed in the instructions to the forms.
(i) [Reserved]. For further guidance, see § 1.42-1T(i).
(j) Effective dates. Section 1.42-1(h) applies to forms filed on or after November 7, 2005. The rules that apply for forms filed before November 7, 2005 are contained in § 1.42-1T(h) and § 1.42-1(h) (see 26 CFR part 1 revised as of April 1, 2003, and April 1, 2005).
§ 1.42-1T Limitation on low-income housing credit allowed with respect to qualified low-income buildings receiving housing credit allocations from a State or local housing credit agency (temporary).
(a) In general—(1) Determination of amount of low-income housing credit. Section 42 provides that, for purposes of section 38, a low-income housing credit is determined for a building in an amount equal to the applicable percentage of the qualified basis of the qualified low-income building. In general, the credit may be claimed annually for a 10-year credit period, beginning with the taxable year in which the building is placed in service or, at the election of the taxpayer, the succeeding taxable year. If, after the first year of the credit period, the qualified basis of a building is increased in excess of the qualified basis upon which the credit was initially determined, the allowable credit with respect to such additional qualified basis is determined using a credit percentage equal to two-thirds of the applicable percentage for the initial qualified basis. The credit for additions to qualified basis is generally allowable for the remaining years in the 15-year compliance period which begins with the first taxable year of the credit period for the building. In general, the low-income housing credit is available with respect to buildings placed in service after December 31, 1986, in taxable years ending after that date. See section 42 for the definitions of “qualified low-income building”, “applicable percentage”, “qualified basis”, “credit period”, “compliance period”, and for other rules relating to determination of the amount of the low-income housing credit.
(2) Limitation on low-income housing credit allowed. Generally, the low-income housing credit determined under section 42 is allowed and may be claimed for any taxable year if, and to the extent that, the owner of a qualified low-income building receives a housing credit allocation from a State or local housing credit agency. The aggregate amount of housing credit allocations that may be made in any calendar year by all housing credit agencies within a State is limited by a State housing credit ceiling, or volume cap, described in paragraph (b) of this section. The authority to make housing credit allocations within the State housing credit ceiling may be apportioned among the State and local housing credit agencies, under the rules prescribed in paragraph (c) of this section. Upon apportionment of the State housing credit volume cap, each State or local housing credit agency receives an aggregate housing credit dollar amount that may be used to make housing credit allocations among qualified low-income buildings located within an agency’s geographic jurisdiction. The rules governing the making of housing credit allocations by any state or local housing credit agency are provided in paragraph (d) of this section. Housing credit allocations are required to be taken into account by owners of qualified low-income buildings under the rules prescribed in paragraph (e) of this section. Exceptions to the requirement that a qualified low-income building receive a housing credit allocation from a State or local housing credit agency are provided in paragraph (f) of this section. Rules regarding termination of the authority of State and local housing credit agencies to make housing credit allocations after December 31, 1989, are specified in paragraph (g) of this section. Rules concerning information reporting by State and local housing credit agencies and owners of qualified low-income buildings are provided in paragraph (h) of this section. Special statutory transitional rules are incorporated into this section of the regulations as described in paragraph (i) of this section.
(b) The State housing credit ceiling. The aggregate amount of housing credit allocations that may be made in any calendar year by all State and local housing credit agencies within a State may not exceed the State’s housing credit ceiling for such calendar year. The State housing credit ceiling for each State for any calendar year is equal to $1.25 multiplied by the State’s population. A State’s population for any calendar year is determined by reference to the most recent census estimate (whether final or provisional) of the resident population of the State released by the Bureau of the Census before the beginning of the calendar year for which the State’s housing credit ceiling is set. Unless otherwise prescribed by applicable revenue procedure, determinations of population are based on the most recent estimates of population contained in the Bureau of the Census publication, “Current Population Reports, Series P-25: Population Estimates and Projections, Estimates of the Population of States”. For purposes of this section, the District of Columbia and United States possessions are treated as States.
(c) Apportionment of State housing credit ceiling among State and local housing credit agencies—(1) In general. A State’s housing credit ceiling for any calendar year is apportioned among the State and local housing credit agencies within such State under the rules prescribed in this paragraph. A “State housing credit agency” is any State agency specifically authorized by gubernatorial act or State statute to make housing credit allocations on behalf of the State and to carry out the provisions of section 42(h). A “local housing credit agency” is any agency of a political subdivision of the State that is specifically authorized by a State enabling act to make housing credit allocations on behalf of the State or political subdivision and to carry out the provisions of section 42(h). A “State enabling act” is any gubernatorial act, State statute, or State housing credit agency regulation (if authorized by gubernatorial act or State statute). A State enabling act enacted on or before October 22, 1986, the date of enactment of the Tax Reform Act of 1986, shall be given effect for purposes of this paragraph if such State enabling act expressly carries out the provisions of section 42(h).
(2) Primary apportionment. Except as otherwise provided in paragraphs (c) (3) and (4) of this section, a State’s housing credit ceiling is apportioned in its entirety to the State housing credit agency. Such an apportionment is the “primary apportionment” of a State’s housing credit ceiling. There shall be no primary apportionment of the State housing credit ceiling and no grants of housing credit allocations in such State until a State housing credit agency is authorized by gubernatorial act or State statute. If a State has more than one State housing credit agency, such agencies shall be treated as a single agency for purposes of the primary apportionment. In such a case, the State housing credit ceiling may be divided among the multiple State housing credit agencies pursuant to gubernatorial act or State statute.
(3) States with 1 or more constitutional home rule cities—(i) In general. Notwithstanding paragraph (c)(2) of this section, in any State with 1 or more constitutional home rule cities, a portion of the State housing credit ceiling is apportioned to each constitutional home rule city. In such a State, except as provided in paragraph (c)(4) of this section, the remainder of the State housing credit ceiling is apportioned to the State housing credit agency under paragraph (c)(2) of this section. See paragraph (c)(3)(iii) of this section. The term “constitutional home rule city” means, with respect to any calendar year, any political subdivision of a State that, under a State constitution that was adopted in 1970 and effective on July 1, 1971, had home rule powers on the first day of the calendar year.
(ii) Amount of apportionment to a constitutional home rule city. The amount of the State housing credit ceiling apportioned to a constitutional home rule city for any calendar year is an amount that bears the same ratio to the State housing credit ceiling for that year as the population of the constitutional home rule city bears to the population of the entire State. The population of any constitutional home rule city for any calendar year is determined by reference to the most recent census estimate (whether final or provisional) of the resident population of the constitutional home rule city released by the Bureau of the Census before the beginning of the calendar year for which the State housing credit ceiling is apportioned. However, determinations of the population of a constitutional home rule city may not be based on Bureau of the Census estimates that do not contain estimates for all of the constitutional home rule cities within the State. If no Bureau of the Census estimate is available for all such constitutional home rule cities, the most recent decennial census of population shall be relied on. Unless otherwise prescribed by applicable revenue procedure, determinations of population for constitutional home rule cities are based on estimates of population contained in the Bureau of the Census publication, “Current Population Reports, Series P-26: Local Population Estimates”.
(iii) Effect of apportionments to constitutional home rule cities on apportionments to other housing credit agencies. The aggregate amounts of the State housing credit ceiling apportioned to constitutional home rule cities under this paragraph (c)(3) reduce the State housing credit ceiling available for apportionment under paragraph (c) (2) or (4) of this section. Unless otherwise provided in a State constitutional amendment or by law changing the home rule provisions adopted in a manner provided by the State constitution, the power of the governor or State legislature to apportion the State housing credit ceiling among local housing credit agencies under paragraph (c)(4) of this section shall not be construed as allowing any reduction of the portion of the State housing credit ceiling apportioned to a constitutional home rule city under this paragraph (c)(3). However, any constitutional home rule city may agree to a reduction in its apportionment of the State housing credit ceiling under this paragraph (c)(3), in which case the amount of the State housing credit ceiling not apportioned to the constitutional home rule city shall be available for apportionment under paragraph (c) (2) or (4) of this section.
(iv) Treatment of governmental authority within constitutional home rule city. For purposes of determining which agency within a constitutional home rule city receives the apportionment of the State housing credit ceiling under this paragraph (c)(3), the rules of this paragraph (c) shall be applied by treating the constitutional home rule city as a “State”, the chief executive officer of a constitutional home rule city as a “governor”, and a city council as a “State legislature”. A constitutional home rule city is also treated as a “State” for purposes of the set-aside requirement for housing credit allocations to projects involving a qualified nonprofit organization. See paragraph (c)(5) of this section for rules governing set-aside requirements. In this connection, a constitutional home rule city may agree with the State housing credit agency to exchange an apportionment set aside for projects involving a qualified nonprofit organization for an apportionment that is not so restricted. In such a case, the authorizing gubernatorial act, State statute, or State housing credit agency regulation (if authorized by gubernatorial act or State statute) must ensure that the set-aside apportionment transferred to the State housing credit agency be used for the purposes described in paragraph (c)(5) of this section.
(4) Apportionment to local housing credit agencies—(i) In general. In lieu of the primary apportionment under paragraph (c)(2) of this section, all or a portion of the State housing credit ceiling may be apportioned among housing credit agencies of governmental subdivisions. Apportionments of the State housing credit ceiling to local housing credit agencies must be made pursuant to a State enabling act as defined in paragraph (c)(1) of this section. Apportionments of the State housing credit ceiling may be made to housing credit agencies of constitutional home rule cities under this paragraph (c)(4), in addition to apportionments made under paragraph (c)(3) of this section. Apportionments of the State housing credit ceiling under this paragraph (c)(4) need not be based on the population of political subdivisions and may, but are not required to, give balanced consideration to the low-income housing needs of the entire State.
(ii) Change in apportionments during a calendar year. The apportionment of the State housing credit ceiling among State and local housing credit agencies under this paragraph (c)(4) may be changed after the beginning of a calendar year, pursuant to a State enabling act. No change in apportionments shall retroactively reduce the housing credit allocations made by any agency during such year. Any change in the apportionment of the State housing credit ceiling under this paragraph (c)(4) that occurs during a calendar year is effective only to the extent housing credit agencies have not previously made housing credit allocations during such year from their original apportionments of the State housing credit ceiling for such year. To the extent apportionments of the State housing credit ceiling to local housing credit agencies made pursuant to this paragraph (c)(4) for any calendar year are not used by such local agencies before a certain date (e.g., November 1) to make housing credit allocations in such year, the amount of unused apportionments may revert back to the State housing credit agency for reapportionment. Such reversion must be specifically authorized by the State enabling act.
(iii) Exchanges of apportionments. Any State or local housing credit agency that receives an apportionment of the State housing credit ceiling for any calendar year under this paragraph (c)(4) may exchange part or all of such apportionment with another State or local housing credit agency to the extent no housing credit allocations have been made in such year from the exchanged portions. Such exchanges must be made with another housing credit agency in the same State and must be consistent with the State enabling act. If an apportionment set aside for projects involving a qualified nonprofit organization is transferred or exchanged, the transferee housing credit agency shall be required to use the set-aside apportionment for the purposes described in paragraph (c)(5) of this section.
(iv) Written records of apportionments. All apportionments, exchanges of apportionments, and reapportionments of the State housing credit ceiling which are authorized by this paragraph (c)(4) must be evidenced in the written records maintained by each State and local housing credit agency.
(5) Set-aside apportionments for projects involving a qualified nonprofit organization—(i) In general. Ten percent of the State housing credit ceiling for a calendar year must be set aside exclusively for projects involving a qualified nonprofit organization (as defined in paragraph (c)(5)(ii) of this section). Thus, at least 10 percent of apportionments of the State housing credit ceiling under paragraphs (c) (2) and (3) of this section must be used only to make housing credit allocations to buildings that are part of projects involving a qualified nonprofit organization. In the case of apportionments of the State housing credit ceiling under paragraph (c)(4) of this section, the State enabling act must ensure that the apportionment of at least 10 percent of the State housing credit ceiling be used exclusively to make housing credit allocations to buildings that are part of projects involving a qualified nonprofit organization. The State enabling act shall prescribe which housing credit agencies in the State receive apportionments that must be set aside for making housing credit allocations to buildings that are part of projects involving a qualified nonprofit organization. These set-aside apportionments may be distributed disproportionately among the State or local housing credit agencies receiving apportionments under paragraph (c)(4) of this section. The 10-percent set-aside requirement of this paragraph (c)(4) is a minimum requirement, and the State enabling act may set aside more than 10 percent of the State housing credit ceiling for apportionment to housing credit agencies for exclusive use in making housing credit allocations to buildings that are part of projects involving a qualified nonprofit organization.
(ii) Projects involving a qualified nonprofit organization. The term “projects involving a qualified nonprofit organization” means projects with respect to which a qualified nonprofit organization is to materially participate (within the meaning of section 469(h)) in the development and continuing operation of the project throughout the 15-year compliance period. The term “qualified nonprofit organization” means any organization that is described in section 501(c) (3) or (4), is exempt from tax under section 501(a), and includes as one of its exempt purposes the fostering of low-income housing.
(6) Expiration of unused apportionments. Apportionments of the State housing credit ceiling under this paragraph (c) for any calendar year may be used by housing credit agencies to make housing credit allocations only in such calendar year. Any part of an apportionment of the State housing credit ceiling for any calendar year that is not used for housing credit allocations in such year expires as of the end of such year and does not carry over to any other year. However, any part of an apportionment for 1989 that is not used to make a housing credit allocation in 1989 may be carried over to 1990 and used to make a housing credit allocation to a qualified low-income building described in section 42(n)(2)(B). See paragraph (g)(2) of this section.
(d) Housing credit allocations made by State and local housing credit agencies—(1) In general. This paragraph governs State and local housing credit agencies in making housing credit allocations to qualified low-income buildings. The amount of the apportionment of the State housing credit ceiling for any calendar year received by any State or local housing credit agency under paragraph (c) of this section constitutes the agency’s aggregate housing credit dollar amount for such year. The aggregate amount of housing credit allocations made in any calendar year by a State or local housing credit agency may not exceed such agency’s aggregate housing credit dollar amount for such year. A State or local housing credit agency may make housing credit allocations only to qualified low-income buildings located within the agency’s geographic jurisdiction.
(2) Amount of a housing credit allocation. In making a housing credit allocation, a State or local housing credit agency must specify a credit percentage, not to exceed the building’s applicable percentage determined under section 42(b), and a qualified basis amount. The amount of the housing credit allocation for any building is the product of the specified credit percentage and the specified qualified basis amount. In specifying the credit percentage and qualified basis amount, the State or local housing credit agency shall not take account of the first-year conventions described in section 42(f) (2)(A) and (3)(B). A State or local housing credit agency may adopt rules or regulations governing conditions for specification of less than the maximum credit percentage and qualified basis amount allowable under section 42 (b) and (c), respectively. For example, an agency may specify a credit percentage and a qualified basis amount of less than the maximum credit percentage and qualified basis amount allowable under section 42 (b) and (c), respectively, when the financing and rental assistance from all sources for the project of which the building is a part is sufficient to provide the continuing operation of the building without the maximum credit amount allowable under section 42.
(3) Counting housing credit allocations against an agency’s aggregate housing credit dollar amount. The aggregate amount of housing credit allocations made in any calendar year by a State or local housing credit agency may not exceed such agency’s aggregate housing credit dollar amount (i.e., the agency’s apportionment of the State housing credit ceiling for such year). This limitation on the aggregate dollar amount of housing credit allocations shall be computed separately for set-aside apportionments received pursuant to paragraph (c)(5) of this section. Housing credit allocations count against an agency’s aggregate housing credit dollar amount without regard to the amount of credit allowable to or claimed by an owner of a building in the taxable year in which the allocation is made or in any subsequent year. Thus, housing credit allocations (which are computed without regard to the first-year conventions as provided in paragraph (d)(2) of this section) count in full against an agency’s aggregate housing credit dollar amount, even though the first-year conventions described in section 42(f) (2)(A) and (3)(B) may reduce the amount of credit claimed by a taxpayer in the first year in which a credit is allowable. See also paragraph (e)(2) of this section. Housing credit allocations count against an agency’s aggregate housing credit dollar amount only in the calendar year in which made and not in subsequent taxable years in the credit period or compliance period during which a taxpayer may claim a credit based on the original housing credit allocation. Since the aggregate amount of housing credit allocations made in any calendar year by a State or local housing credit agency may not exceed such agency’s aggregate housing credit dollar amount, an agency shall at all times during a calendar year maintain a record of its cumulative allocations made during such year and its remaining unused aggregate housing credit dollar amount.
(4) Rules for when applications for housing credit allocations exceed an agency’s aggregate housing credit dollar amount. A State or local housing credit agency may adopt rules or regulations governing the awarding of housing credit allocations when an agency expects that applicants during a calendar year will seek aggregate allocations in excess of the agency’s aggregate housing credit dollar amount. The State enabling act may provide uniform standards for the awarding of housing credit allocations when there is actual or anticipated excess demand from applicants in any calendar year.
(5) Reduced or additional housing credit allocations—(i) In general. A State or local housing credit agency may not reduce or rescind a housing credit allocation made to a qualified low-income building in the manner prescribed in paragraph (d)(8) of this section. Thus, a housing credit agency may not reduce or rescind a housing credit allocation made to a qualified low-income building which is acquired by a new owner who is entitled to a carryover of the allowable credit for such building under section 42(d)(7). A housing credit agency may make additional housing credit allocations to a building in any year in the building’s compliance period, whether or not there are additions to qualified basis for which an increased credit is allowable under section 42(f)(3). Each additional housing credit allocation made to a building is treated as a separate allocation and is subject to the rules and requirements of this section. However, in the case of an additional housing credit allocation made with respect to additions to qualified basis for which an increased credit is allowable under section 42(f)(3), the amount of the allocation that counts against the agency’s aggregate housing credit dollar amount shall be computed as if the specified credit percentage were unreduced in the manner prescribed in section 42(f)(3)(A) and the specified qualified basis amount were unreduced by the first-year convention prescribed in section 42(f)(3)(B).
(ii) Examples. The rules of paragraph (d)(5)(i) of this section may be illustrated by the following examples:
(6) No carryover of unused aggregate housing credit dollar amount. Any portion of a State or local housing credit agency’s aggregate housing credit dollar amount for any calendar year that is not used to make a housing credit allocation in such year may not be carried over to any other year, except as provided in paragraph (g) of this section. An agency may not permit owners of qualified low-income buildings to transfer housing credit allocations to other buildings. However, an agency may provide a procedure whereby owners may return to the agency, prior to the end of the calendar year in which housing credit allocations are made, unusable portions of such allocations. In such a case, an owner’s housing credit allocation is deemed reduced by the amount of the allocation returned to the agency, and the agency may reallocate such amount to other qualified low-income buildings prior to the end of the year.
(7) Effect of housing credit allocations in excess of an agency’s aggregate housing credit dollar amount. In the event that a State or local housing credit agency makes housing credit allocations in excess of its aggregate housing credit dollar amount for any calendar year, the allocations shall be deemed reduced (to the extent of such excess) for buildings in the reverse order in which such allocations were made during such year.
(8) Time and manner for making housing credit allocations—(i) Time. Housing credit allocations are effective for the calendar year in which made in the manner prescribed in paragraph (d)(8)(ii) of this section. A State or local housing credit agency may not make a housing credit allocation to a qualified low-income building prior to the calendar year in which such building is placed in service. An agency may adopt its own procedures for receiving applications for housing credit allocations from owners of qualified low-income buildings. An agency may provide a procedure for making, in advance of a building’s being placed in service, a binding commitment (e.g., by contract, inducement, resolution, or other means) to make a housing credit allocation in the calendar year in which a qualified low-income building is placed in service or in a subsequent calendar year. Any advance commitment shall not constitute a housing credit allocation for purposes of this section.
(ii) Manner. Housing credit allocations are deemed made when part I of IRS Form 8609, Low-Income Housing Credit Allocation Certification, is completed and signed by an authorized official of the housing credit agency and mailed to the owner of the qualified low-income building. A copy of all completed (as to part I) Form 8609 allocations along with a single completed Form 8610, Annual Low-Income Housing Credit Agencies Report, must also be mailed to the Internal Revenue Service not later than the 28th day of the second calendar month after the close of the calendar year in which the housing credit was allocated to the qualified low-income building. Housing credit allocations to a qualified low-income building must be made on Form 8609 and must include—
(A) The address of the building;
(B) The name, address, and taxpayer identification number of the housing credit agency making the housing credit allocation;
(C) The name, address, and taxpayer identification number of the owner of the qualified low-income building;
(D) The date of the allocation of housing credit;
(E) The housing credit dollar amount allocated to the building on such date;
(F) The specified maximum applicable credit percentage allocated to the building on such date;
(G) The specified maximum qualified basis amount;
(H) The percentage of the aggregate basis financed by tax-exempt bonds taken into account for purposes of the volume cap under section 146;
(I) A certification under penalties of perjury by an authorized State or local housing credit agency official that the allocation is made in compliance with the requirements of section 42(h); and
(J) Any additional information that may be required by Form 8609 or by an applicable revenue procedure.
(iii) Certification. The certifying official for the State or local housing credit agency need not perform an independent investigation of the qualified low-income building in order to certify on part I of Form 8609 that the housing credit allocation meets the requirements of section 42(h). For example, the certifying official may rely on information contained in an application for a low-income housing credit allocation submitted by the building owner which sets forth facts necessary to determine that the building is eligible for the low-income housing credit under section 42.
(iv) Fee. A State or local housing credit agency may charge building owners applying for housing credit allocations a reasonable fee to cover the agency’s administrative expenses for processing applications.
(v) No continuing agency responsibility. The State or local housing credit agency need not monitor or investigate the continued compliance of a qualified low-income building with the requirements of section 42 throughout the applicable compliance period.
(e) Housing credit allocation taken into account by owner of a qualified low-income building—(1) Time and manner for taking housing credit allocation into account. An owner of a qualified low-income building may not claim a low-income housing credit determined under section 42 in any year in excess of an effective housing credit allocation received from a State or local housing credit agency. A housing credit allocation made to a qualified low-income building is effective with respect to any owner of the building beginning with the owner’s taxable year in which the housing credit allocation is received. A housing credit allocation is deemed received in a taxable year, except as modified in the succeeding sentence, if that allocation is made (in the manner described in paragraph (d)(8) of this section) not later than the earlier of (i) the 60th day after the close of the taxable year, or (ii) the close of the calendar year in which such taxable year ends. A housing credit allocation is deemed received in a taxable year ending in 1987, if such allocation is made (in the manner described in paragraph (d)(8) of this section) on or before December 31, 1987. A housing credit allocation is not effective for any taxable year if received in a calendar year which ends prior to when the qualified low-income building is placed in service. A housing credit allocation made to a qualified low-income building remains effective for all taxable years in the compliance period.
(2) First-year convention limitation on housing credit allocation taken into account. For purposes of the limitation that the allowable low-income housing credit may not exceed the effective housing credit allocation received from a State or local housing credit agency, as provided in paragraph (e)(1) of this section, the amount of the effective housing credit allocation shall be adjusted by applying the first-year convention provided in section 42(f)(2)(A) and (3)(B) and the percentage credit reduction provided in section 42(f)(3)(A). Under paragraphs (d) (2) and (5) of this section, the State or local housing credit agency must specify the credit percentage and qualified basis amount, the product of which is the amount of the housing credit allocation, without taking account of the first-year convention described in section 42(f)(2)(A) and (3)(B) or the percentage credit reduction prescribed in section 42(f)(3)(A). However, for purposes of the limitation on the amount of the allowable low-income housing credit, as provided in paragraph (e)(1) of this section, in a taxable year in which the first-year convention applies to the amount of credit determined under section 42(a), the specified qualified basis amount shall be adjusted by the first-year convention fraction which is equal to the number of full months (during the first taxable year) in which the building was in service divided by 12. In addition, for purposes of the limitation on the amount of the allowable low-income housing credit, as provided in paragraph (e)(1) of this section, in a taxable year in which the reduction in credit percentage applies to additions to qualified basis, as prescribed in section 42(f)(3), the specified credit percentage shall be reduced by one-third. See examples in paragraphs (d)(5)(ii) and (e)(3)(ii) of this section.
(3) Use of excess housing credit allocation for increases in qualified basis—(i) In general. If the housing credit allocation made to a qualified low-income building exceeds the amount of credit allowable with respect to such building in any taxable year (without regard to the first-year conventions under section 42(f)), such excess is not transferable to another qualified low-income building. However, if in a subsequent year there are increases in the qualified basis for which an increased credit is allowable under section 42(f)(3) at a reduced credit percentage, the original housing credit allocation (including the specified credit percentage and qualified basis amount) would be effective with respect to such increased credit.
(ii) Example. The provisions of this paragraph (e)(3) may be illustrated by the following example:
(4) Separate housing credit allocations for new buildings and increases in qualified basis. Separate housing credit allocations must be received for each building with respect to which a housing credit may be claimed. Rehabilitation expenditures with respect to a qualified low-income building are treated as a separate new building under section 42(e) and must receive a separate housing credit allocation. Increases in qualified basis in a qualified low-income building are not generally treated as a new building for purposes of section 42. To the extent that a prior housing credit allocation received with respect to a qualified low-income building does not allow an increased credit with respect to an increase in the qualified basis of such building, an additional housing credit allocation must be received in order to claim a credit with respect to that portion of increase in qualified basis. See paragraph (e)(3) of this section. The amount of credit allowable with respect to an increase in qualified basis is subject to the credit percentage limitation of section 42(f)(3)(A) and the first-year convention of section 42(f)(3)(B). See paragraph (d)(5) of this section for a rule requiring that the State or local housing credit agency count a housing credit allocation made with respect to an increase in qualified basis as if the specified credit percentage were unreduced in the manner prescribed in section 42(f)(3) and the specified basis amount were unreduced by the first-year convention prescribed in section 42(f)(3)(B).
(5) Acquisition of building for which a prior housing credit allocation has been made. If a carryover credit would be allowable to an acquirer of a qualified low-income building under section 42(d)(7), such acquirer need not obtain a new housing credit allocation with respect to such building. Under section 42(d)(7), the acquirer would be entitled to claim only such credits as would have been allowable to the prior owner of the building.
(6) Multiple housing credit allocations. A qualified low-income building may receive multiple housing credit allocations from different housing credit agencies having overlapping jurisdictions. A qualified low-income building that receives a housing credit allocation set aside exclusively for projects involving a qualified nonprofit organization may also receive a housing credit allocation from a housing credit agency’s aggregate housing credit dollar amount that is not so set aside.
(f) Exception to housing credit allocation requirement—(1) Tax-exempt bond financing—(i) In general. No housing credit allocation is required in order to claim a credit under section 42 with respect to that portion of the eligible basis (as defined in section 42(d)) of a qualified low-income building that is financed with the proceeds of an obligation described in section 103(a) (“tax-exempt bond”) which is taken into account for purposes of the volume cap under section 146. In addition, no housing credit allocation is required in order to claim a credit under section 42 with respect to the entire qualified basis (as defined in section 42(c)) of a qualified low-income building if 70 percent or more of the aggregate basis of the building and the land on which the building is located is financed with the proceeds of tax-exempt bonds which are taken into account for purposes of the volume cap under section 146. For purposes of this paragraph, “land on which the building is located” includes only land that is functionally related and subordinate to the qualified low-income building. See § 1.103-8(b)(4)(iii) for the meaning of the term “functionally related and subordinate”. For purposes of this paragraph, the basis of the land shall be determined using principles that are consistent with the rules contained in section 42(d).
(ii) Determining use of bond proceeds. For purposes of determining the portion of proceeds of an issue of tax-exempt bonds used to finance (A) the eligible basis of a qualified low-income building, and (B) the aggregate basis of the building and the land on which the building is located, the proceeds of the issue must be allocated in the bond indenture or a related document (as defined in § 1.103-13(b)(8)) in a manner consistent with the method used to allocate the net proceeds of the issue for purposes of determining whether 95 percent or more of the net proceeds of the issue are to be used for the exempt purpose of the issue. If the issuer is not consistent in making this allocation throughout the bond indenture and related documents, or if neither the bond indenture nor a related document provides an allocation, the proceeds of the issue will be allocated on a pro rata basis to all of the property financed by the issue, based on the relative cost of the property.
(iii) Example. The provisions of this paragraph may be illustrated by the following example:
(g) Termination of authority to make housing credit allocation—(1) In general. No State or local housing credit agency shall receive an apportionment of a State housing credit ceiling for calendar years after 1989. Consequently, no housing credit allocations may be made after 1989, except as provided in paragraph (g)(2) of this section. Housing credit allocations made prior to January 1, 1990, remain effective after such date.
(2) Carryover of unused 1989 apportionment. Any State or local housing credit agency that has an unused portion of its apportionment of the State housing credit ceiling for 1989 from which housing credit allocations have not been made in 1989 may carry over such unused portion into 1990. Such carryover portion of the 1989 apportionment shall be treated as the agency’s apportionment for 1990. From this 1990 apportionment, the State or local housing credit agency may make housing credit allocations only to a qualified low-income building meeting the following requirements:
(i) The building must be constructed, reconstructed, or rehabilitated by the taxpayer seeking the allocation;
(ii) More than 10 percent of the reasonably anticipated cost of such construction, reconstruction, or rehabilitation must have been incurred as of January 1, 1989; and
(iii) The building must be placed in service before January 1, 1991.
(3) Expiration of exception for tax-exempt bond financed projects. The exception to the requirement that a housing credit allocation be received with respect to any portion of the eligible basis of a qualified low-income building, as provided in paragraph (f) of this section, shall not apply to any building placed in service after 1989, unless such building is described in paragraphs (g)(2) (i), (ii), and (iii) of this section.
(h) Filing of forms. For further guidance, see § 1.42-1(h).
(i) Transitional rules. The transitional rules contained in section 252(f)(1) of the Tax Reform Act of 1986 are incorporated into this section of the regulations for purposes of determining whether a qualified low-income building is entitled to receive a housing credit allocation or is excepted from the requirement that a housing credit allocation be received. Housing credit allocations made to qualified low-income buildings described in section 252(f)(1) shall not count against the State or local housing credit agency’s aggregate housing credit dollar amount. The transitional rules contained in section 252(f)(2) of the Tax Reform Act of 1986 are incorporated into this section of the regulations for purposes of determining amounts available to certain State or local housing credit agencies for the making of housing credit allocations to certain qualified low-income housing projects. Amounts available to housing credit agencies under section 252(f)(2) shall be treated as special apportionments unavailable for housing credit allocations to qualified low-income buildings not described in section 252(f)(2). Housing credit allocations made from the special apportionments shall not count against the State or local credit agency’s aggregate housing credit dollar amount. The set-aside requirements shall not apply to these special apportionments. The transitional rules contained in section 252(f)(3) of the Tax Reform Act 1986 are incorporated in this section of the regulations for purposes of determining the amount of housing credit allocations received by certain qualified low-income buildings. Housing credit allocations deemed received under section 252(f)(3) shall not count against the State or local housing credit agency’s aggregate housing credit dollar amount.
§ 1.42-2 [Reserved]
§ 1.42-3 Treatment of buildings financed with proceeds from a loan under an Affordable Housing Program established pursuant to section 721 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).
(a) Treatment under sections 42(i) and 42(b). A below market loan funded in whole or in part with funds from an Affordable Housing Program established under section 721 of FIRREA is not, solely by reason of the Affordable Housing Program funds, a below market Federal loan as defined in section 42(i)(2)(D). Thus, any building with respect to which the proceeds of the loan are used during the tax year is not, solely by reason of the Affordable Housing Program funds, treated as a federally subsidized building for that tax year and subsequent tax years for purposes of determining the applicable percentage for the building under section 42(b).
(b) Effective date. The rules set forth in paragraph (a) of this section are effective for loans made after August 8, 1989.
§ 1.42-4 Application of not-for-profit rules of section 183 to low-income housing credit activities.
(a) Inapplicability to section 42. In the case of a qualified low-income building with respect to which the low-income housing credit under section 42 is allowable, section 183 does not apply to disallow losses, deductions, or credits attributable to the ownership and operation of the building.
(b) Limitation. Notwithstanding paragraph (a) of this section, losses, deductions, or credits attributable to the ownership and operation of a qualified low-income building with respect to which the low-income housing credit under section 42 is allowable may be limited or disallowed under other provisions of the Code or principles of tax law. See, e.g., sections 38(c), 163(d), 465, 469; Knetsch v. United States, 364 U.S. 361 (1960), 1961-1 C.B. 34 (“sham” or “economic substance” analysis); and Frank Lyon Co. v. Commissioner, 435 U.S. 561 (1978), 1978-1 C.B. 46 (“ownership” analysis).
(c) Effective date. The rules set forth in paragraphs (a) and (b) of this section are effective with respect to buildings placed in service after December 31, 1986.
§ 1.42-5 Monitoring compliance with low-income housing credit requirements.
(a) Compliance monitoring requirement—(1) In general. Under section 42(m)(1)(B)(iii), an allocation plan is not qualified unless it contains a procedure that the State or local housing credit agency (“Agency”) (or an agent of, or other private contractor hired by, the Agency) will follow in monitoring for noncompliance with the provisions of section 42 and in notifying the Internal Revenue Service of any noncompliance of which the Agency becomes aware. These regulations only address compliance monitoring procedures required of Agencies. The regulations do not address forms and other records that may be required by the Service on examination or audit. For example, if a building is sold or otherwise transferred by the owner, the transferee should obtain from the transferor information related to the first year of the credit period so that the transferee can substantiate credits claimed.
(2) Requirements for a monitoring procedure—(i) In general. A procedure for monitoring for noncompliance under section 42(m)(1)(B)(iii) must include—
(A) The recordkeeping and record retention provisions of paragraph (b) of this section;
(B) The certification and review provisions of paragraph (c) of this section;
(C) The inspection provision of paragraph (d) of this section; and
(D) The notification-of-noncompliance provisions of paragraph (e) of this section.
(ii) Order and form. A monitoring procedure will meet the requirements of section 42 (m)(1)(B)(iii) if it contains the substance of these provisions. The particular order and form of the provisions in the allocation plan is not material. A monitoring procedure may contain additional provisions or requirements.
(b) Recordkeeping and record retention provisions—(1) Recordkeeping provision. Under the recordkeeping provision, the owner of a low-income housing project must be required to keep records for each qualified low-income building in the project that show for each year in the compliance period—
(i) The total number of residential rental units in the building (including the number of bedrooms and the size in square feet of each residential rental unit);
(ii) The percentage of residential rental units in the building that are low-income units;
(iii) The rent charged on each residential rental unit in the building (including any utility allowances);
(iv) The number of occupants in each low-income unit, but only if rent is determined by the number of occupants in each unit under section 42(g)(2) (as in effect before the amendments made by the Omnibus Budget Reconciliation Act of 1989);
(v) The low-income unit vacancies in the building and information that shows when, and to whom, the next available units were rented;
(vi) The annual income certification of each low-income tenant per unit. For an exception to this requirement, see section 42(g)(8)(B) (which provides a special rule for a 100 percent low-income building);
(vii) Documentation to support each low-income tenant’s income certification (for example, a copy of the tenant’s federal income tax return, Forms W-2, or verifications of income from third parties such as employers or state agencies paying unemployment compensation). For an exception to this requirement, see section 42(g)(8)(B) (which provides a special rule for a 100 percent low-income building). Tenant income is calculated in a manner consistent with the determination of annual income under section 8 of the United States Housing Act of 1937 (“Section 8”), not in accordance with the determination of gross income for federal income tax liability. In the case of a tenant receiving housing assistance payments under Section 8, the documentation requirement of this paragraph (b)(1)(vii) is satisfied if the public housing authority provides a statement to the building owner declaring that the tenant’s income does not exceed the applicable income limit under section 42 (g);
(viii) The eligible basis and qualified basis of the building at the end of the first year of the credit period; and
(ix) The character and use of the nonresidential portion of the building included in the building’s eligible basis under section 42 (d) (e.g., tenant facilities that are available on a comparable basis to all tenants and for which no separate fee is charged for use of the facilities, or facilities reasonably required by the project).
(2) Record retention provision. Under the record retention provision, the owner of a low-income housing project must be required to retain the records described in paragraph (b)(1) of this section for at least 6 years after the due date (with extensions) for filing the federal income tax return for that year. The records for the first year of the credit period, however, must be retained for at least 6 years beyond the due date (with extensions) for filing the federal income tax return for the last year of the compliance period of the building.
(3) Inspection record retention provision. Under the inspection record retention provision, the owner of a low-income housing project must be required to retain the original local health, safety, or building code violation reports or notices that were issued by the State or local government unit (as described in paragraph (c)(1)(vi) of this section) for the Agency’s inspection under paragraph (d) of this section. Retention of the original violation reports or notices is not required once the Agency reviews the violation reports or notices and completes its inspection, unless the violation remains uncorrected.
(c) Certification and review provisions—(1) Certification. Under the certification provision, the owner of a low-income housing project must be required to certify at least annually to the Agency that, for the preceding 12-month period—
(i) The project met the requirements of:
(A) The 20-50 test under section 42 (g)(1)(A), the 40-60 test under section 42 (g)(1)(B), or the 25-60 test under sections 42 (g)(4) and 142 (d)(6) for New York City, whichever minimum set-aside test was applicable to the project; and
(B) If applicable to the project, the 15-40 test under sections 42(g)(4) and 142 (d)(4)(B) for “deep rent skewed” projects;
(ii) There was no change in the applicable fraction (as defined in section 42(c)(1)(B)) of any building in the project, or that there was a change, and a description of the change;
(iii) The owner has received an annual income certification from each low-income tenant, and documentation to support that certification; or, in the case of a tenant receiving Section 8 housing assistance payments, the statement from a public housing authority described in paragraph (b)(1)(vii) of this section. For an exception to this requirement, see section 42(g)(8)(B) (which provides a special rule for a 100 percent low-income building);
(iv) Each low-income unit in the project was rent-restricted under section 42(g)(2);
(v) All units in the project were for use by the general public (as defined in § 1.42-9), including the requirement that no finding of discrimination under the Fair Housing Act, 42 U.S.C. 3601-3619, occurred for the project. A finding of discrimination includes an adverse final decision by the Secretary of the Department of Housing and Urban Development (HUD), 24 CFR 180.680, an adverse final decision by a substantially equivalent state or local fair housing agency, 42 U.S.C. 3616a(a)(1), or an adverse judgment from a federal court;
(vi) The buildings and low-income units in the project were suitable for occupancy, taking into account local health, safety, and building codes (or other habitability standards), and the State or local government unit responsible for making local health, safety, or building code inspections did not issue a violation report for any building or low-income unit in the project. If a violation report or notice was issued by the governmental unit, the owner must attach a statement summarizing the violation report or notice or a copy of the violation report or notice to the annual certification submitted to the Agency under paragraph (c)(1) of this section. In addition, the owner must state whether the violation has been corrected;
(vii) There was no change in the eligible basis (as defined in section 42(d)) of any building in the project, or if there was a change, the nature of the change (e.g., a common area has become commercial space, or a fee is now charged for a tenant facility formerly provided without charge);
(viii) All tenant facilities included in the eligible basis under section 42(d) of any building in the project, such as swimming pools, other recreational facilities, and parking areas, were provided on a comparable basis without charge to all tenants in the building;
(ix) If a low-income unit in the project became vacant during the year, that reasonable attempts were or are being made to rent that unit or the next available unit of comparable or smaller size to tenants having a qualifying income before any units in the project were or will be rented to tenants not having a qualifying income;
(x) If the income of tenants of a low-income unit in the building increased above the limit allowed in section 42(g)(2)(D)(ii), the next available unit of comparable or smaller size in the building was or will be rented to tenants having a qualifying income;
(xi) An extended low-income housing commitment as described in section 42(h)(6) was in effect (for buildings subject to section 7108(c)(1) of the Omnibus Budget Reconciliation Act of 1989, 103 Stat. 2106, 2308-2311), including the requirement under section 42(h)(6)(B)(iv) that an owner cannot refuse to lease a unit in the project to an applicant because the applicant holds a voucher or certificate of eligibility under section 8 of the United States Housing Act of 1937, 42 U.S.C. 1437f (for buildings subject to section 13142(b)(4) of the Omnibus Budget Reconciliation Act of 1993, 107 Stat. 312, 438-439); and
(xii) All low-income units in the project were used on a nontransient basis (except for transitional housing for the homeless provided under section 42(i)(3)(B)(iii) or single-room-occupancy units rented on a month-by-month basis under section 42(i)(3)(B)(iv)).
(2) Review. The review provision must—
(i) Require that the Agency review the certifications submitted under paragraph (c)(1) of this section for compliance with the requirements of section 42;
(ii) Require that, with respect to each low-income housing project, the Agency conduct on-site inspections and review low-income certifications (including in that term the documentation supporting the low-income certifications and the rent records for tenants).
(iii) Require that the on-site inspections that the Agency must conduct satisfy both the requirements of § 1.42-5(d) and the requirements in paragraph (c)(2)(iii)(A) through (D) of this section, and require that the low-income certification review that the Agency must perform satisfies the requirements in paragraphs (c)(2)(iii)(A) through (D) of this section. Paragraph (c)(2)(iii)(A) through (D) of this section provides rules determining how these on-site inspection requirements and how these low-income certification review requirements may be satisfied by an inspection or review, as the case may be, that includes only a sample of the low-income units.
(A) Timing. The Agency must conduct on-site inspections of all buildings in the low-income housing project and must review low-income certifications of the low-income housing project—
(1) By the end of the second calendar year following the year the last building in the low-income housing project is placed in service; and
(2) At least once every 3 years thereafter.
(B) Number of low-income units. The Agency must conduct on-site inspections and low-income certification review of not fewer than the minimum number of low-income units for the corresponding number of low-income units in the low-income housing project set forth in the table to paragraph (c)(2)(iii).
Table to Paragraph
Number of low-income units in the low-income housing project | Number of low-income units selected for inspection or for low-income certification review (minimum unit sample size) |
---|---|
1 | 1 |
2 | 2 |
3 | 3 |
4 | 4 |
5-6 | 5 |
7 | 6 |
8-9 | 7 |
10-11 | 8 |
12-13 | 9 |
14-16 | 10 |
17-18 | 11 |
19-21 | 12 |
22-25 | 13 |
26-29 | 14 |
30-34 | 15 |
35-40 | 16 |
41-47 | 17 |
48-56 | 18 |
57-67 | 19 |
68-81 | 20 |
82-101 | 21 |
102-130 | 22 |
131-175 | 23 |
176-257 | 24 |
258-449 | 25 |
450-1,461 | 26 |
1,462-9,999 | 27 |
(C) Selection of low-income units for inspection and low-income certifications for review—(1) Random selection. The Agency must select in a random manner the low-income units to be inspected and the units whose low-income certifications are to be reviewed. Agencies generally may not select the same low-income units of a low-income housing project for on-site inspections and low-income certification review, because doing so would usually give prohibited advance notice. See paragraph (c)(2)(iii)(C)(2) of this section. An Agency may choose a different number of units for on-site inspections and for low-income certification review, provided the Agency chooses at least the minimum number of low-income units in each case. The Agency must select the units for inspections or low-income certification review separately and in a random manner.
(2) Advance notification limited to reasonable notice. The Agency must select the low-income units to inspect and low-income certifications to review in a manner that does not give advance notice that a particular low-income unit (or low-income certifications for a particular low-income unit) will or will not be inspected (or reviewed) for a particular year. The Agency may notify the owner of the low-income units for on-site inspection only on the day of inspection. However, the Agency may give an owner reasonable notice that an inspection of the project and of not-yet-identified low-income units or review of low-income certifications will occur. The notice serves to enable the owner to assemble needed documentation for low-income certifications for review and to notify tenants of the possibility of physical inspection of their units.
(3) Meaning of reasonable notice. For purposes of paragraph (c)(2)(iii)(C)(2) of this section, reasonable notice is generally no more than 15 days. The notice period begins on the date the Agency informs the owner that an on-site inspection of a project and low-income units or low-income certification review will occur. Notice of more than 15 days, however, may be reasonable in extraordinary circumstances that are beyond an Agency’s control and that prevent an Agency from carrying out within 15 days an on-site inspection or low-income certification review. Extraordinary circumstances include, but are not limited to, natural disasters and severe weather conditions. In the event of extraordinary circumstances that result in a reasonable-notice period longer than 15 days, an Agency must select the relevant units and conduct the same-day on-site inspection or low-income certification review as soon as practicable.
(4) Alternative means of conducting on-site inspections—Use of the REAC protocol. An Agency may satisfy the requirements of paragraphs (c)(2)(ii) and (iii) of this section if the inspection is performed under the Department of Housing and Urban Development (HUD) Real Estate Assessment Center (REAC) protocol and the inspection satisfies the following requirements:
(i) Both vacant and occupied low-income units in a low-income housing project are included in the population of units from which units are selected for inspection;
(ii) The inspection complies with the procedural and substantive requirements of the REAC protocol, including the requirements of the most recent REAC Uniform Physical Condition Standards (UPCS) inspection software, or software accepted by HUD;
(iii) The inspection is performed by HUD or HUD-Certified REAC inspectors;
(iv) The inspection results are sent to HUD, the results are reviewed and scored within HUD’s secure system without any involvement of the inspector who conducted the inspection, and HUD makes its inspection report available.
(5) HUD Inspections that comply with the requirements of the REAC Protocol. If, consistent with the requirements of paragraph (c)(2)(iii)(4) of this section, an Agency conducts on-site inspections under the REAC protocol, then—
(i) Paragraph (c)(2)(iii)(A) of this section is applied as if it did not contain the word “all”;
(ii) The number of low-income units required to be inspected under the REAC protocol satisfies the requirements of paragraph (c)(2)(iii)(B) of this section concerning the number of low-income units an Agency must inspect; and
(iii) The manner in which the low-income units are selected for inspection under the REAC protocol satisfies the requirements of paragraph (c)(2)(iii)(C) of this section.
(6) Income Certification Requirements for HUD Inspections that comply with the requirements of the REAC Protocol. An agency that conducts on-site inspections under the REAC protocol is not excused from reviewing low-income certifications in accordance with paragraphs (c)(2)(ii) and (iii) of this section.
(7) Applicability of reasonable notice limitation when the same units are chosen for inspection and file review. If the Agency chooses to select the same units for on-site inspections and low-income certification review, the Agency must complete both the inspections and review before the end of the day on which the units are selected. See paragraph (c)(2)(iii)(C)(1) and (2) of this section.
(D) Method of low-income certification review. The Agency may review the low-income certifications wherever the owner maintains or stores the records (either on-site or off-site).
(3) Frequency and form of certification. A monitoring procedure must require that the certifications and reviews of § 1.42-5(c)(1) and (c)(2)(i) be made at least annually covering each year of the 15-year compliance period under section 42(i)(1). The certifications must be made under penalties of perjury. A monitoring procedure may require certifications and reviews more frequently than every 12 months, provided that all months within each 12-month period are subject to certification.
(4) Exception for certain buildings—(i) In general. The review requirements under paragraph (c)(2)(ii) of this section may provide that owners are not required to submit, and the Agency is not required to review, the tenant income certifications, supporting documentation, and rent records for buildings financed by the Rural Housing Service (RHS), formerly known as Farmers Home Administration, under the section 515 program, or buildings of which 50 percent or more of the aggregate basis (taking into account the building and the land) is financed with the proceeds of obligations the interest on which is exempt from tax under section 103 (tax-exempt bonds). In order for a monitoring procedure to except these buildings, the Agency must meet the requirements of paragraph (c)(4)(ii) of this section.
(ii) Agreement and review. The Agency must enter into an agreement with the RHS or tax-exempt bond issuer. Under the agreement, the RHS or tax-exempt bond issuer must agree to provide information concerning the income and rent of the tenants in the building to the Agency. The Agency may assume the accuracy of the information provided by RHS or the tax-exempt bond issuer without verification. The Agency must review the information and determine that the income limitation and rent restriction of section 42 (g)(1) and (2) are met. However, if the information provided by the RHS or tax-exempt bond issuer is not sufficient for the Agency to make this determination, the Agency must request the necessary additional income or rent information from the owner of the buildings. For example, because RHS determines tenant eligibility based on its definition of “adjusted annual income,” rather than “annual income” as defined under Section 8, the Agency may have to calculate the tenant’s income for section 42 purposes and may need to request additional income information from the owner.
(iii) Example. The exception permitted under paragraph (c)(4)(i) and (ii) of this section is illustrated by the following example.
(5) Agency reports of compliance monitoring activities. The Agency must report its compliance monitoring activities annually on Form 8610, “Annual Low-Income Housing Credit Agencies Report.”
(d) Inspection provision—(1) In general. Under the inspection provision, the Agency must have the right to perform an on-site inspection of any low-income housing project at least through the end of the compliance period of the buildings in the project. The inspection provision of this paragraph (d) is a separate requirement from any tenant file review under paragraph (c)(2)(ii) of this section.
(2) Inspection standard. For the on-site inspections of buildings and low-income units required by paragraph (c)(2)(ii) of this section, the Agency must review any local health, safety, or building code violations reports or notices retained by the owner under paragraph (b)(3) of this section and must determine—
(i) Whether the buildings and units are suitable for occupancy, taking into account local health, safety, and building codes (or other habitability standards); or
(ii) Whether the buildings and units satisfy, as determined by the Agency, the uniform physical condition standards for public housing established by HUD (24 CFR 5.703). The HUD physical condition standards do not supersede or preempt local health, safety, and building codes. A low-income housing project under section 42 must continue to satisfy these codes and, if the Agency becomes aware of any violation of these codes, the Agency must report the violation to the Service. However, provided the Agency determines by inspection that the HUD standards are met, the Agency is not required under this paragraph (d)(2)(ii) to determine by inspection whether the project meets local health, safety, and building codes.
(3) Exception from inspection provision. An Agency is not required to inspect a building under this paragraph (d) if the building is financed by the RHS under the section 515 program, the RHS inspects the building (under 7 CFR part 1930), and the RHS and Agency enter into a memorandum of understanding, or other similar arrangement, under which the RHS agrees to notify the Agency of the inspection results.
(4) Delegation. An Agency may delegate inspection under this paragraph (d) to an Authorized Delegate retained under paragraph (f) of this section. Such Authorized Delegate, which may include HUD or a HUD-approved inspector, must notify the Agency of the inspection results.
(e) Notification-of-noncompliance provision—(1) In general. Under the notification-of-noncompliance provisions, the Agency must be required to give the notice described in paragraph (e)(2) of this section to the owner of a low-income housing project and the notice described in paragraph (e)(3) of this section to the Service.
(2) Notice to owner. The Agency must be required to provide prompt written notice to the owner of a low-income housing project if the Agency does not receive the certification described in paragraph (c)(1) of this section, or does not receive or is not permitted to inspect the tenant income certifications, supporting documentation, and rent records described in paragraph (c)(2)(ii) of this section, or discovers by inspection, review, or in some other manner, that the project is not in compliance with the provisions of section 42.
(3) Notice to Internal Revenue Service—(i) In general. The Agency must be required to file Form 8823, “Low-Income Housing Credit Agencies Report of Noncompliance,” with the Service no later than 45 days after the end of the correction period (as described in paragraph (e)(4) of this section, including extensions permitted under that paragraph) and no earlier than the end of the correction period, whether or not the noncompliance or failure to certify is corrected. The Agency must explain on Form 8823 the nature of the noncompliance or failure to certify and indicate whether the owner has corrected the noncompliance or failure to certify. Any change in either the applicable fraction or eligible basis under paragraph (c)(1)(ii) and (vii) of this section, respectively, that results in a decrease in the qualified basis of the project under section 42 (c)(1)(A) is noncompliance that must be reported to the Service under this paragraph (e)(3). If an Agency reports on Form 8823 that a building is entirely out of compliance and will not be in compliance at any time in the future, the Agency need not file Form 8823 in subsequent years to report that building’s noncompliance. If the noncompliance or failure to certify is corrected within 3 years after the end of the correction period, the Agency is required to file Form 8823 with the Service reporting the correction of the noncompliance or failure to certify.
(ii) Agency retention of records. An Agency must retain records of noncompliance or failure to certify for 6 years beyond the Agency’s filing of the respective Form 8823. In all other cases, the Agency must retain the certifications and records described in paragraph (c) of this section for 3 years from the end of the calendar year the Agency receives the certifications and records.
(4) Correction period. The correction period shall be that period specified in the monitoring procedure during which an owner must supply any missing certifications and bring the project into compliance with the provisions of section 42. The correction period is not to exceed 90 days from the date of the notice to the owner described in paragraph (e)(2) of this section. An Agency may extend the correction period for up to 6 months, but only if the Agency determines there is good cause for granting the extension.
(f) Delegation of Authority—(1) Agencies permitted to delegate compliance monitoring functions—(i) In general. An Agency may retain an agent or other private contractor (“Authorized Delegate”) to perform compliance monitoring. The Authorized Delegate must be unrelated to the owner of any building that the Authorized Delegate monitors. The Authorized Delegate may be delegated all of the functions of the Agency, except for the responsibility of notifying the Service under paragraphs (c)(5) and (e)(3) of this section. For example, the Authorized Delegate may be delegated the responsibility of reviewing tenant certifications and documentation under paragraph (c) (1) and (2) of this section, the right to inspect buildings and records as described in paragraph (d) of this section, and the responsibility of notifying building owners of lack of certification or noncompliance under paragraph (e)(2) of this section. The Authorized Delegate must notify the Agency of any noncompliance or failure to certify.
(ii) Limitations. An Agency that delegates compliance monitoring to an Authorized Delegate under paragraph (f)(1)(i) of this section must use reasonable diligence to ensure that the Authorized Delegate properly performs the delegated monitoring functions. Delegation by an Agency of compliance monitoring functions to an Authorized Delegate does not relieve the Agency of its obligation to notify the Service of any noncompliance of which the Agency becomes aware.
(2) Agencies permitted to delegate compliance monitoring functions to another Agency. An Agency may delegate all or some of its compliance monitoring responsibilities for a building to another Agency within the State. This delegation may include the responsibility of notifying the Service under paragraph (e)(3) of this section.
(g) Liability. Compliance with the requirements of section 42 is the responsibility of the owner of the building for which the credit is allowable. The Agency’s obligation to monitor for compliance with the requirements of section 42 does not make the Agency liable for an owner’s noncompliance.
(h) Effective/applicability dates—(1) In general. Allocation plans must comply with these regulations by June 30, 1993. The requirement of section 42 (m)(1)(B)(iii) that allocation plans contain a procedure for monitoring for noncompliance becomes effective on January 1, 1992, and applies to buildings for which a low-income housing credit is, or has been, allowable at any time. Thus, allocation plans must comply with section 42(m)(1)(B)(iii) prior to June 30, 1993, the effective date of these regulations. An allocation plan that complies with these regulations, with the notice of proposed rulemaking published in the
(2) Applicability dates. The requirements in paragraphs (c)(2)(ii) and (iii) and (c)(3) of this section apply beginning on February 26, 2019. A state housing credit agency is allowed a reasonable period of time to amend its qualified allocation plan, but must amend its qualified allocation plan no later than December 31, 2020.
§ 1.42-6 Buildings qualifying for carryover allocations.
(a) Carryover allocations—(1) In general. A carryover allocation is an allocation that meets the requirements of section 42(h)(1)(E) or (F). If the requirements of section § 42(h)(1)(E) or (F) that are required to be satisfied by the close of a calendar year are not satisfied, the allocation is not valid and is treated as if it had not been made for that calendar year. For example, if a carryover allocation fails to satisfy a requirement in § 1.42-6(d) for making an allocation, such as failing to be signed or dated by an authorized official of an allocating agency by the close of a calendar year, the allocation is not valid and is treated as if it had not been made for that calendar year.
(2) 10 percent basis requirement. A carryover allocation may only be made with respect to a qualified building. A qualified building is any building which is part of a project if, by the date specified under paragraph (a)(2)(i) or (ii) of this section, a taxpayer’s basis in the project is more than 10 percent of the taxpayer’s reasonably expected basis in the project as of the close of the second calendar year following the calendar year the allocation is made. For purposes of meeting the 10 percent basis requirement, the determination of whether a building is part of a single-building project or multi-building project is based on whether the carryover allocation is made under section 42(h)(1)(E) (building-based allocation) or section 42(h)(1)(F) (project-based allocation). In the case of a multi-building project that receives an allocation under section 42(h)(1)(F), the 10 percent basis requirement is satisfied by reference to the entire project.
(i) Allocation made before July 1. If a carryover allocation is made before July 1 of a calendar year, a taxpayer must meet the 10 percent basis requirement by the close of that calendar year. If a taxpayer does not meet the 10 percent basis requirement by the close of the calendar year, the carryover allocation is not valid and is treated as if it had not been made.
(ii) Allocation made after June 30. If a carryover allocation is made after June 30 of a calendar year, a taxpayer must meet the 10 percent basis requirement by the close of the date that is 6 months after the date the allocation was made. If a taxpayer does not meet the 10 percent basis requirement by the close of the required date, the carryover allocation must be returned to the Agency. Unlike a carryover allocation made before July 1, if a taxpayer does not meet the 10 percent basis requirement by the close of the required date, the carryover allocation is treated as a valid allocation for the calendar year of allocation, but is included in the “returned credit component” for purposes of determining the State housing credit ceiling under section 42(h)(3)(C) for the calendar year following the calendar year of the allocation. See § 1.42-14(d)(1).
(b) Carryover-allocation basis—(1) In general. Subject to the limitations of paragraph (b)(2) of this section, a taxpayer’s basis in a project for purposes of section 42(h)(1) (E)(ii) or (F) (carryover-allocation basis) is the taxpayer’s adjusted basis in land or depreciable property that is reasonably expected to be part of the project, whether or not these amounts are includible in eligible basis under section 42(d). Thus, for example, if the project is to include property that is not residential rental property, such as commercial space, the basis attributable to the commercial space, although not includible in eligible basis, is includible in carryover-allocation basis. The adjusted basis of land and depreciable property is determined under sections 1012 and 1016, and generally includes the direct and indirect costs of acquiring, constructing, and rehabilitating the property. Costs otherwise includible in carryover-allocation basis are not excluded by reason of having been incurred prior to the calendar year in which the carryover allocation is made.
(2) Limitations—For purposes of determining carryover-allocation basis under paragraph (b)(1) of this section, the following limitations apply.
(i) Taxpayer must have basis in land or depreciable property related to the project. A taxpayer has carryover-allocation basis to the extent that it has basis in land or depreciable property and the land or depreciable property is reasonably expected to be part of the project for which the carryover allocation is made. This basis includes all items that are properly capitalizable with respect to the land or depreciable property. For example, a nonrefundable downpayment for, or an amount paid to acquire an option to purchase, land or depreciable property may be included in carryover-allocation basis if properly capitalizable into the basis of land or depreciable property that is reasonably expected to be part of a project.
(ii) High cost areas. Any increase in eligible basis that may result under section 42(d)(5)(C) from a building’s location in a qualified census tract or difficult development area is not taken into account in determining carryover-allocation basis or reasonably expected basis.
(iii) Amounts not treated as paid or incurred. An amount is not includible in carryover-allocation basis unless it is treated as paid or incurred under the method of accounting used by the taxpayer. For example, a cash method taxpayer cannot include construction costs in carryover-allocation basis unless the costs have been paid, and an accrual method taxpayer cannot include construction costs in carryover- allocation basis unless they have been properly accrued. See paragraph (b)(2)(iv) of this section for a special rule for fees.
(iv) Fees. A fee is includible in carryover-allocation basis only to the extent the requirements of paragraph (b)(2)(iii) of this section are met and—
(A) The fee is reasonable;
(B) The taxpayer is legally obligated to pay the fee;
(C) The fee is capitalizable as part of the taxpayer’s basis in land or depreciable property that is reasonably expected to be part of the project;
(D) The fee is not paid (or to be paid) by the taxpayer to itself; and
(E) If the fee is paid (or to be paid) by the taxpayer to a related person, and the taxpayer uses the cash method of accounting, the taxpayer could properly accrue the fee under the accrual method of accounting (considering, for example, the rules of section 461(h)). A person is a related person if the person bears a relationship to the taxpayer specified in sections 267(b) or 707(b)(1), or if the person and the taxpayer are engaged in trades or businesses under common control (within the meaning of subsections (a) and (b) of section 52).
(3) Reasonably expected basis. Rules similar to the rules of paragraphs (a) and (b) of this section apply in determining the taxpayer’s reasonably expected basis in a project (land and depreciable basis) as of the close of the second calendar year following the calendar year of the allocation.
(4) Examples. The following examples illustrate the rules of paragraphs (a) and (b) of this section.
(ii) Determination of carryover-allocation basis. C’s $100,000 basis in the land is includible in carryover-allocation basis even though C has owned the land since 1985. The $150,000 of costs C has incurred for architects’ fees and site preparation are also includible in carryover-allocation basis. The expected increase in basis due to the project’s location in a qualified census tract is not taken into account in determining C’s carryover-allocation basis. Accordingly, C’s carryover-allocation basis in the project of which the building is a part is $250,000.
(iii) Determination of whether building is qualified. C’s reasonably expected basis in the project at the close of the second calendar year following the calendar year of allocation is $2,000,000. The expected increase in eligible basis due to the project’s location in a qualified census tract is not taken into account in determining this amount. Because C’s carryover-allocation basis is more than 10 percent of C’s reasonably expected basis in the project of which the building is a part, the building for which C received the carryover allocation is a qualified building for purposes of section 42(h)(1)(E)(ii) and paragraph (a) of this section.
(ii) Determination of whether building is qualified. Because D’s carryover-allocation basis as of the close of March 12, 2004, is not more than 10 percent of D’s reasonably expected basis in the single-building project, the building is not a qualified building for purposes of section 42(h)(1)(E)(ii) and paragraph (a) of this section. Accordingly, the carryover allocation to D must be returned to the Agency. The allocation is valid for purposes of determining the amount of credit allocated by Agency from State X’s 2003 State housing credit ceiling, but is included in the returned credit component of State X’s 2004 housing credit ceiling.
(c) Verification of basis by Agency—(1) Verification requirement. An Agency that makes a carryover allocation to a taxpayer must verify that the taxpayer has met the 10 percent basis requirement of paragraph (a)(2) of this section.
(2) Manner of verification. An Agency may verify that a taxpayer has incurred more than 10 percent of its reasonably expected basis in a project by obtaining a certification from the taxpayer, in writing and under penalty of perjury, that the taxpayer has incurred by the close of the calendar year of the allocation (for allocations made before July 1) or by the close of the date that is 6 months after the date the allocation is made (for allocations made after June 30) more than 10 percent of the reasonably expected basis in the project. The certification must be accompanied by supporting documentation that the Agency must review. Supporting documentation may include, for example, copies of checks or other records of payments. Alternatively, an Agency may verify that the taxpayer has incurred adequate basis by requiring that the taxpayer obtain from an attorney or certified public accountant a written certification to the Agency, that the attorney or accountant has examined all eligible costs incurred with respect to the project and that, based upon this examination, it is the attorney’s or accountant’s belief that the taxpayer has incurred more than 10 percent of its reasonably expected basis in the project by the close of the calendar year of the allocation (for allocations made before July 1) or by the close of the date that is 6 months after the date the allocation is made (for allocations made after June 30).
(3) Time of verification—(i) Allocations made before July 1. For a carryover allocation made before July 1, an Agency may require that the basis certification be submitted to or received by the Agency prior to the close of the calendar year of allocation or within a reasonable time following the close of the calendar year of allocation. The Agency will need to verify basis as provided in paragraph (c)(2) of this section to accurately complete the Form 8610, “Annual Low-Income Housing Credit Agencies Report,” and the Schedule A (Form 8610), “Carryover Allocation of Low-Income Housing Credit,” for the calendar year of the allocation. If the basis certification is not timely made, or supporting documentation is lacking, inadequate, or does not actually support the certification, the Agency should notify the taxpayer and try to get adequate documentation. If the Agency cannot verify before the Form 8610 is filed that the taxpayer has satisfied the 10 percent basis requirement for a carryover allocation made before July 1, the allocation is not valid and is treated as if it had not been made and the carryover allocation should not be reported on the Schedule A (Form 8610).
(ii) Allocations made after June 30. An Agency may require that the basis certification be submitted to or received by the Agency prior to the close of the date that is 6 months after the date the allocation was made or within a reasonable period of time following the close of the date that is 6 months after the date the allocation was made. The Agency will need to verify basis as provided in paragraph (c)(2) of this section. If the basis certification is not timely made, or supporting documentation is lacking, inadequate, or does not actually support the certification, the Agency should notify the taxpayer and try to get adequate documentation. If the Agency cannot verify that the taxpayer has satisfied the 10 percent basis requirement for a carryover allocation made after June 30, the allocation must be returned to the Agency. The carryover allocation is a valid allocation for the calendar year of the allocation, but is included in the returned credit component of the State housing credit ceiling for the calendar year following the calendar year of the allocation.
(d) Requirements for making carryover allocations—(1) In general. Generally, an allocation is made when an Agency issues the Form 8609, ‘Low-Income Housing Credit Allocation Certification,’ for a building. See § 1.42-1T(d)(8)(ii). An Agency does not issue the Form 8609 for a building until the building is placed in service. However, in cases where allocations of credit are made pursuant to section 42(h)(1)(E) (relating to carryover allocations for buildings) or section 42(h)(1)(F) (relating to carryover allocations for multiple-building projects), Form 8609 is not used as the allocating document because the buildings are not yet in service. When an allocation is made pursuant to section 42(h)(1) (E) or (F), the allocating document is the document meeting the requirements of paragraph (d)(2) of this section. In addition, when an allocation is made pursuant to section 42(h)(1)(F), the requirements of paragraph (d)(3) of this section must be met for the allocation to be valid. An allocation pursuant to section 42(h)(1) (E) or (F) reduces the state housing credit ceiling for the year in which the allocation is made, whether or not the Form 8609 is also issued in that year.
(2) Requirements for allocation. An allocation pursuant to section 42(h)(1) (E) or (F) is made when an allocation document containing the following information is completed, signed, and dated by an authorized official of the Agency—
(i) The address of each building in the project, or if none exists, a specific description of the location of each building;
(ii) The name, address, and taxpayer identification number of the taxpayer receiving the allocation;
(iii) The name and address of the Agency;
(iv) The taxpayer identification number of the Agency;
(v) The date of the allocation;
(vi) The housing credit dollar amount allocated to the building or project, as applicable;
(vii) The taxpayer’s reasonably expected basis in the project (land and depreciable basis) as of the close of the second calendar year following the calendar year in which the allocation is made;
(viii) For carryover allocations made before July 1, the taxpayer’s basis in the project (land and depreciable basis) as of the close of the calendar year of the allocation and the percentage that basis bears to the reasonably expected basis in the project (land and depreciable basis) as of the close of the second calendar year following the calendar year of allocation;
(ix) The date that each building in the project is expected to be placed in service; and
(x) The Building Identification Number (B.I.N.) to be assigned to each building in the project. The B.I.N. must reflect the year an allocation is first made to the building, regardless of the year that the building is placed in service. This B.I.N. must be used for all allocations of credit for the building. For example, rehabilitation expenditures treated as a separate new building under section 42(e) should not have a separate B.I.N. if the building to which the rehabilitation expenditures are made has a B.I.N. In this case, the B.I.N. used for the rehabilitation expenditures shall be the B.I.N. previously assigned to the building, although the rehabilitation expenditures must have a separate Form 8609 for the allocation. Similarly, a newly constructed building that receives an allocation of credit in different calendar years must have a separate Form 8609 for each allocation. The B.I.N. assigned to the building for the first allocation must be used for the subsequent allocation.
(3) Special rules for project-based allocations—(i) In general. An allocation pursuant to section 42(h)(1)(F) (a project-based allocation) must meet the requirements of this section as well as the requirements of section 42(h)(1)(F), including the minimum basis requirement of section 42(h)(1)(E)(ii).
(ii) Requirement of section 42(h)(1)(F)(i)(III). An allocation satisfies the requirement of section 42(h)(1)(F)(i)(III) if the Form 8609 that is issued for each building that is placed in service in the project states the portion of the project-based allocation that is applied to that building.
(4) Recordkeeping requirements—(i) Taxpayer. When an allocation is made pursuant to section 42(h)(1)(E) or (F), the taxpayer must retain a copy of the allocation document. The Form 8609 that reflects the allocation must be filed for the first taxable year that the credit is claimed and for each taxable year thereafter throughout the compliance period, whether or not a credit is claimed for the taxable year.
(ii) Agency. The Agency must retain the original carryover allocation document made under paragraph (d)(2) of this section and file Schedule A (Form 8610) with the Agency’s Form 8610 for the year the allocation is made. The Agency must also retain a copy of the Form 8609 that is issued to the taxpayer and file the original with the Agency’s Form 8610 that reflects the year the form is issued.
(5) Separate procedure for election of appropriate percentage month. If a taxpayer receives an allocation under section 42(h)(1) (E) or (F) and wishes to elect under section 42(b)(2)(A)(ii) to use the appropriate percentage for a month other than the month in which a building is placed in service, the requirements specified in § 1.42-8 must be met for the election to be effective.
(e) Special rules. The following rules apply for purposes of this section.
(1) Treatment of partnerships and other flow-through entities. With respect to taxpayers that own projects through partnerships or other flow-through entities (e.g., S corporations, estates, or trusts), carryover-allocation basis is determined at the entity level using the rules provided by this section. In addition, the entity is responsible for providing to the Agency the certification and documentation required under the basis verification requirement in paragraph (c) of this section.
(2) Transferees. If land or depreciable property that is expected to be part of a project is transferred after a carryover allocation has been made for a building that is reasonably expected to be part of the project, but before the close of the calendar year of the allocation (for allocations made before July 1) or by the close of the date that is 6 months after the date the allocation is made (for allocations made after June 30), the transferee’s carryover-allocation basis is determined under the principles of this section and section 42(d)(7). See also Rev. Rul. 91-38, 1991-2 C.B. 3 (see § 601.601(d)(2)(ii)(b) of this chapter). In addition, the transferee is treated as the taxpayer for purposes of the basis verification requirement of this section, and therefore, is responsible for providing to the Agency the required certifications and documentation.
§ 1.42-7 Substantially bond-financed buildings. [Reserved]
§ 1.42-8 Election of appropriate percentage month.
(a) Election under section 42(b)(2)(A)(ii)(I) to use the appropriate percentage for the month of a binding agreement—(1) In general. For purposes of section 42(b)(2)(A)(ii)(I), an agreement between a taxpayer and an Agency as to the housing credit dollar amount to be allocated to a building is considered binding if it—
(i) Is in writing;
(ii) Is binding under state law on the Agency, the taxpayer, and all successors in interest;
(iii) Specifies the type(s) of building(s) to which the housing credit dollar amount applies (i.e., a newly constructed or existing building, or substantial rehabilitation treated as a separate new building under section 42(e));
(iv) Specifies the housing credit dollar amount to be allocated to the building(s); and
(v) Is dated and signed by the taxpayer and the Agency during the month in which the requirements of paragraphs (a)(1) (i) through (iv) of this section are met.
(2) Effect on state housing credit ceiling. Generally, a binding agreement described in paragraph (a)(1) of this section is an agreement by the Agency to allocate credit to the taxpayer at a future date. The binding agreement may include a reservation of credit or a binding commitment (under section 42(h)(1)(C)) to allocate credit in a future taxable year. A reservation or a binding commitment to allocate credit in a future year has no effect on the state housing credit ceiling until the year the Agency actually makes an allocation. However, if the binding agreement is also a carryover allocation under section 42(h)(1) (E) or (F), the state housing credit ceiling is reduced by the amount allocated by the Agency to the taxpayer in the year the carryover allocation is made. For a binding agreement to be a valid carryover allocation, the requirements of paragraph (a)(1) of this section and § 1.42-6 must be met.
(3) Time and manner of making election. An election under section 42(b)(2)(A)(ii)(I) may be made either as part of the binding agreement under paragraph (a)(1) of this section to allocate a specific housing credit dollar amount or in a separate document that references the binding agreement. In either case, the election must—
(i) Be in writing;
(ii) Reference section 42(b)(2)(A)(ii)(I);
(iii) Be signed by the taxpayer;
(iv) If it is in a separate document, reference the binding agreement that meets the requirements of paragraph (a)(1) of this section; and
(v) Be notarized by the 5th day following the end of the month in which the binding agreement was made.
(4) Multiple agreements—(i) Rescinded agreements. A taxpayer may not make an election under section 42(b)(2)(A)(ii)(I) for a building if an election has previously been made for the building for a different month. For example, assume a taxpayer entered into a binding agreement for allocation of a specific housing credit dollar amount to a building and made the election under section 42(b)(2)(A)(ii)(I) to apply the appropriate percentage for the month of the binding agreement. If the binding agreement subsequently is rescinded under state law, and the taxpayer enters into a new binding agreement for allocation of a specific housing credit dollar amount to the building, the taxpayer must apply to the building the appropriate percentage for the elected month of the rescinded binding agreement. However, if no prior election was made with respect to the rescinded binding agreement, the taxpayer may elect the appropriate percentage for the month of the new binding agreement.
(ii) Increases in credit. The election under section 42(b)(2)(A)(ii)(I), once made, applies to any increase in the credit amount allocated for a building, whether the increase occurs in the same or in a subsequent year. However, in the case of a binding agreement (or carryover allocation that is treated as a binding agreement) to allocate a credit amount under section 42(e)(1) for substantial rehabilitation treated as a separate new building, a taxpayer may make the election under section 42(b)(2)(A)(ii)(I) notwithstanding that a prior election under section 42(b)(2)(A)(ii)(I) is in effect for a prior allocation of credit for a substantial rehabilitation that was previously placed in service under section 42(e).
(5) Amount allocated. The housing credit dollar amount eventually allocated to a building may be more or less than the amount specified in the binding agreement. Depending on the Agency’s determination pursuant to section 42(m)(2) as to the financial feasibility of the building (or project), the Agency may allocate a greater housing credit dollar amount to the building (provided that the Agency has additional housing credit dollar amounts available to allocate for the calendar year of the allocation) or the Agency may allocate a lesser housing credit dollar amount. Under section 42(h)(7)(D), in allocating a housing credit dollar amount, the Agency must specify the applicable percentage and maximum qualified basis of the building. The applicable percentage may be less, but not greater than, the appropriate percentage for the month the building is placed in service, or the month elected by the taxpayer under section 42(b)(2)(A)(ii)(I). Whether the appropriate percentage is the appropriate percentage for the 70-percent present value credit or the 30-percent present value credit is determined under section 42(i)(2) when the building is placed in service.
(6) Procedures—(i) Taxpayer. The taxpayer must give the original notarized election statement to the Agency before the close of the 5th calendar day following the end of the month in which the binding agreement is made. The taxpayer must retain a copy of the binding agreement and the election statement.
(ii) Agency. The Agency must retain the original of the binding agreement and election statement and, to the extent required by Schedule A (Form 8610), “Carryover Allocation of Low-Income Housing Credit,” account for the binding agreement and election statement on that schedule.
(7) Examples. The following examples illustrate the provisions of this section. In each example, X is the taxpayer, Agency is the state housing credit agency, and the carryover allocations meet the requirements of § 1.42-6 and are otherwise valid.
(ii) Agency makes a carryover allocation of $100,000 of housing credit dollar amount for the building on October 2, 2003. The carryover allocation reduces Agency’s state housing credit ceiling for 2003. Due to unexpectedly high construction costs, when X places the building in service in July 2004, the product of the building’s qualified basis and the applicable percentage for the building (the appropriate percentage for the month of August 2003) is $150,000, rather than $100,000. Notwithstanding that only $100,000 of credit was allocated for the building in 2003, Agency may allocate an additional $50,000 of housing credit dollar amount for the building from its state housing credit ceiling for 2004. The appropriate percentage for the month of August 2003 is the applicable percentage for the building for the entire $150,000 of credit allocated for the building, even though separate allocations were made in 2003 and 2004. Because allocations were made for the building in two separate calendar years, Agency must issue two Forms 8609, “Low-Income Housing Credit Allocation Certification,” to X. One Form 8609 must reflect the $100,000 allocation made in 2003, and the other Form 8609 must reflect the $50,000 allocation made in 2004.
(iii) X gives the original notarized statement to Agency on or before September 5, 2003, and retains a copy of the binding agreement, election statement, and carryover allocation document.
(iv) Agency retains the original of the binding agreement, election statement, and 2003 carryover allocation document. Agency accounts for the binding agreement, election statement, and 2003 carryover allocation on the Schedule A (Form 8610) that it files for the 2003 calendar year. After the building is placed in service in 2004, and assuming other necessary requirements for issuing a Form 8609 are met (for example, taxpayer has certified all sources and uses of funds and development costs for the building under § 1.42-17), Agency issues to X a copy of the Form 8609 reflecting the 2003 carryover allocation of $100,000. Agency files the original of this Form 8609 with the Form 8610, “Annual Low-Income Housing Credit Agencies Report,” that it files for the 2004 calendar year. Agency also issues to X a copy of the Form 8609 reflecting the 2004 allocation of $50,000 and files the original of this Form 8609 with the Form 8610 that it files for the 2004 calendar year. Agency retains copies of the Forms 8609 that are issued to X.
(ii) In October 2004, X and Agency enter into another binding agreement meeting the requirements of paragraph (a)(1) of this section. Under the agreement, Agency will allocate $50,000 of housing credit dollar amount for additional rehabilitation expenditures by X that qualify as a second separate new building under section 42(e)(1). On or before November 5, 2004, X signs and has notarized a written election statement meeting the requirements of paragraph (a)(3) of this section. On December 1, 2004, X receives a carryover allocation under section 42(h)(1)(E) for $50,000. The carryover allocation reduces by $50,000 Agency’s state housing credit ceiling for 2004. The applicable percentage for the rehabilitation expenditures treated as the second separate new building is the appropriate percentage for the month of October 2004, not September 2003. The appropriate percentage for the month of September 2003 still applies to the allocation of $70,000 for the rehabilitation expenditures treated as the first separate new building. Because allocations were made for the building in two separate calendar years, Agency must issue two Forms 8609 to X. One Form 8609 must reflect the $70,000 allocation made in 2003, and the other Form 8609 must reflect the $50,000 allocation made in 2004.
(iii) X gives the first original notarized statement to Agency on or before October 5, 2003, and retains a copy of the first binding agreement, election statement, and carryover allocation document issued in 2003. X gives the second original notarized statement to Agency on or before November 5, 2004, and retains a copy of the second binding agreement, election statement, and carryover allocation document issued in 2004.
(iv) Agency retains the original of the binding agreements, election statements, and carryover allocation documents. Agency accounts for the binding agreement, election statement, and 2003 carryover allocation on the Schedule A (Form 8610) that it files for the 2003 calendar year. Agency also accounts for the binding agreement, election statement, and 2004 carryover allocation on the Schedule A (Form 8610) that it files for the 2004 calendar year. After each separate new building is placed in service, and assuming other necessary requirements for issuing a Form 8609 are met (for example, taxpayer has certified all sources and uses of funds and development costs for the building under § 1.42-17), the Agency will issue to X a copy of the Form 8609 reflecting the 2003 carryover allocation of $70,000 and a copy of the Form 8609 reflecting the 2004 carryover allocation of $50,000, respectively. Agency files the original of each Form 8609 with the Form 8610 that reflects the calendar year each Form 8609 is issued. Agency retains copies of the Forms 8609 that are issued to X.
(b) Election under section 42(b)(2)(A)(ii)(II) to use the appropriate percentage for the month tax-exempt bonds are issued—(1) Time and manner of making election. In the case of any building to which section 42(h)(4)(B) applies, an election under section 42(b)(2)(A)(ii)(II) to use the appropriate percentage for the month tax-exempt bonds are issued must—
(i) Be in writing;
(ii) Reference section 42(b)(2)(A)(ii)(II);
(iii) Specify the percentage of the aggregate basis of the building and the land on which the building is located that is financed with the proceeds of obligations described in section 42(h)(4)(A) (tax-exempt bonds);
(iv) State the month in which the tax-exempt bonds are issued;
(v) State that the month in which the tax-exempt bonds are issued is the month elected for the appropriate percentage to be used for the building;
(vi) Be signed by the taxpayer; and
(vii) Be notarized by the 5th day following the end of the month in which the bonds are issued.
(2) Bonds issued in more than one month. If a building described in section 42(h)(4)(B) (substantially bond-financed building) is financed with tax-exempt bonds issued in more than one month, the taxpayer may elect the appropriate percentage for any month in which the bonds are issued. Once the election is made, the appropriate percentage elected applies for the building even if all bonds are not issued in that month. The requirements of this paragraph (b), including the time limitation contained in paragraph (b)(1)(vii) of this section, must also be met.
(3) Limitations on appropriate percentage. Under section 42(m)(2)(D), the credit allowable for a substantially bond- financed building is limited to the amount necessary to assure the project’s feasibility. Accordingly, in making the determination under section 42(m)(2), an Agency may use an applicable percentage that is less, but not greater than, the appropriate percentage for the month the building is placed in service, or the month elected by the taxpayer under section 42(b)(2)(A)(ii)(II).
(4) Procedures—(i) Taxpayer. The taxpayer must provide the original notarized election statement to the Agency before the close of the 5th calendar day following the end of the month in which the bonds are issued. If an authority other than the Agency issues the tax-exempt bonds, the taxpayer must also give the Agency a signed statement from the issuing authority that certifies the information described in paragraphs (b)(1)(iii) and (iv) of this section. The taxpayer must also retain a copy of the election statement.
(ii) Agency. The Agency must retain the original of the election statement and a copy of the Form 8609 that reflects the election statement. The Agency must file an additional copy of the Form 8609 with the Agency’s Form 8610 that reflects the calendar year the Form 8609 is issued.
§ 1.42-9 For use by the general public.
(a) General rule. If a residential rental unit in a building is not for use by the general public, the unit is not eligible for a section 42 credit. A residential rental unit is for use by the general public if the unit is rented in a manner consistent with housing policy governing non-discrimination, as evidenced by rules or regulations of the Department of Housing and Urban Development (HUD) (24 CFR subtitle A and chapters I through XX). See HUD Handbook 4350.3 (or its successor). A copy of HUD Handbook 4350.3 may be requested by writing to: HUD, Directives Distribution Section, room B-100, 451 7th Street, SW., Washington, DC 20410.
(b) Limitations. Notwithstanding paragraph (a) of this section, if a residential rental unit is provided only for a member of a social organization or provided by an employer for its employees, the unit is not for use by the general public and is not eligible for credit under section 42. In addition, any residential rental unit that is part of a hospital, nursing home, sanitarium, lifecare facility, trailer park, or intermediate care facility for the mentally and physically handicapped is not for use by the general public and is not eligible for credit under section 42.
(c) Treatment of units not for use by the general public. The costs attributable to a residential rental unit that is not for use by the general public are not excludable from eligible basis by reason of the unit’s ineligibility for the credit under this section. However, in calculating the applicable fraction, the unit is treated as a residential rental unit that is not a low-income unit.
§ 1.42-10 Utility allowances.
(a) Inclusion of utility allowances in gross rent. If the cost of any utility (other than telephone, cable television, or Internet) for a residential rental unit is paid directly by the tenant(s), and not by or through the owner of the building, the gross rent for that unit includes the applicable utility allowance determined under this section. For purposes of the preceding sentence, if the cost of a particular utility for a residential unit is paid pursuant to an actual-consumption submetering arrangement within the meaning of paragraph (e)(1) of this section, then that cost is treated as being paid directly by the tenant(s) and not by or through the owner of the building. This section only applies for purposes of determining gross rent under section 42(g)(2)(B)(ii) as to rent-restricted units.
(b) Applicable utility allowances—(1) Buildings assisted by the Rural Housing Service. If a building receives assistance from the Rural Housing Service (RHS-assisted building), the applicable utility allowance for all rent-restricted units in the building is the utility allowance determined under the method prescribed by the Rural Housing Service (RHS) for the building (whether or not the building or its tenants also receive other state or federal assistance).
(2) Buildings with Rural Housing Service assisted tenants. If any tenant in a building receives RHS rental assistance payments (RHS tenant assistance), the applicable utility allowance for all rent-restricted units in the building (including any units occupied by tenants receiving rental assistance payments from the Department of Housing and Urban Development (HUD)) is the applicable RHS utility allowance.
(3) Buildings regulated by the Department of Housing and Urban Development. If neither a building nor any tenant in the building receives RHS housing assistance, and the rents and utility allowances of the building are regulated by HUD (HUD-regulated buildings), the applicable utility allowance for all rent-restricted units in the building is the applicable HUD utility allowance.
(4) Other buildings. If a building is neither an RHS-assisted nor a HUD-regulated building, and no tenant in the building receives RHS tenant assistance, the applicable utility allowance for rent-restricted units in the building is determined under the following methods.
(i) Tenants receiving HUD rental assistance. The applicable utility allowance for any rent-restricted units occupied by tenants receiving HUD rental assistance payments (HUD tenant assistance) is the applicable Public Housing Authority (PHA) utility allowance established for the Section 8 Existing Housing Program.
(ii) Other tenants—(A) General rule. If none of the rules of paragraphs (b)(1), (2), (3), and (4)(i) of this section apply to determine the appropriate utility allowance for a rent-restricted unit, then the appropriate utility allowance for the unit is the applicable PHA utility allowance. However, if a local utility company estimate is obtained for any unit in the building in accordance with paragraph (b)(4)(ii)(B) of this section, that estimate becomes the appropriate utility allowance for all rent-restricted units of similar size and construction in the building. This local utility company estimate procedure is not available for and does not apply to units to which the rules of paragraphs (b) (1), (2), (3), or (4)(i) of this section apply. However, if a local utility company estimate is obtained for any unit in the building under paragraph (b)(4)(ii)(B) of this section, a State or local housing credit agency (Agency) provides a building owner with an estimate for any unit in a building under paragraph (b)(4)(ii)(C) of this section, a cost estimate is calculated using the HUD Utility Schedule Model under paragraph (b)(4)(ii)(D) of this section, or a cost estimate is calculated by an energy consumption model under paragraph (b)(4)(ii)(E) of this section, then the estimate under paragraph (b)(4)(ii)(B), (C), (D), or (E) becomes the applicable utility allowance for all rent-restricted units of similar size and construction in the building. Paragraphs (b)(4)(ii)(B), (C), (D), and (E) of this section do not apply to units to which the rules of paragraphs (b)(1), (2), (3), or (4)(i) of this section apply.
(B) Utility company estimate. Any interested party (including a low-income tenant, a building owner, or an Agency) may obtain a local utility company estimate for a unit. The estimate is obtained when the interested party receives, in writing, information from a local utility company providing the estimated cost of that utility for a unit of similar size and construction for the geographic area in which the building containing the unit is located. In the case of deregulated utility services, the interested party is required to obtain an estimate only from one utility company even if multiple companies can provide the same utility service to a unit. However, the utility company must offer utility services to the building in order for that utility company’s rates to be used in calculating utility allowances. The estimate should include all component deregulated charges for providing the utility service. The local utility company estimate may be obtained by an interested party at any time during the building’s extended use period (see section 42(h)(6)(D)) or, if the building does not have an extended use period, during the building’s compliance period (see section 42(i)(1)). Unless the parties agree otherwise, costs incurred in obtaining the estimate are borne by the initiating party. The interested party that obtains the local utility company estimate (the initiating party) must retain the original of the utility company estimate and must furnish a copy of the local utility company estimate to the owner of the building (where the initiating party is not the owner), and the Agency that allocated credit to the building (where the initiating party is not the Agency). The owner of the building must make available copies of the utility company estimate to the tenants in the building.
(C) Agency estimate. A building owner may obtain a utility estimate for each unit in the building from the Agency that has jurisdiction over the building provided the Agency agrees to provide the estimate. The estimate is obtained when the building owner receives, in writing, information from the Agency providing the estimated per-unit cost of the utilities for units of similar size and construction for the geographic area in which the building containing the units is located. The Agency estimate may be obtained by a building owner at any time during the building’s extended use period (see section 42(h)(6)(D)). Costs incurred in obtaining the estimate are borne by the building owner. In establishing an accurate utility allowance estimate for a particular building, an Agency (or an agent or other private contractor of the Agency that is a qualified professional within the meaning of paragraph (b)(4)(ii)(E) of this section) must take into account, among other things, local utility rates, property type, climate and degree-day variables by region in the State, taxes and fees on utility charges, building materials, and mechanical systems. If the Agency uses an agent or other private contractor to calculate the utility estimates, the agent or contractor and the owner must not be related within the meaning of section 267(b) or 707(b). An Agency may also use actual utility company usage data and rates for the building. However, use of the Agency estimate is limited to the building’s consumption data for the twelve-month period ending no earlier than 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section and utility rates used for the Agency estimate must be no older than the rates in place 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section. In the case of newly constructed or renovated buildings with less than 12 months of consumption data, the Agency (or an agent or other private contractor of the Agency that is a qualified professional within the meaning of paragraph (b)(4)(ii)(E) of this section) may use consumption data for the 12-month period of units of similar size and construction in the geographic area in which the building containing the units is located.
(D) HUD Utility Schedule Model. A building owner may calculate a utility estimate using the “HUD Utility Schedule Model” that can be found on the Low-Income Housing Tax Credits page at http://www.huduser.org/datasets/lihtc.html (or successor URL). Utility rates used for the HUD Utility Schedule Model must be no older than the rates in place 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section.
(E) Energy consumption model. A building owner may calculate utility estimates using an energy and water and sewage consumption and analysis model (energy consumption model). The energy consumption model must, at a minimum, take into account specific factors including, but not limited to, unit size, building orientation, design and materials, mechanical systems, appliances, characteristics of the building location, and available historical data. The utility consumption estimates must be calculated by a properly licensed engineer or other qualified professional. The qualified professional and the building owner must not be related within the meaning of section 267(b) or 707(b). If a qualified professional is not a properly licensed engineer and if the building owner wants to utilize that qualified professional to calculate utility consumption estimates, then the owner must obtain approval from the Agency that has jurisdiction over the building. Further, regardless of the type of qualified professional, the Agency may approve or disapprove of the energy consumption model or require information before permitting its use. In addition, utility rates used for the energy consumption model must be no older than the rates in place 60 days prior to the beginning of the 90-day period under paragraph (c)(1) of this section.
(c) Changes in applicable utility allowance—(1) In general. If, at any time during the building’s extended use period (as defined in section 42(h)(6)(D)), the applicable utility allowance for units changes, the new utility allowance must be used to compute gross rents of the units due 90 days after the change (the 90-day period). For example, if rent must be lowered because a local utility company estimate is obtained that shows a higher utility cost than the otherwise applicable PHA utility allowance, the lower rent must be in effect for rent due at the end of the 90-day period. A building owner using a utility company estimate under paragraph (b)(4)(ii)(B) of this section, the HUD Utility Schedule Model under paragraph (b)(4)(ii)(D) of this section, or an energy consumption model under paragraph (b)(4)(ii)(E) of this section must submit copies of the utility estimates to the Agency that has jurisdiction over the building and make the estimates available to all tenants in the building at the beginning of the 90-day period before the utility allowances can be used in determining the gross rent of rent-restricted units. An Agency may require additional information from the owner during the 90-day period. Any utility estimates obtained under the Agency estimate under paragraph (b)(4)(ii)(C) of this section must also be made available to all tenants in the building at the beginning of the 90-day period. The building owner must pay for all costs incurred in obtaining the estimates under paragraphs (b)(4)(ii)(B), (C), (D), and (E) of this section and providing the estimates to the Agency and the tenants. The building owner is not required to review the utility allowances, or implement new utility allowances, until the building has achieved 90 percent occupancy for a period of 90 consecutive days or the end of the first year of the credit period, whichever is earlier.
(2) Annual review. A building owner must review at least once during each calendar year the basis on which utility allowances have been established and must update the applicable utility allowance in accordance with paragraph (c)(1) of this section. The review must take into account any changes to the building such as any energy conservation measures that affect energy consumption and changes in utility rates.
(d) Record retention. The building owner must retain any utility consumption estimates and supporting data as part of the taxpayer’s records for purposes of § 1.6001-1(a).
(e) Actual-consumption submetering arrangements—(1) Definition. For purposes of this section, an actual-consumption submetering arrangement for a utility in a residential unit possesses all of the following attributes:
(i) The utility consumed in the unit is described in paragraph (e)(1)(i)(A) or (e)(1)(i)(B) of this section;
(A) The utility is purchased from or through a local utility company by the building owner (or its agent or other party acting on behalf of the building owner).
(B) The utility is not purchased from or through a local utility company and is produced from a renewable source (within the meaning of paragraph (e)(1)(i)(C) of this section).
(C) For purposes of paragraph (e)(1)(i)(B) of this section, a utility is produced from a renewable source if—
(1) It is energy that is produced from energy property described in section 48;
(2) It is energy that is produced from a facility described in section 45(d)(1), (2), (3), (4), (6), (9), or (11); or
(3) It is a utility that is described in guidance published for this purpose in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter).
(D) Determinations under paragraphs (e)(1)(i)(C)(1) and (2) of this section take into account only the manner in which the energy is produced and not who owns the energy property or the facility or whether the applicability of relevant portions of sections 45 and 48 has expired.
(ii) The tenants in the unit are billed for, and pay the building owner (or its agent or other party acting on behalf of the building owner) for, the unit’s consumption of the utility;
(iii) The billed amount reflects the unit’s actual consumption of the utility. In the case of sewerage charges, however, if the unit’s sewerage charges are combined on the bill with water charges and the sewerage charges are determined based on the actual water consumption of the unit, then the bill is treated as reflecting the actual sewerage consumption of the unit; and
(iv) The rate at which the building owner bills for the utility satisfies the following requirements:
(A) To the extent that the utility consumed is described in paragraph (e)(1)(i)(A) of this section, the utility rate charged to the tenants of the unit does not exceed the rate incurred by the building owner for that utility; and
(B) To the extent that the utility consumed is described in paragraph (e)(1)(i)(B) of this section, the utility rate charged to the tenants of the unit does not exceed the highest rate that the tenants would have paid if they had obtained the utility from a local utility company. In determining whether a rate satisfies the preceding sentence, a building owner may rely on the rates published by local utility companies.
(2) Administrative fees. If the owner charges a unit’s tenants a fee for administering an actual-consumption submetering arrangement, the fee is not considered gross rent for purposes of section 42(g)(2). The preceding sentence, however, does not apply unless the fee is computed in the same manner for every unit receiving the same submetered utility service, nor does it apply to any amount by which the aggregate monthly fee or fees for all of the unit’s utilities under one or more actual-consumption submetering arrangements exceed the greater of—
(i) Five dollars per month;
(ii) An amount (if any) designated by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter); or
(iii) The lesser of—
(A) The dollar amount (if any) specifically prescribed under a State or local law; or
(B) A maximum amount (if any) designated by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter).
§ 1.42-11 Provision of services.
(a) General rule. The furnishing to tenants of services other than housing (whether or not the services are significant) does not prevent the units occupied by the tenants from qualifying as residential rental property eligible for credit under section 42. However, any charges to low-income tenants for services that are not optional generally must be included in gross rent for purposes of section 42(g).
(b) Services that are optional—(1) General rule. A service is optional if payment for the service is not required as a condition of occupancy. For example, for a qualified low-income building with a common dining facility, the cost of meals is not included in gross rent for purposes of section 42(g)(2)(A) if payment for the meals in the facility is not required as a condition of occupancy and a practical alternative exists for tenants to obtain meals other than from the dining facility.
(2) Continual or frequent services. If continual or frequent nursing, medical, or psychiatric services are provided, it is presumed that the services are not optional and the building is ineligible for the credit, as is the case with a hospital, nursing home, sanitarium, lifecare facility, or intermediate care facility for the mentally and physically handicapped. See also § 1.42-9(b).
(3) Required services—(i) General rule. The cost of services that are required as a condition of occupancy must be included in gross rent even if federal or state law requires that the services be offered to tenants by building owners.
(ii) Exceptions—(A) Supportive services. Section 42(g)(2)(B)(iii) provides an exception for certain fees paid for supportive services. For purposes of section 42(g)(2)(B)(iii), a supportive service is any service provided under a planned program of services designed to enable residents of a residential rental property to remain independent and avoid placement in a hospital, nursing home, or intermediate care facility for the mentally or physically handicapped. For a building described in section 42(i)(3)(B)(iii) (relating to transitional housing for the homeless) or section 42(i)(3)(B)(iv) (relating to single-room occupancy), a supportive service includes any service provided to assist tenants in locating and retaining permanent housing.
(B) Specific project exception. Gross rent does not include the cost of mandatory meals in any federally-assisted project for the elderly and handicapped (in existence on or before January 9, 1989) that is authorized by 24 CFR 278 to provide a mandatory meals program.
§ 1.42-12 Effective dates and transitional rules.
(a) Effective dates—(1) In general. Except as provided in paragraphs (a)(2) and (a)(3) of this section, the rules set forth in §§ 1.42-6 and 1.42-8 through 1.42-12 are applicable on May 2, 1994. However, binding agreements, election statements, and carryover allocation documents entered into before May 2, 1994, that follow the guidance set forth in Notice 89-1, 1989-1 C.B. 620 (see § 601.601(d)(2)(ii)(b) of this chapter) need not be changed to conform to the rules set forth in §§ 1.42-6 and 1.42-8 through 1.42-12.
(2) Community Renewal Tax Relief Act of 2000—(i) In general. Section 1.42-6 (a), (b)(4)(iii) Example 1 and Example 2, (c), (d)(2)(viii), and (e)(2) are applicable for housing credit dollar amounts allocated after January 6, 2004. However, the rules in § 1.42-6 (a), (b)(4)(iii) Example 1 and Example 2, (c), (d)(2)(viii), and (e)(2) may be applied by Agencies and taxpayers for housing credit dollar amounts allocated after December 31, 2000, and on or before January 6, 2004. Otherwise, subject to the applicable effective dates of the corresponding statutory provisions, the rules that apply for housing credit dollar amounts allocated on or before January 6, 2004, are contained in § 1.42-6 in effect on and before January 6, 2004 (see 26 CFR part 1 revised as of April 1, 2003).
(3) Electronic filing simplification changes. Sections 1.42-6(d)(4) and 1.42-8(a)(6)(i), (a)(6)(ii), (a)(7) Example 1 and Example 2, (b)(4)(i), and (b)(4)(ii) are applicable for forms filed after January 6, 2004. The rules that apply for forms filed on or before January 6, 2004, are contained in § 1.42-6 and § 1.42-8 in effect on and before January 6, 2004 (see 26 CFR part 1 revised as of April 1, 2003).
(4) Utility allowances. The first sentence in § 1.42-10(a), § 1.42-10(b)(1), (2), (3), and (4), the last two sentences in § 1.42-10(b)(4)(ii)(A), the third, fourth, and fifth sentences in § 1.42-10(b)(4)(ii)(B), § 1.42-10(b)(4)(ii)(C), (D), and (E), and § 1.42-10(c) and (d) are applicable to a building owner’s taxable years beginning on or after July 29, 2008. Taxpayers may rely on these provisions before the beginning of the building owner’s taxable year beginning on or after July 29, 2008 provided that any utility allowances calculated under these provisions are effective no earlier than the first day of the building owner’s taxable year beginning on or after July 29, 2008. The utility allowances provisions that apply to taxable years beginning before July 29, 2008 are contained in § 1.42-10 (see 26 CFR part 1 revised as of April 1, 2008).
(5) Additional effective dates affecting utility allowances. (i) The following provisions apply to a building owner’s taxable years beginning on or after March 3, 2016—
(A) The second sentence in § 1.42-10(a);
(B) Section 1.42-10(b)(3);
(C) The first sentence in § 1.42-10(b)(4)(ii)(A);
(D) Section 1.42-10(b)(4)(ii)(E); and
(E) Section 1.42-10(e), except as provided in paragraph (a)(5)(iii) of this section.
(ii) Except as provided in paragraph (a)(5)(iii) of this section, a building owner may apply the provisions described in paragraphs (a)(5)(i)(A) through (E) of this section to the building owner’s taxable years beginning before March 3, 2016. Otherwise, the utility allowance provisions that apply to those taxable years are contained in § 1.42-10, as contained in 26 CFR part 1, revised as of April 1, 2015.
(iii) The provisions in § 1.42-10(e)(1)(i) introductory text, (e)(1)(i)(B) through (D), and (e)(1)(iv)(B) apply to a building owner’s taxable years beginning on or after March 4, 2019. A building owner, however, may apply these provisions to earlier taxable years. Otherwise, the submetering provisions that apply to taxable years beginning after March 3, 2016, and before March 4, 2019, are contained in § 1.42-10 and § 1.42-10T as contained in 26 CFR part 1 revised as of April 1, 2016. In addition, a building owner may apply those submetering provisions to taxable years beginning before March 3, 2016.
(b) Prior periods. Notice 89-1, 1989-1 C.B. 620 and Notice 89-6, 1989-1 C.B. 625 (see § 601.601(d)(2)(ii)(b) of this chapter) may be applied for periods prior to May 2, 1994.
(c) Carryover allocations. The rule set forth in § 1.42-6(d)(4)(ii) relating to the requirement that state and local housing agencies file Schedule A (Form 8610), “Carryover Allocation of the Low-Income Housing Credit,” is applicable for carryover allocations made after December 31, 1999.
§ 1.42-13 Rules necessary and appropriate; housing credit agencies’ correction of administrative errors and omissions.
(a) Publication of guidance. Under section 42(n), the Secretary has authority to prescribe regulations as may be necessary or appropriate to carry out the purposes of section 42. The Secretary may also provide guidance through various publications in the Internal Revenue Bulletin. (See § 601.601(d)(2)(ii)(b) of this chapter.)
(b) Correcting administrative errors and omissions—(1) In general. An Agency may correct an administrative error or omission with respect to allocations and recordkeeping, as described in paragraph (b)(2) of this section, within a reasonable period after the Agency discovers the administrative error or omission. Whether a correction is made within a reasonable period depends on the facts and circumstances of each situation. Except as provided in paragraph (b)(3)(iii) of this section, an Agency need not obtain the prior approval of the Secretary to correct an administrative error or omission, if the correction is made in accordance with paragraph (b)(3)(i) of this section. The administrative errors and omissions to which this paragraph (b) applies are strictly limited to those described in paragraph (b)(2) of this section, and, thus, do not include, for example, any misinterpretation of the applicable rules and regulations under section 42. Accordingly, an Agency’s allocation of a particular calendar year’s low-income housing credit dollar amount made after the close of that calendar year, or the use of an incorrect population amount in calculating a State’s housing credit ceiling for a calendar year are not administrative errors that can be corrected under this paragraph (b).
(2) Administrative errors and omissions described. An administrative error or omission is a mistake that results in a document that inaccurately reflects the intent of the Agency at the time the document is originally completed or, if the mistake affects a taxpayer, a document that inaccurately reflects the intent of the Agency and the affected taxpayer at the time the document is originally completed. Administrative errors and omissions described in this paragraph (b)(2) include the following—
(i) A mathematical error;
(ii) An entry on a document that is inconsistent with another entry on the same or another document regarding the same property, or taxpayer;
(iii) A failure in tracking the housing credit dollar amount an Agency has allocated (or that remains to be allocated) in the current calendar year (e.g., a failure to include in its State housing credit ceiling a previously allocated credit dollar amount that has been returned by a taxpayer);
(iv) An omission of information that is required on a document; and
(v) Any other type of error or omission identified by guidance published in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter) as an administrative error or omission covered by this paragraph (b).
(3) Procedures for correcting administrative errors or omissions—(i) In general. An Agency’s correction of an administrative error or omission, as described in paragraph (b)(2) of this section, must amend the document so that the corrected document reflects the original intent of the Agency, or the Agency and the affected taxpayer, and complies with applicable rules and regulations under section 42.
(ii) Specific procedures. If a document corrects a document containing an administrative error or omission that has not yet been filed with the Internal Revenue Service, the Agency, or the Agency and the affected taxpayer, should complete and file the corrected document as the original. When a document containing an administrative error or omission has already been filed with the Service, the Agency, or the Agency and the affected taxpayer, should refile a copy of the document containing the administrative error or omission, and prominently and clearly note the correction thereon or on an attached new document. The Agency should indicate at the top of the document(s) that the correction is being made under § 1.42-13 of the Income Tax Regulations.
(iii) Secretary’s prior approval required. Except as provided in paragraph (b)(3)(vi) of this section, an Agency must obtain the Secretary’s prior approval to correct an administrative error or omission, as described in paragraph (b)(2) of this section, if the correction is not made before the close of the calendar year of the error or omission and the correction—
(A) Is a numerical change to the housing credit dollar amount allocated for the building or project;
(B) Affects the determination of any component of the State’s housing credit ceiling under section 42(h)(3)(C); or
(C) Affects the State’s unused housing credit carryover that is assigned to the Secretary under section 42(h)(3)(D).
(iv) Requesting the Secretary’s approval. To obtain the Secretary’s approval under paragraph (b)(3)(iii) of this section, an Agency must submit a request for the Secretary’s approval within a reasonable period after discovering the administrative error or omission, and must agree to any conditions that may be required by the Secretary under paragraph (b)(3)(v) of this section. When requesting the Secretary’s approval, the Agency, or the Agency and the affected taxpayer, must file an application that complies with the requirements of this paragraph (b)(3)(iv). For further information on the application procedure see Rev. Proc. 93-1, 1993-1 I.R.B. 10 (or any subsequent applicable revenue procedure). (See § 601.601(d)(2)(ii)(b) of this chapter.) The application requesting the Secretary’s approval must contain the following information—
(A) The name, address, and identification number of each affected taxpayer;
(B) The Building Identification Number (B.I.N.) and address of each building or project affected by the administrative error or omission;
(C) A statement explaining the administrative error or omission and the intent of the Agency, or of the Agency and the affected taxpayer, when the document was originally completed;
(D) Copies of any supporting documentation;
(E) A statement explaining the effect, if any, that a correction of the administrative error or omission would have on the housing credit dollar amount allocated for any building or project; and
(F) A statement explaining the effect, if any, that a correction of the administrative error or omission would have on the determination of the components of the State’s housing credit ceiling under section 42(h)(3)(C) or on the State’s unused housing credit carryover that is assigned to the Secretary under section 42(h)(3)(D).
(v) Agreement to conditions. To obtain the Secretary’s approval under paragraph (b)(3)(iii) of this section, an Agency, or the Agency and the affected taxpayer, must agree to the conditions the Secretary considers appropriate.
(vi) Secretary’s automatic approval. The Secretary grants automatic approval to correct an administrative error or omission described in paragraph (b)(2) of this section if—
(A) The correction is not made before the close of the calendar year of the error or omission and the correction is a numerical change to the housing credit dollar amount allocated for the building or multiple-building project;
(B) The administrative error or omission resulted in an allocation document (the Form 8609, “Low-Income Housing Credit Allocation Certification,” or the allocation document under the requirements of section 42(h)(1)(E) or (F), and § 1.42-6(d)(2)) that either did not accurately reflect the number of buildings in a project (for example, an allocation document for a 10-building project only references 8 buildings instead of 10 buildings), or the correct information (other than the amount of credit allocated on the allocation document);
(C) The administrative error or omission does not affect the Agency’s ranking of the building(s) or project and the total amount of credit the Agency allocated to the building(s) or project; and
(D) The Agency corrects the administrative error or omission by following the procedures described in paragraph (b)(3)(vii) of this section.
(vii) How Agency corrects errors or omissions subject to automatic approval. An Agency corrects an administrative error or omission described in paragraph (b)(3)(vi) of this section by—
(A) Amending the allocation document described in paragraph (b)(3)(vi)(B) of this section to correct the administrative error or omission. The Agency will indicate on the amended allocation document that it is making the “correction under § 1.42-13(b)(3)(vii).” If correcting the allocation document requires including any additional B.I.N.(s) in the document, the document must include any B.I.N.(s) already existing for buildings in the project. If possible, the additional B.I.N.(s) should be sequentially numbered from the existing B.I.N.(s);
(B) Amending, if applicable, the Schedule A (Form 8610), “Carryover Allocation of the Low-Income Housing Credit,” and attaching a copy of this schedule to Form 8610, “Annual Low-Income Housing Credit Agencies Report,” for the year the correction is made. The Agency will indicate on the schedule that it is making the “correction under § 1.42-13(b)(3)(vii).” For a carryover allocation made before January 1, 2000, the Agency must complete Schedule A (Form 8610), and indicate on the schedule that it is making the “correction under § 1.42-13(b)(3)(vii)”;
(C) Amending, if applicable, the Form 8609 and attaching the original of this amended form to Form 8610 for the year the correction is made. The Agency will indicate on the Form 8609 that it is making the “correction under § 1.42-13(b)(3)(vii)”; and
(D) Mailing or otherwise delivering a copy of any amended allocation document and any amended Form 8609 to the affected taxpayer.
(viii) Other approval procedures. The Secretary may grant automatic approval to correct other administrative errors or omissions as designated in one or more documents published either in the
(c) Examples. The following examples illustrate the scope of this section:
(d) Effective date. This section is effective February 24, 1994. However, an Agency may elect to apply these regulations to administrative errors or omissions that occurred before the publication of these regulations. Any reasonable method used by a State or local housing credit agency to correct an administrative error or omission prior to February 24, 1994, will be considered proper, provided that the method is consistent with the rules of section 42. Paragraphs (b)(3)(vi), (vii), and (viii) of this section are effective January 14, 2000.
§ 1.42-14 Allocation rules for post-2000 State housing credit ceiling amount.
(a) State housing credit ceiling—(1) In general. The State housing credit ceiling for a State for any calendar year after 2000 is comprised of four components. The four components are—
(i) The unused State housing credit ceiling, if any, of the State for the preceding calendar year (the unused carryforward component);
(ii) The greater of—
(A) $1.75 ($1.50 for calendar year 2001) multiplied by the State population; or
(B) $2,000,000 (the population component);
(iii) The amount of State housing credit ceiling returned in the calendar year (the returned credit component); plus
(iv) The amount, if any, allocated to the State by the Secretary under section 42(h)(3)(D) from a national pool of unused credit (the national pool component).
(2) Cost-of-living adjustment—(i) General rule. For any calendar year after 2002, the $2,000,000 and $1.75 amounts in paragraph (a)(1)(ii) of this section are each increased by an amount equal to—
(A) The dollar amount; multiplied by
(B) The cost-of-living adjustment determined under section 1(f)(3) for the calendar year by substituting “calendar year 2001” for “calendar year 1992” in section 1(f)(3)(B).
(ii) Rounding. Any increase resulting from the application of paragraph (a)(2)(i) of this section which, in the case of the $2,000,000 amount, is not a multiple of $5,000, is rounded to the next lowest multiple of $5,000, and which, in the case of the $1.75 amount, is not a multiple of 5 cents, is rounded to the next lowest multiple of 5 cents.
(b) The unused carryforward component. The unused carryforward component of the State housing credit ceiling for any calendar year is the unused State housing credit ceiling, if any, of the State for the preceding calendar year. The unused State housing credit ceiling for any calendar year is the excess, if any, of—
(1) The sum of the population, returned credit, and national pool components for the calendar year; over
(2) The aggregate housing credit dollar amount allocated for the calendar year reduced by the housing credit dollar amounts allocated from the unused carryforward component for the calendar year.
(c) The population component. The population component of the State housing credit ceiling of a State for any calendar year is determined pursuant to section 146(j). Thus, a State’s population for any calendar year is determined by reference to the most recent census estimate, whether final or provisional, of the resident population of the State released by the Bureau of the Census before the beginning of the calendar year for which the State’s housing credit ceiling is set. Unless otherwise prescribed by applicable revenue procedure, determinations of population are based on the most recent estimates of population contained in the Bureau of the Census publication, Current Population Report, Series P-25; Population Estimates and Projections, Estimates of the Population of States. For convenience, the Internal Revenue Service publishes the population estimates annually in the Internal Revenue Bulletin. (See § 601.601(d)(2)(ii)(b)).
(d) The returned credit component—(1) In general. The returned credit component of the State housing credit ceiling of a State for any calendar year equals the housing credit dollar amount returned during the calendar year that was validly allocated within the State in a prior calendar year to any project that does not become a qualified low-income housing project within the period required by section 42, or as required by the terms of the allocation. The returned credit component also includes credit allocated in a prior calendar year that is returned as a result of the cancellation of an allocation by mutual consent or by an Agency’s determination that the amount allocated is not necessary for the financial feasibility of the project. For purposes of this section, credit is allocated within a State if it is allocated from the State’s housing credit ceiling by an Agency of the State or of a constitutional home rule city in the State.
(2) Limitations and special rules. The following limitations and special rules apply for purposes of this paragraph (d).
(i) General limitations. Notwithstanding any other provision of this paragraph (d), returned credit does not include any credit that was—
(A) Allocated prior to calendar year 1990;
(B) Allowable under section 42(h)(4) (relating to the portion of credit attributable to eligible basis financed by certain tax-exempt bonds under section 103); or
(C) Allocated during the same calendar year that it is received back by the Agency.
(ii) Credit period limitation. Notwithstanding any other provision of this paragraph (d), an allocation of credit may not be returned any later than 180 days following the close of the first taxable year of the credit period for the building that received the allocation. After this date, credit that might otherwise be returned expires, and cannot be returned to or reallocated by any Agency.
(iii) Three-month rule for returned credit. An Agency may, in its discretion, treat any portion of credit that is returned from a project after September 30 of a calendar year and that is not reallocated by the close of the calendar year as returned on January 1 of the succeeding calendar year. In this case, the returned credit becomes part of the returned credit component of the State housing credit ceiling for the succeeding calendar year. Any portion of credit that is returned from a project after September 30 of a calendar year that is reallocated by the close of the calendar year is treated as part of the returned credit component of the State housing credit ceiling for the calendar year that the credit was returned.
(iv) Returns of credit. Subject to the limitations of paragraphs (d)(2) (i) and (ii) of this section, credit is returned to the Agency in the following instances in the manner described in paragraph (d)(3) of this section.
(A) Building not qualified within required time period. If a building is not a qualified building within the time period required by section 42, it loses its credit allocation and the credit is returned. For example, a building is not qualified within the required time period if it is not placed in service within the period required by section 42 or if the project of which the building is a part fails to meet the minimum set-aside requirements of section 42(g)(1) by the close of the first year of the credit period. Also, a building that has received a post-June 30 carryover allocation is not qualified within the required time period if the taxpayer does not meet the 10 percent basis requirement by the date that is 6 months after the date the allocation was made (as described in § 1.42-6(a)(2)(ii)).
(B) Noncompliance with terms of the allocation. If a building does not comply with the terms of its allocation, it loses the credit allocation and the credit is returned. The terms of an allocation are the written conditions agreed to by the Agency and the allocation recipient in the allocation document.
(C) Mutual consent. If the Agency and the allocation recipient cancel an allocation of an amount of credit by mutual consent, that amount of credit is returned.
(D) Amount not necessary for financial feasibility. If an Agency determines under section 42(m)(2) that an amount of credit allocated to a project is not necessary for the financial feasibility of the project and its viability as a qualified low-income housing project throughout the credit period, that amount of credit is returned.
(3) Manner of returning credit—( i) Taxpayer notification. After an Agency determines that a building or project no longer qualifies under paragraph (d)(2)(iv)(A), (B), or (D) of this section for all or part of the allocation it received, the Agency must provide written notification to the allocation recipient, or its successor in interest, that all or part of the allocation is no longer valid. The notification must also state the amount of the allocation that is no longer valid. The date of the notification is the date the credit is returned to the Agency. If an allocation is cancelled by mutual consent under paragraph (d)(2)(iv)(C) of this section, there must be a written agreement signed by the Agency, and the allocation recipient, or its successor in interest, indicating the amount of the allocation that is returned to the Agency. The effective date of the agreement is the date the credit is returned to the Agency.
(ii) Internal Revenue Service notification. If a credit is returned within 180 days following the close of the first taxable year of a building’s credit period as provided in paragraph (d)(2)(ii) of this section, and a Form 8609, Low-Income Housing Credit Allocation Certification, has been issued for the building, the Agency must notify the Internal Revenue Service that the credit has been returned. If only part of the credit has been returned, this notification requirement is satisfied when the Agency attaches to an amended Form 8610, Annual Low- Income Housing Credit Agencies Report, the original of an amended Form 8609 reflecting the correct amount of credit attributed to the building together with an explanation for the filing of the amended Forms. The Agency must send a copy of the amended Form 8609 to the taxpayer that owns the building. If the building is not issued an amended Form 8609 because all of the credit allocated to the building is returned, notification to the Internal Revenue Service is satisfied by following the requirements prescribed in § 1.42-5(e)(3) for filing a Form 8823, Low-Income Housing Credit Agencies Report of Noncompliance.
(e) The national pool component. The national pool component of the State housing credit ceiling of a State for any calendar year is the portion of the National Pool allocated to the State by the Secretary for the calendar year. The national pool component for any calendar year is zero unless a State is a qualified State. (See paragraph (i) of this section for rules regarding the National Pool and the description of a qualified State.) A national pool component credit that is allocated during a calendar year and returned after the close of the calendar year may qualify as part of the returned credit component of the State housing credit ceiling for the calendar year that the credit is returned.
(f) When the State housing credit ceiling is determined. For purposes of accounting for the State housing credit ceiling on Form 8610 and for purposes of determining the set-aside apportionment for projects involving qualified nonprofit organizations described in section 42(h)(5) and § 1.42-1T(c)(5), the State housing credit ceiling for any calendar year is determined at the close of the calendar year.
(g) Stacking order. Credit is treated as allocated from the various components of the State housing credit ceiling in the following order. The first credit allocated for any calendar year is treated as credit from the unused carryforward component of the State housing credit ceiling for the calendar year. After all of the credit in the unused carryforward component has been allocated, any credit allocated is treated as allocated from the sum of the population, returned credit, and national pool components of the State housing credit ceiling.
(h) Nonprofit set-aside—(1) Determination of set-aside. Under section 42(h)(5) and § 1.42-1T(c)(5), at least 10 percent of a State housing credit ceiling in any calendar year must be set aside exclusively for projects involving qualified nonprofit organizations (the nonprofit set-aside). However, credit allocated from the nonprofit set-aside in a calendar year and returned in a subsequent calendar year does not retain its nonprofit set-aside character. The credit becomes part of the returned credit component of the State housing credit ceiling for the calendar year that the credit is returned and must be included in determining the nonprofit set-aside of the State housing credit ceiling for that calendar year. Similarly, credit amounts that are not allocated from the nonprofit set-aside in a calendar year and are returned in a subsequent calendar year become part of the returned credit component of the State housing credit ceiling for that year and are also included in determining the set-aside for that year.
(2) Allocation rules. An Agency may allocate credit from any component of the State housing credit ceiling as part of the nonprofit set-aside and need not reserve 10 percent of each component for the nonprofit set-aside. Thus, an Agency may satisfy the nonprofit set-aside requirement of section 42(h)(5) and § 1.42-1T(c)(5) in any calendar year by setting aside for allocation an amount equal to at least 10 percent of the total State housing credit ceiling for the calendar year.
(i) National Pool—(1) In general. The unused housing credit carryover of a State for any calendar year is assigned to the Secretary for inclusion in a national pool of unused housing credit carryovers (National Pool) that is reallocated among qualified States the succeeding calendar year. The assignment to the Secretary is made on Form 8610.
(2) Unused housing credit carryover. The unused housing credit carryover of a State for any calendar year is the excess, if any, of—
(i) The unused carryforward component of the State housing credit ceiling for the calendar year; over
(ii) The total housing credit dollar amount allocated for the calendar year.
(3) Qualified State—(i) In general. The term qualified State means, with respect to any calendar year, any State that has allocated its entire State housing credit ceiling for the preceding calendar year and for which a request is made by the State, not later than May 1 of the calendar year, to receive an allocation of credit from the National Pool for that calendar year. Except as provided in paragraph (i)(3)(ii) of this section, a State is not a qualified State in a calendar year if there remains any unallocated credit in its State housing credit ceiling at the close of the preceding calendar year that was apportioned to any Agency within the State for the calendar year.
(ii) Exceptions—(A) De minimis amount. If the amount remaining unallocated at the close of a calendar year is only a de minimis amount of credit, the State is a qualified State eligible to participate in the National Pool. For that purpose, a credit amount is de minimis if it does not exceed 1 percent of the aggregate State housing credit ceiling of the State for the calendar year.
(B) Other circumstances. Pursuant to the authority under section 42(n), the Internal Revenue Service may determine that a State is a qualified State eligible to participate in the National Pool even though the State’s unallocated credit is in excess of the 1 percent safe harbor set forth in paragraph (A) of this section. The Internal Revenue Service will make this determination based on all the facts and circumstances, weighing heavily the interests of the States who would otherwise qualify for the National Pool. The Internal Revenue Service will generally grant relief under this paragraph only where a State’s unallocated credit is not substantial.
(iii) Time and manner for making request. For further guidance as to the time and manner for making a request of housing credit dollar amounts from the National Pool by a qualified State, see Rev. Proc. 92-31, 1992-1 C.B. 775. (See 601.601(d)(2)(ii)(b)).
(4) Formula for determining the National Pool. The amount allocated to a qualified State in any calendar year is an amount that bears the same ratio to the aggregate unused housing credit carryovers of all States for the preceding calendar year as that State’s population for the calendar year bears to the population of all qualified States for the calendar year.
(j) Coordination between Agencies. The Agency responsible for filing Form 8610 on behalf of all Agencies within a State and making any request on behalf of the State for credit from the National Pool (the Filing Agency) must coordinate with each Agency within the State to ensure that the various requirements of this section are complied with. For example, the Filing Agency of a State must ensure that all Agencies within the State that were apportioned a credit amount for the calendar year have allocated all of their respective credit amounts for the calendar year before the Filing Agency can make a request on behalf of the State for a distribution of credit from the National Pool.
(k) Example. (1) The operation of the rules of this section is illustrated by the following examples. Unless otherwise stated in an example, Agency A is the sole Agency authorized to make allocations of housing credit dollar amounts in State M, all of Agency A’s allocations are valid, and for calendar year 2003, Agency A has available for allocation a State housing credit ceiling consisting of the following housing credit dollar amounts:
A. Unused carryforward component | $50 |
B. Population component | 110 |
C. Returned credit component | 10 |
D. National pool component | 0 |
Total | 170 |
(2) In addition, the $10 of returned credit component was returned before October 1, 2003.
(ii) Application of stacking rules. The $80 of allocated credit is first treated as allocated from the unused carryforward component of the State housing credit ceiling. The $80 of allocated credit exceeds the $50 attributable to the unused carryforward component by $30. Because the unused carryforward component is fully utilized no credit will be forfeited by State M to the 2004 National Pool. The remaining $30 of allocated credit will next be treated as allocated from the $120 in credit determined by aggregating the population, returned credit, and national pool components ($110 + 10 + 0 = $120). The $90 of unallocated credit remaining in State M’s 2003 State housing credit ceiling ($120 − 30 = $90) represents the unused carryforward component of State M’s 2004 State housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.
(iii) Nonprofit set-aside. Agency A allocated exactly the amount of credit to projects involving qualified nonprofit organizations as necessary to meet the nonprofit set-aside requirement ($17, 10% of the $170 ceiling).
(ii) Application of stacking rules. The $40 of allocated credit is first treated as allocated from the unused carryforward component of the State housing credit ceiling. Because the $40 of allocated credit does not exceed the $50 attributable to the unused carryforward component, the remaining components of the State housing credit ceiling are unaffected. The $10 remaining in the unused carryforward component is assigned to the Secretary for inclusion in the 2004 National Pool. The $120 in credit determined by aggregating the population, returned credit, and national pool components becomes the unused carryforward component of State M’s 2004 State housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.
(iii) Nonprofit set-aside. Agency A allocated $3 more credit to projects involving qualified nonprofit organizations than necessary to meet the nonprofit set-aside requirement. This does not reduce the application of the 10% nonprofit set-aside requirement to the State M housing credit ceiling for calendar year 2004.
(ii) Nonprofit set-aside. Because at least 10% of the State housing credit ceiling must be set aside for projects involving a qualified nonprofit organization, Agency A can allocate only $153 of the $170 State housing credit ceiling for calendar year 2003 ($170 −17 = $153). If Agency A allocates $153 of credit, the credit is treated as allocated $50 from the unused carryforward component and $103 from the sum of the population, returned credit, and national pool components. The $17 of unallocated credit that is set aside for projects involving qualified nonprofit organizations becomes the unused carryforward component of State M’s 2004 State housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.
(ii) Effect of three-month rule. Under the three-month rule of paragraph (d)(2)(iii) of this section, Agency A may treat all or part of the $40 of previously allocated credit as returned on January 1, 2004. If Agency A treats all of the $40 amount as having been returned in calendar year 2004, the State M housing credit ceiling for 2003 is $170. This entire amount, including the $17 nonprofit set-aside, has been allocated in 2003. Under paragraph (i)(3) of this section, State M qualifies for the 2004 National Pool.
(iii) If three-month rule not used. If Agency A treats all of the $40 of previously allocated credit as returned in calendar year 2003, the State housing credit ceiling for the 2003 calendar year will be $210 of which $50 will be attributable to the returned credit component ($10 + $40 = $50). Because credit amounts allocated to a qualified nonprofit organization in a prior calendar year that are returned in a subsequent calendar year do not retain their nonprofit character, the nonprofit set-aside for calendar year 2003 is $21 (10% of the $210 State housing credit ceiling). The $170 that Agency A allocated during 2003 is first treated as allocated from the unused carryforward component of the State housing credit ceiling. The $170 of allocated credit exceeds the $50 attributable to the unused carryforward component by $120. Because the unused carryforward component is fully utilized no credit will be forfeited by State M to the 2004 National Pool. The remaining $120 of allocated credit will next be treated as allocated from the $160 in credit determined by aggregating the population, returned credit, and national pool components ($110 + 50 + 0 = $160). The $40 of unallocated credit (which includes $4 of unallocated credit from the $21 nonprofit set-aside) remaining in State M’s 2003 housing credit ceiling ($160−120 = $40) represents the unused carryforward component of State M’s 2004 housing credit ceiling. Under paragraph (i)(3) of this section, State M does not qualify for credit from the 2004 National Pool.
(l) Effective dates—(1) In general. Except as provided in paragraph (l)(2) of this section, the rules set forth in § 1.42-14 are applicable on January 1, 1994.
(2) Community Renewal Tax Relief Act of 2000 changes. Paragraphs (a), (b), (c), (e), (i)(2) and (k) of this section are applicable for housing credit dollar amounts allocated after January 6, 2004. However, paragraphs (a), (b), (c), (e), (i)(2) and (k) of this section may be applied by Agencies and taxpayers for housing credit dollar amounts allocated after December 31, 2000, and on or before January 6, 2004. Otherwise, subject to the applicable effective dates of the corresponding statutory provisions, the rules that apply for housing credit dollar amounts allocated on or before January 6, 2004, are contained in this section in effect on and before January 6, 2004 (see 26 CFR part 1 revised as of April 1, 2003).
§ 1.42-15 Available unit rule.
(a) Definitions. The following definitions apply to this section:
Applicable income limitation means the limitation applicable under section 42(g)(1) or, for deep rent skewed projects described in section 142(d)(4)(B), 40 percent of area median gross income.
Available unit rule means the rule in section 42(g)(2)(D)(ii).
Comparable unit means a residential unit in a low-income building that is comparably sized or smaller than an over-income unit or, for deep rent skewed projects described in section 142(d)(4)(B), any low-income unit. For purposes of determining whether a residential unit is comparably sized, a comparable unit must be measured by the same method used to determine qualified basis for the credit year in which the comparable unit became available.
Current resident means a person who is living in the low-income building.
Low-income unit is defined by section 42(i)(3)(A).
Nonqualified resident means a new occupant or occupants whose aggregate income exceeds the applicable income limitation.
Over-income unit means, in the case of a project with respect to which the taxpayer elects the requirements of section 42(g)(1)(A) or (B) (that is, the 20-50 or 40-60 tests), a low-income unit in which the aggregate income of the occupants of the unit increases above 140 percent of the applicable income limitation under section 42(g)(1)(A) and (B), or above 170 percent of the applicable income limitation for deep rent skewed projects described in section 142(d)(4)(B). In the case of a project with respect to which the taxpayer elects the requirements of section 42(g)(1)(C) (that is, the average income test), over-income unit means a residential unit described in § 1.42-19(b)(1)(i) through (iii) in which the aggregate income of the occupants of the unit increases above 140 percent (170 percent in case of deep rent skewed projects described in section 142(d)(4)(B)) of the greater of 60 percent of area median gross income or the imputed income limitation designated with respect to the unit under § 1.42-19(b).
Qualified resident means an occupant either whose aggregate income (combined with the income of all other occupants of the unit) does not exceed the applicable income limitation and who is otherwise a low-income resident under section 42, or who is a current resident.
(b) General section 42(g)(2)(D)(i) rule. Except as provided in paragraph (c) of this section, notwithstanding an increase in the income of the occupants of a low-income unit above the applicable income limitation, if the income of the occupants initially met the applicable income limitation, and the unit continues to be rent-restricted—
(1) The unit continues to be treated as a low-income unit; and
(2) The unit continues to be included in the numerator and the denominator of the ratio used to determine whether a project satisfies the applicable minimum set-aside requirement of section 42(g)(1).
(c) Exceptions—(1) In general. A unit ceases to be treated as a low-income unit if it becomes an over-income unit and a nonqualified resident occupies any comparable unit that is available or that subsequently becomes available in the same low-income building. In other words, the owner of a low-income building must rent to qualified residents all comparable units that are available or that subsequently become available in the same building to continue treating the over-income unit as a low-income unit. Once the percentage of low-income units in a building (excluding the over-income units) equals the percentage of low-income units on which the credit is based, failure to maintain the over-income units as low-income units has no immediate significance. The failure to maintain the over-income units as low-income units, however, may affect the decision of whether or not to rent a particular available unit at market rate at a later time. A unit is not available for purposes of the available unit rule when the unit is no longer available for rent due to contractual arrangements that are binding under local law (for example, a unit is not available if it is subject to a preliminary reservation that is binding on the owner under local law prior to the date a lease is signed or the unit is occupied).
(2) Rental of next available unit in case of the average income test—(i) Basic rule. In the case of a project with respect to which the taxpayer elects the average income test, if a unit becomes an over-income unit within the meaning of paragraph (a) of this section, that unit ceases to be described in § 1.42-19(b)(1)(ii) if—
(A) Any residential rental unit (of a size comparable to, or smaller than, the over-income unit) is available, or subsequently becomes available, in the same low-income building; and
(B) That available unit is occupied by a new resident whose income exceeds the limitation described in paragraph (c)(2)(iv) of this section.
(ii) No requirement to comply with the next available unit rule in a specific order. Where multiple units in a building are over-income units at the same time—
(A) The order in which available units are occupied makes no difference for purposes of complying with the rules in this section (next available unit rule); and
(B) In making imputed income limitation designations, the taxpayer must take into account the limitations described in paragraphs (c)(2)(iii) and (iv) of this section.
(iii) Deep rent skewed projects. In the case of a project described in section 142(d)(4)(B) with respect to which the taxpayer elects the average income test, if a unit becomes an over-income unit within the meaning of paragraph (a) of this section, that unit ceases to be a unit described in § 1.42-19(b)(1)(ii) if—
(A) Any residential unit described in § 1.42-19(b)(1)(i) through (iii) is available, or subsequently becomes available, in the same low-income building; and
(B) That unit is occupied by a new resident whose income exceeds the lesser of 40 percent of area median gross income or the imputed income limitation designated with respect to that unit.
(iv) Limitation. The limitation described in this paragraph (c)(2)(iv) is—
(A) In the case of a unit that was described in § 1.42-19(b)(1)(i) through (iii) prior to becoming vacant, the imputed income limitation designated with respect to the available unit for the average income test under § 1.42-19(b); and
(B) In the case of any other unit, the highest imputed income limitation that could be designated (consistent with section 42(g)(1)(C)(ii)(III)) for that available unit under § 1.42-19(c) such that the average of all imputed income designations of residential units in the project does not exceed 60 percent of area median gross income (AMGI).
(v) Example. The operation of paragraph (c)(2) of this section (that is, the next available unit rule for the average income test) is illustrated by the following example.
(A) Facts. (1) A single-building housing project received an allocation of housing credit dollar amount for 10 low-income units. The taxpayer who owns the project constructs the building with 10 identically sized units and elects the average income test. In the first year, the taxpayer intended to have 8 units that will qualify as low-income units (within the meaning of § 1.42-19(b)(1)), and 2 units that are market-rate units. The taxpayer properly and timely designates the imputed income limitations for the 8 units as follows: 4 units at 80 percent of AMGI; and 4 units at 40 percent of AMGI.
Table 1 to Paragraph
Unit No. | Imputed income
limitation of the unit |
---|---|
1 | 80 percent of AMGI. |
2 | 80 percent of AMGI. |
3 | 80 percent of AMGI. |
4 | 80 percent of AMGI. |
5 | Market Rate. |
6 | 40 percent of AMGI. |
7 | 40 percent of AMGI. |
8 | 40 percent of AMGI. |
9 | 40 percent of AMGI. |
10 | Market Rate. |
(2) In the first taxable year of the credit period (Year 1), the project is fully leased and occupied by income-qualified residents in Units ##1-4 and 6-9. In Year 2, Unit #1 and Unit #6 become over-income. The tenant residing in Unit #5 vacated that unit. Taxpayer then designated an imputed income limitation of 40 percent of AMGI for Unit #5. Later in Year 2, the tenant residing in Unit #10 vacated that unit. Taxpayer designated an imputed income limitation of 80 percent of AMGI for Unit #10. After those designations, Unit #10 was occupied by a new income-qualified tenant, and then later, Unit #5 was occupied by a new income-qualified resident.
(B) Analysis. Taxpayer sought to maintain the status of the over-income units (Unit #1 and Unit #6) as units described in § 1.42-19(b)(1)(ii). As the then-market rate units (Units ##5 and 10) became available to rent, Taxpayer designated imputed income limitations for them at 40 percent and 80 percent of AMGI, respectively. Immediately after each designation, the average of the designations in the project does not exceed 60 percent AMGI. Pursuant to the rule in paragraph (c)(2)(ii) of this section, when there are multiple over-income units, Taxpayer is not required to rent the next-available units in a specific order, even though they may have different imputed income limitations. Thus, Taxpayer complied with the rules of the next available unit rule, and Unit #1 and Unit #6 maintain status as units described in § 1.42-19(b)(1)(ii).
(d) Effect of current resident moving within building. When a current resident moves to a different unit within the building, the newly occupied unit adopts the status of the vacated unit. Thus, if a current resident, whose income exceeds the applicable income limitation, moves from an over-income unit to a vacant unit in the same building, the newly occupied unit is treated as an over-income unit. The vacated unit assumes the status the newly occupied unit had immediately before it was occupied by the current resident.
(e) Available unit rule applies separately to each building in a project. In a project containing more than one low-income building, the available unit rule applies separately to each building.
(f) Result of noncompliance with available unit rule. If any comparable unit that is available or that subsequently becomes available is rented to a nonqualified resident, all over-income units for which the available unit was a comparable unit within the same building lose their status as low-income units; thus, comparably sized or larger over-income units would lose their status as low-income units.
(g) Relationship to tax-exempt bond provisions. Financing arrangements that purport to be exempt-facility bonds under section 142 must meet the requirements of sections 103 and 141 through 150 for interest on the obligations to be excluded from gross income under section 103(a). This section is not intended as an interpretation under section 142.
(h) Examples. The following examples illustrate this section:
(i) Applicability dates—(1) In general. Except for paragraph (c)(2) of this section, this section applies to leases entered into or renewed on and after September 26, 1997.
(2) Applicability dates under the average income test. The requirements of the second sentence of the definition of over-income unit in paragraph (a) of this section and paragraph (c)(2) of this section apply to taxable years beginning after December 31, 2022. A taxpayer may choose to apply this section to a taxable year beginning after October 12, 2022, and before January 1, 2023, provided that the taxpayer chooses to apply § 1.42-19 to the same taxable year.
§ 1.42-16 Eligible basis reduced by federal grants.
(a) In general. If, during any taxable year of the compliance period (described in section 42(i)(1)), a grant is made with respect to any building or the operation thereof and any portion of the grant is funded with federal funds (whether or not includible in gross income), the eligible basis of the building for the taxable year and all succeeding taxable years is reduced by the portion of the grant that is so funded.
(b) Grants do not include certain rental assistance payments. A federal rental assistance payment made to a building owner on behalf or in respect of a tenant is not a grant made with respect to a building or its operation if the payment is made pursuant to—
(1) Section 8 of the United States Housing Act of 1937 (42 U.S.C. 1437f)
(2) A qualifying program of rental assistance administered under section 9 of the United States Housing Act of 1937 (42 U.S.C. 1437g); or
(3) A program or method of rental assistance as the Secretary may designate by publication in the
(c) Qualifying rental assistance program. For purposes of paragraph (b)(2) of this section, payments are made pursuant to a qualifying rental assistance program administered under section 9 of the United States Housing Act of 1937 to the extent that the payments—
(1) Are made to a building owner pursuant to a contract with a public housing authority with respect to units the owner has agreed to maintain as public housing units (PH-units) in the building;
(2) Are made with respect to units occupied by public housing tenants, provided that, for this purpose, units may be considered occupied during periods of short term vacancy (not to exceed 60 days); and
(3) Do not exceed the difference between the rents received from a building’s PH-unit tenants and a pro rata portion of the building’s actual operating costs that are reasonably allocable to the PH-units (based on square footage, number of bedrooms, or similar objective criteria), and provided that, for this purpose, operating costs do not include any development costs of a building (including developer’s fees) or the principal or interest of any debt incurred with respect to any part of the building.
(d) Effective date. This section is effective September 26, 1997.
§ 1.42-17 Qualified allocation plan.
(a) Requirements—(1) In general. [Reserved]
(2) Selection criteria. [Reserved]
(3) Agency evaluation. Section 42(m)(2)(A) requires that the housing credit dollar amount allocated to a project is not to exceed the amount the Agency determines is necessary for the financial feasibility of the project and its viability as a qualified low-income housing project throughout the credit period. In making this determination, the Agency must consider—
(i) The sources and uses of funds and the total financing planned for the project. The taxpayer must certify to the Agency the full extent of all federal, state, and local subsidies that apply (or which the taxpayer expects to apply) to the project. The taxpayer must also certify to the Agency all other sources of funds and all development costs for the project. The taxpayer’s certification should be sufficiently detailed to enable the Agency to ascertain the nature of the costs that will make up the total financing package, including subsidies and the anticipated syndication or placement proceeds to be raised. Development cost information, whether or not includible in eligible basis under section 42(d), that should be provided to the Agency includes, but is not limited to, site acquisition costs, construction contingency, general contractor’s overhead and profit, architect’s and engineer’s fees, permit and survey fees, insurance premiums, real estate taxes during construction, title and recording fees, construction period interest, financing fees, organizational costs, rent-up and marketing costs, accounting and auditing costs, working capital and operating deficit reserves, syndication and legal fees, and developer fees;
(ii) Any proceeds or receipts expected to be generated by reason of tax benefits;
(iii) The percentage of the housing credit dollar amount used for project costs other than the costs of intermediaries. This requirement should not be applied so as to impede the development of projects in hard-to-develop areas under section 42(d)(5)(C); and
(iv) The reasonableness of the developmental and operational costs of the project.
(4) Timing of Agency evaluation—(i) In general. The financial determinations and certifications required under paragraph (a)(3) of this section must be made as of the following times—
(A) The time of the application for the housing credit dollar amount;
(B) The time of the allocation of the housing credit dollar amount; and
(C) The date the building is placed in service.
(ii) Time limit for placed-in-service evaluation. For purposes of paragraph (a)(4)(i)(C) of this section, the evaluation for when a building is placed in service must be made not later than the date the Agency issues the Form 8609, “Low-Income Housing Credit Allocation Certification.” The Agency must evaluate all sources and uses of funds under paragraph (a)(3)(i) of this section paid, incurred, or committed by the taxpayer for the project up until date the Agency issues the Form 8609.
(5) Special rule for final determinations and certifications. For the Agency’s evaluation under paragraph (a)(4)(i)(C) of this section, the taxpayer must submit a schedule of project costs. Such schedule is to be prepared on the method of accounting used by the taxpayer for federal income tax purposes, and must detail the project’s total costs as well as those costs that may qualify for inclusion in eligible basis under section 42(d). For projects with more than 10 units, the schedule of project costs must be accompanied by a Certified Public Accountant’s audit report on the schedule (an Agency may require an audited schedule of project costs for projects with fewer than 11 units). The CPA’s audit must be conducted in accordance with generally accepted auditing standards. The auditor’s report must be unqualified.
(6) Bond-financed projects. A project qualifying under section 42(h)(4) is not entitled to any credit unless the governmental unit that issued the bonds (or on behalf of which the bonds were issued), or the Agency responsible for issuing the Form(s) 8609 to the project, makes determinations under rules similar to the rules in paragraphs (a) (3), (4), and (5) of this section.
(b) Effective date. This section is effective on January 1, 2001.
§ 1.42-18 Qualified contracts.
(a) Extended low-income housing commitment—(1) In general. No credit under section 42(a) is allowed by reason of section 42 with respect to any building for the taxable year unless an extended low-income housing commitment (commitment) (as defined in section 42(h)(6)(B)) is in effect as of the end of such taxable year. A commitment must be in effect for the extended use period (as defined in paragraph (a)(1)(i) of this section).
(i) Extended use period. The term extended use period means the period beginning on the first day in the compliance period (as defined in section 42(i)(1)) on which the building is part of a qualified low-income housing project (as defined in section 42(g)(1)) and ending on the later of—
(A) The date specified by the low-income housing credit agency (Agency) in the commitment; or
(B) The date that is 15 years after the close of the compliance period.
(ii) Termination of extended use period. The extended use period for any building will terminate—
(A) On the date the building is acquired by foreclosure (or instrument in lieu of foreclosure) unless the Commissioner determines that such acquisition is part of an arrangement with the taxpayer (“the owner”) a purpose of which is to terminate such period; or
(B) On the last day of the one-year period beginning on the date (after the 14th year of the compliance period) on which the owner submits a written request to the Agency to find a person to acquire the owner’s interest in the low-income portion of the building if the Agency is unable to present during such period a qualified contract for the acquisition of the low-income portion of the building by any person who will continue to operate such portion as a qualified low-income building (as defined in section 42(c)(2)).
(iii) Owner non-acceptance. If the Agency provides a qualified contract within the one-year period and the owner rejects or fails to act upon the contract, the building remains subject to the existing commitment.
(iv) Eviction, gross rent increase concerning existing low-income tenants not permitted. Prior to the close of the three year period following the termination of a commitment, no owner shall be permitted to evict or terminate the tenancy (other than for good cause) of an existing tenant of any low-income unit, or increase the gross rent for such unit in a manner or amount not otherwise permitted by section 42.
(2) Exception. Paragraph (a)(1)(ii)(B) of this section shall not apply to the extent more stringent requirements are provided in the commitment or under State law.
(b) Definitions. For purposes of this section, the following terms are defined:
(1) As provided by section 42(h)(6)(G)(iii), base calendar year means the calendar year with or within which the first taxable year of the credit period ends.
(2) The low-income portion of a building is the portion of the building equal to the applicable fraction (as defined in section 42(c)(1)(B)) specified in the commitment for the building.
(3) The fair market value of the non-low-income portion of the building is determined at the time of the Agency’s offer of sale of the building to the general public. The fair market value of the non-low-income portion also includes the fair market value of the land underlying the entire building (both the non-low-income portion and the low-income portion). This valuation must take into account the existing and continuing requirements contained in the commitment for the building. The fair market value of the non-low-income portion also includes the fair market value of items of personal property not included in eligible basis under section 42(d) that convey under the contract with the building.
(4) Qualifying building costs include—
(i) Costs that are included in eligible basis of a low-income housing building under section 42(d) and that are included in the adjusted basis of depreciable property that is subject to section 168 and that is residential rental property for purposes of section 142(d) and § 1.103-8(b);
(ii) Costs that are included in eligible basis of a low-income housing building under section 42(d) and that are included in the adjusted basis of depreciable property that is subject to section 168 and that is used in a common area or is provided as a comparable amenity to all residential rental units in the building; and
(iii) Costs of the type described in paragraph (b)(4)(i) and (ii) of this section incurred after the first year of the low-income housing building’s credit period under section 42(f).
(5) The qualified contract amount is the sum of the fair market value of the non-low-income portion of the building (within the meaning of section 42(h)(6)(F) and paragraph (b)(3) of this section) and the price for the low-income portion of the building (within the meaning of section 42(h)(6)(F) and paragraph (b)(2) of this section) as calculated in paragraph (c)(2) of this section. If this sum is not a multiple of $1,000, then when the Agency offers the building for sale to the general public, the Agency may round up the offering price to the next highest multiple of $1,000.
(c) Qualified contract purchase price formula—(1) In general. For purposes of this section, qualified contract means a bona fide contract to acquire the building (within a reasonable period after the contract is entered into) for the qualified contract amount.
(i) Initial determination. The qualified contract amount is determined at the time of the Agency’s offer of sale of the building to the general public.
(ii) Mandatory adjustment by the buyer and owner. The buyer and owner under a qualified contract must adjust the amount of the low-income portion of the qualified contract formula to reflect changes in the components of the qualified contract formula such as mortgage payments that reduce outstanding indebtedness between the time of the Agency’s offer of sale to the general public and the building’s actual sale closing date.
(iii) Optional adjustment by the Agency and owner. The Agency and owner may agree to adjust the fair market value of the non low-income portion of the building after the Agency’s offer of sale of the building to the general public and before the close of the one-year period described in paragraph (a)(1)(ii)(B) of this section. If no agreement between the Agency and owner is reached, the fair market value of the non-low-income portion of the building determined at the time of the Agency’s offer of sale of the building to the general public remains unchanged.
(2) Low-income portion amount. The low-income portion amount is an amount not less than the applicable fraction specified in the commitment, as defined in section 42(h)(6)(B)(i), multiplied by the total of—
(i) The outstanding indebtedness for the building (as defined in paragraph (c)(3) of this section); plus
(ii) The adjusted investor equity in the building for the calendar year (as defined in paragraph (c)(4) of this section); plus
(iii) Other capital contributions (as defined in paragraph (c)(5) of this section), not including any amounts described in paragraphs (c)(2)(i) and (ii) of this section; minus
(iv) Cash distributions from (or available for distribution from) the building (as defined in paragraph (c)(6) of this section).
(3) Outstanding indebtedness. For purposes of paragraph (c)(2)(i) of this section, outstanding indebtedness means the remaining stated principal balance (which is initially determined at the time of the Agency’s offer of sale of the building to the general public) of any indebtedness secured by, or with respect to, the building that does not exceed the amount of qualifying building costs described in paragraph (b)(4) of this section. Thus, any refinancing indebtedness or additional mortgages in excess of such qualifying building costs are not outstanding indebtedness for purposes of section 42(h)(6)(F) and this section. Examples of outstanding indebtedness include certain mortgages and developer fee notes (excluding developer service costs not included in eligible basis). Outstanding indebtedness does not include debt used to finance nondepreciable land costs, syndication costs, legal and accounting costs, and operating deficit payments. Outstanding indebtedness includes only obligations that are indebtedness under general principles of Federal income tax law and that are actually paid to the lender upon the sale of the building or are assumed by the buyer as part of the sale of the building.
(4) Adjusted investor equity—(i) Application of cost-of-living factor. For purposes of paragraph (c)(2)(ii) of this section, the adjusted investor equity for any calendar year equals the unadjusted investor equity, as described in paragraph (c)(4)(ii) of this section, multiplied by the qualified-contract cost-of-living adjustment for that year, as defined in paragraph (c)(4)(iii) of this section.
(ii) Unadjusted investor equity. For purposes of this paragraph (c)(4), unadjusted investor equity means the aggregate amount of cash invested by owners for qualifying building costs described in paragraph (b)(4)(i) and (ii) of this section. Thus, equity paid for land, credit adjuster payments, Agency low-income housing credit application and allocation fees, operating deficit contributions, and legal, syndication, and accounting costs all are examples of cost payments that do not qualify as unadjusted investor equity. Unadjusted investor equity takes an amount into account only to the extent that, as of the beginning of the low-income building’s credit period (as defined in section 42(f)(1)), there existed an obligation to invest the amount. Unadjusted investor equity does not include amounts included in the calculation of outstanding indebtedness as defined in paragraph (c)(3) of this section.
(iii) Qualified-contract cost-of-living adjustment. For purposes of this paragraph (c)(4), the qualified-contract cost-of-living adjustment for a calendar year is the number that is computed under the general rule in paragraph (c)(4)(iv) of this section or a number that may be provided by the Commissioner as described in paragraph (c)(4)(v) of this section.
(iv) General rule. Except as provided in paragraph (c)(4)(v) of this section, the qualified-contract cost-of-living adjustment is the quotient of—
(A) The sum of the 12 monthly Consumer Price Index (CPI) values whose average is the CPI for the calendar year that precedes the calendar year in which the Agency offers the building for sale to the general public (The term “CPI for a calendar year” has the meaning given to it by section 1(f)(4) for purposes of computing annual inflation adjustments to the rate brackets.); divided by
(B) The sum of the 12 monthly CPI values whose average is the CPI for the base calendar year (within the meaning of section 1(f)(4)), unless that sum has been increased under paragraph (c)(4)(iii)(D) of this section.
(v) Provision by the Commissioner of the qualified-contract cost-of-living adjustment. The Commissioner may publish in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter) a process pursuant to which the Internal Revenue Service will compute the qualified-contract cost-of-living adjustment for a calendar year and make available the results of that computation.
(vi) Methodology. The calculations in paragraph (c)(4)(iv) of this section are to be made in the following manner:
(A) The CPI data to be used for purposes of this paragraph (c)(4) are the not seasonally adjusted values of the CPI for all urban consumers. (The U.S. Department of Labor’s Bureau of Labor Statistics (BLS) sometimes refers to these values as “CPI-U.”) The BLS publishes the CPI data on-line (including a History Table that contains monthly CPI-U values for all years back to 1913). See www.BLS.gov/data.
(B) The quotient is to be carried out to 10 decimal places.
(C) The Agency may round adjusted investor equity to the nearest dollar.
(D) If the CPI for any calendar year (within the meaning of section 1(f)(4)) during the extended use period after the base calendar year exceeds by more than 5 percent the CPI for the preceding calendar year (within the meaning of section 1(f)(4)), then the sum described in paragraph (c)(4)(i)(B) is to be increased so that the excess is never taken into account under this paragraph (c)(4).
(vii) Example. The following example illustrates the calculations described in this paragraph (c)(4):
(ii) Determination of adjusted investor equity. The qualified-contract cost-of-living adjustment is 1.3615962171 (the quotient of 2605.959, divided by 1913.9). Owner’s adjusted investor equity, therefore, is $27,231,924, which is $20,000,000, multiplied by 1.3615962171, rounded to the nearest dollar.
(5) Other capital contributions. For purposes of paragraph (c)(2)(iii) of this section, other capital contributions to a low-income building are qualifying building costs described in paragraph (b)(4)(ii) of this section paid or incurred by the owner of the low-income building other than amounts included in the calculation of outstanding indebtedness or adjusted investor equity as defined in this section. For example, other capital contributions may include amounts incurred to replace a furnace after the first year of a low-income housing credit building’s credit period under section 42(f), provided any loan used to finance the replacement of the furnace is not secured by the furnace or the building. Other capital contributions do not include expenditures for land costs, operating deficit payments, credit adjuster payments, and payments for legal, syndication, and accounting costs.
(6) Cash distributions—(i) In general. For purposes of paragraph (c)(2)(iv) of this section, the term cash distributions from (or available for distribution from) the building include—
(A) All distributions from the building to the owners or to persons whose relationship to the owner is described in section 267(b) or section 707(b)(1)), including distributions under section 301 (relating to distributions by a corporation), section 731 (relating to distributions by a partnership), or section 1368 (relating to distributions by an S corporation); and
(B) All cash and cash equivalents available for distribution at, or before, the time of sale, including, for example, reserve funds whether operating or replacement reserves, unless the reserve funds are legally required by mortgage restrictions, regulatory agreements, or third party contractual agreements to remain with the building following the sale.
(ii) Excess proceeds. For purposes of paragraph (c)(6)(i) of this section, proceeds from the refinancing of indebtedness or additional mortgages that are in excess of qualifying building costs are not considered cash available for distribution.
(iii) Anti-abuse rule. The Commissioner will interpret and apply the rules in this paragraph (c)(6) as necessary and appropriate to prevent manipulation of the qualified contract amount. For example, cash distributions include payments to owners or persons whose relation to owners is described in section 267(b) or section 707(b) for any operating expenses in excess of amounts reasonable under the circumstances.
(d) Administrative discretion and responsibilities of the Agency—(1) In general. An Agency may exercise administrative discretion in evaluating and acting upon an owner’s request to find a buyer to acquire the building. An Agency may establish reasonable requirements for written requests and may determine whether failure to follow one or more applicable requirements automatically prevents a purported written request from beginning the one-year period described in section 42(h)(6)(I). If the one-year-period has already begun, the Agency may determine whether failure to follow one or more requirements suspends the running of that period. Examples of Agency administrative discretion include, but are not limited to, the following:
(i) Concluding that the owner’s request lacks essential information and denying the request until such information is provided.
(ii) Refusing to consider an owner’s representations without substantiating documentation verified with the Agency’s records.
(iii) Determining how many, if any, subsequent requests to find a buyer may be submitted if the owner has previously submitted a request for a qualified contract and then rejected or failed to act upon a qualified contract presented by the Agency.
(iv) Assessing and charging the owner certain administrative fees for the performance of services in obtaining a qualified contract (for example, real estate appraiser costs).
(v) Requiring all appraisers involved in the qualified contract process to be State certified general appraisers that are acceptable to the Agency.
(vi) Specifying other conditions applicable to the qualified contract consistent with section 42 and this section.
(2) Actual offer. Upon receipt of a written request from the owner to find a person to acquire the building, the Agency must offer the building for sale to the general public, based on reasonable efforts, at the determined qualified contract amount in order for the qualified contract to satisfy the requirements of this section unless the Agency has already identified a willing buyer who submitted a qualified contract to purchase the project.
(3) Debarment of certain appraisers. Agencies shall not utilize any individual or organization as an appraiser if that individual or organization is currently on any list for active suspension or revocation for performing appraisals in any State or is listed on the Excluded Parties Lists System (EPLS) maintained by the General Services Administration for the United States Government found at www.epls.gov.
(e) Effective date/applicability date. These regulations are applicable to owner requests to housing credit agencies on or after May 3, 2012 to obtain a qualified contract for the acquisition of a low-income housing credit building.
§ 1.42-19 Average income test.
(a) Average income set-aside. A project for residential rental property satisfies the average income test in section 42(g)(1)(C) for a taxable year if the project contains a qualified group of units (within the meaning of paragraph (b)(2) of this section) that constitutes 40 percent or more of the residential units in the project. (In the case of a project described in section 142(d)(6), “40 percent” in the preceding sentence is replaced with “25 percent.”)
(b) Definition of low-income unit and qualified group of units—(1) Definition of low-income unit. For purposes of this section, a residential unit is a low-income unit if and only if –
(i) Such unit is rent-restricted (as defined in section 42(g)(2));
(ii) The individuals occupying such unit satisfy the imputed income limitation of that unit designated by the taxpayer in accordance with paragraphs (c)(3) and (d) of this section and with § 1.42-19T(c) and (d), or the unit meets the requirements under section 42(g)(2)(D);
(iii) No provision in section 42 (including section 42(i)(3)(B)-(E)) or in the regulations under section 42 denies low-income status to that unit; and
(iv) The unit is part of a qualified group of units under paragraph (b)(2) of this section.
(2) Definition of qualified group of units. A group of residential units is a qualified group of units for a taxable year if and only if—
(i) Each unit in the group satisfies the requirements of paragraphs (b)(1)(i) through (iii) of this section; and
(ii) The average of the imputed income limitations of all of the units in the group does not exceed 60 percent of area median gross income (AMGI).
(3) Identification of qualified groups of units—(i) Average income set-aside test. For each taxable year in the extended use period, the taxpayer must identify a qualified group of units that constitute 40 percent or more of the residential units in the project. The requirements in paragraph (b)(3)(iii) of this section apply to these identifications.
(ii) Applicable fraction determinations. For each taxable year in the extended use period, the taxpayer must identify a qualified group of units to be used in determining the applicable fractions for the buildings in the project.
(A) Identification of the units in the qualified group of units used for determining applicable fractions. The residential units that are identified for purposes of this paragraph (b)(3)(ii) include the units that, under paragraph (b)(3)(i) of this section, are included in the qualified group of units identified for purposes of the set-aside qualification of the project. The taxpayer may identify additional units for inclusion in the group of units used in determining the applicable fractions for buildings in the project provided that the resulting group is a qualified group of units within the meaning of paragraph (b)(2) of this section.
(B) Computing applicable fractions of buildings. For a taxable year, the applicable fraction of a building in a project is computed using the units that are in the particular building and that are also in the qualified group of units for the project identified for purposes of this paragraph (b)(3)(ii). The units included in the applicable fraction of a building do not have to be a qualified group of units on their own. See Example 4 of paragraph (e) of this section.
(iii) Identification of units. The recordkeeping and reporting requirements in § 1.42-19T(c)(1) apply both to the identification of units that is required by paragraph (b)(3)(i) of this section and the identification of units that is described in paragraph (b)(3)(ii) of this section.
(c) Procedures. (1)-(2) [Reserved]
(3) Designation of imputed income limitations—(i) Timing of designation. (A) Before a unit is first occupied as a low-income unit, or, except as provided in paragraph (c)(3)(i)(B) of this section, is first occupied under a changed income limit, the taxpayer must designate the unit’s imputed income limitation or changed imputed income limitation.
(B) For an occupied unit that is subject to a change in imputed income limitation pursuant to paragraph (d) of this section, the taxpayer must designate the unit’s changed imputed income limitation not later than the end of the taxable year in which the change occurs.
(ii) 10-percent increments. Under section 42(g)(1)(C)(ii)(III), a designation is valid only if it is one of the following: 20 percent, 30 percent, 40 percent, 50 percent, 60 percent, 70 percent, or 80 percent of AMGI.
(iii) Continuity. Except as provided in paragraph (d) of this section, the imputed income limitation of a residential unit does not change.
(iv) [Reserved]
(4) [Reserved]
(d) Changing a unit’s designated imputed income limitation—(1) Permitted changes. Notwithstanding paragraph (c)(3)(iii) of this section, the taxpayer may change the imputed income limitation of a unit in the following circumstances subject to the timing of designation requirement in paragraph (c)(3)(i)(B) of this section.
(i) Federally permitted changes. Permission for the change is contained in IRS forms, instructions, or guidance published in the Internal Revenue Bulletin pursuant to § 601.601(d)(2)(ii)(b) of this chapter.
(ii) Housing credit agency (Agency)-permitted changes. The Agency with jurisdiction of the project has issued public written guidance that provides conditions for a permitted change and that applies to all average income test projects under the jurisdiction of the Agency.
(iii) Certain laws. The change in designation is required or appropriate to enhance protections contained in the following, as amended—
(A) The Americans with Disabilities Act of 1990 (ADA), Pub. L. 101-336, 104 Stat. 328, 42 U.S.C. 12101, et seq.;
(B) The Fair Housing Amendments Act of 1988, Pub. L. 100-430, 102 Stat.1619, 42 U.S.C. 3601, et. seq.;
(C) The Violence Against Women Act of 1994, Pub. L. 103-322, 108 Stat. 1902, 34 U.S.C. 12291, et. seq.;
(D) The Rehabilitation Act of 1973, Pub. L. 93-112, 87 Stat. 394, 29 U.S.C. 701, et seq.; or
(E) Any other State, Federal, or local law or program that protects tenants and that is identified pursuant to paragraph (d)(1)(i) or (ii) of this section.
(iv) Tenant movement. If a current income-qualified tenant moves to a different unit in the project—
(A) The unit to which the tenant moves has its imputed income designation, if any, changed to the limitation of the unit from which the tenant is moving; and
(B) The vacated unit takes on the prior limitation, if any, of the tenant’s new unit.
(v) Restoring compliance with average income requirements. If one or more units lose low-income status or if there is a change in the imputed income limitation of some unit and if either event would cause a previously qualifying group of units to cease to be described in paragraph (b)(2)(ii) of this section, then the taxpayer may designate an imputed income limitation for a market-rate unit or may reduce the existing imputed income limitations of one or more other units in the project in order to restore compliance with the average income requirement. The rule in this paragraph (d)(1)(v) may be applied to market-rate, vacant, or low-income units, but, in the case of occupied units, the current tenants must qualify under the new, lower imputed income limitation.
(2) [Reserved]
(e) Examples. The operation of this section is illustrated by the following examples.
(1) Example 1—(i) Facts. (A) A single-building housing project received an allocation of housing credit dollar amount. The taxpayer who owns the project elects the average income test, intending for the 10-unit building to have 100 percent low-income occupancy. The taxpayer properly and timely designates the imputed income limitations for the 10 units as follows: 5 units at 80 percent of AMGI; and 5 units at 40 percent of AMGI. Also, for the first credit year, the taxpayer follows proper procedure in identifying 4 units as the qualified group of units that are to be used for qualifying under the average income set-aside (Units ##1, 2, 6, and 7). Additionally, for the first credit year, the taxpayer follows proper procedure in identifying all 10 units as the qualified group of units that are to be used for the applicable fraction determination. All of the units in the project are described in paragraphs (b)(1)(i) through (iii) of this section.
Table 1 to Paragraph
Unit No. | Imputed income
limitation of the unit |
---|---|
1 | 80 percent of AMGI. |
2 | 80 percent of AMGI. |
3 | 80 percent of AMGI. |
4 | 80 percent of AMGI. |
5 | 80 percent of AMGI. |
6 | 40 percent of AMGI. |
7 | 40 percent of AMGI. |
8 | 40 percent of AMGI. |
9 | 40 percent of AMGI. |
10 | 40 percent of AMGI. |
(B) In the first taxable year of the credit period (Year 1), the project is fully leased and occupied.
(ii) Analysis. The identified groups are qualified groups under paragraph (b)(2) of this section. All units in both of the groups are described in paragraphs (b)(1)(i) through (iii) of this section, and the averages of the imputed income limitations of both the 4-unit group (Units ##1, 2, 6, and 7) and the 10-unit group do not exceed 60 percent of AMGI.
(A) Average income set-aside. The project qualifies under the average income set-aside because the identified group of 4 units (Units ##1, 2, 6, and 7) is a qualified group of units that comprise at least 40% of the residential units in the project.
(B) Qualified basis. All 10 units in the identified qualified group of units are used in the applicable fraction determination when calculating qualified basis for purposes of determining the annual credit amount under section 42(a).
(2) Example 2—(i) Facts. Assume the same facts as Example 1 of paragraph (e)(1) of this section. In Year 2, Unit #6 (which has a designated imputed income limitation of 40 percent of AMGI) becomes uninhabitable. Repair work on Unit #6 is completed in Year 3. For Year 2, Taxpayer identifies the following as a qualified group of units that are to be used for both the set-aside requirement and the applicable fraction determination: Units ##1-4 and 7-10. For Year 3, Taxpayer identifies all 10 units as the qualified group of units that are to be used for the set-aside requirement and the applicable fraction determination.
(ii) Analysis. For Year 2, the identified group is a qualified group under paragraph (b)(2) of this section. All 8 units in the group are described in paragraphs (b)(1)(i) through (iii) of this section, and the average of the imputed income limitations of the 8 units in the group of units does not exceed 60 percent of AMGI.
(A) Average income set-aside. For Year 2, the project qualifies for the average income set-aside because the project contains a qualified group of units that comprises at least 40% of the residential units in the project.
(B) Qualified basis. To determine qualified basis in Year 2, the 8 units in the identified qualified group of units are used in the applicable fraction determination when calculating qualified basis for purposes of determining the annual credit amount under section 42(a). Unit #6 could not have been identified in the qualified group of units for use in the applicable fraction determination because its lack of habitability prevents it from being a low-income unit. Further, Taxpayer could not have identified all 9 of the habitable units to be used in the qualified group of units for the applicable fraction determination because the average of imputed income limitations of those 9 exceeds 60 percent of AMGI. Taxpayer had a choice of which of Units ##1-5 it was going to not identify for use in the applicable fraction determination. Omitting any one of them reduces the average limitation of the remaining group of 8 units to an amount that does not exceed 60 percent of AMGI. Given taxpayer’s decision to leave out Unit #5, Units ##1, 2, 3, 4, 7, 8, 9, and 10 are taken into account in the applicable fraction.
(C) Recapture. At the close of Year 2, Unit #6’s unsuitability for occupancy precludes it from being described in paragraph (b)(1)(iii) of this section. Unit #6’s resulting failure to be a low-income unit prevents it from being in a qualified group for purposes of computing the applicable fraction. The decline in the applicable fraction yields a decline in qualified basis, which results in credit recapture under section 42(j) for Year 2. Additionally, Unit #5 is not a low-income unit because the taxpayer did not include it in the qualified group of units identified for determining the building’s applicable fraction. The exclusion of Unit #5 from the qualified group of units further reduces the applicable fraction for Year 2 and so reduces qualified basis for that year as well. Thus, this exclusion increases the credit recapture amount under section 42(j).
(D) Restoration of habitability and of qualified basis. As described in the facts in paragraph (e)(2)(i) of this section, in Year 3, after repair work is complete, the formerly uninhabitable Unit #6 is again occupied by a qualified tenant at the same imputed income limitation, and the Taxpayer identifies all 10 units as the qualified group of units that are to be used for the set-aside requirement and the applicable fraction determination. The identified group is a qualified group under paragraph (b)(2) of this section. All 10 units in the group are described in paragraphs (b)(1)(i) through (iii) of this section, and the average of the imputed income limitations of the 10 units in the group of units does not exceed 60 percent of AMGI. For Year 3, all 10 units are included in the qualified group of units for purposes of the average income set-aside test and are a qualified group of units for the applicable fraction determination.
(3) Example 3—(i) Facts. Assume the same facts as Example 2 of paragraph (e)(2) of this section, except that the income for the tenant residing in Unit #5 has declined so that tenant’s income does not exceed 60 percent of AMGI. For Year 2, taxpayer timely redesignates Unit #5 pursuant to the rule in paragraph (d)(1)(v) of this section so that the imputed income limitation is 60 percent of AMGI instead of 80 percent of AMGI. Taxpayer also makes revisions so that Unit #5 is rent-restricted under the redesignated imputed income limitation. Taxpayer identifies 9 units (Units ##1-5 and 7-10) as the qualified group of units that are to be used for the set-aside requirement and the applicable fraction determination.
(ii) Analysis. For Year 2, the identified group is a qualified group under paragraph (b)(2) of this section. All 9 units in the group are described in paragraphs (b)(1)(i) through (iii) of this section, and the average of the imputed income limitations of the 9 units in the group of units does not exceed 60 percent of AMGI.
(A) Average income set-aside. For Year 2, project contains a qualified group of units that comprises at least 40% of the residential units in the project.
(B) Qualified basis. To determine qualified basis, all 9 units in the identified qualified group of units are used in the applicable fraction determination when calculating qualified basis for purposes of determining the annual credit amount under section 42(a). Unit #6 could not have been identified in the qualified group of units for use in the applicable fraction determination because its lack of habitability prevents it from being a low-income unit. Thus, Units ##1, 2, 3, 4, 5, 7, 8, 9, and 10 are taken into account in the applicable fraction determination.
(C) Recapture. At the close of Year 2, the amount of the qualified basis is less than the amount of the qualified basis at the close of Year 1, because Unit #6’s unsuitability for occupancy prohibits it from being a low-income unit. Unit #6’s failure to be a low-income unit results in a credit recapture amount under section 42(j) for Year 2 related to Unit #6. Because Units ##1-5 and 7-10 are all included in the qualified group of units for use in the applicable fraction determination, Units ##1-5 and 7-10 are included in qualified basis for Year 2 when determining the recapture amount.
(4) Example 4—(i) Facts. (A) A multiple-building housing project consisting of two buildings received an allocation of housing credit dollar amount, and the taxpayer who owns the project elects the average income test. The taxpayer intends for the buildings (each containing 5 units) to have 100 percent low-income occupancy. The taxpayer properly and timely designates the imputed income limitations for the 10 units in Buildings 1 and 2 as follows: Building A contains 2 units at 80 percent of AMGI and 3 units at 40 percent of AMGI; and Building B contains 2 units at 40 percent of AMGI and 3 units at 80 percent of AMGI.
Table 3 to Paragraph
Building A, Unit No. | Imputed income
limitation of the unit |
---|---|
A1 | 80 percent of AMGI. |
A2 | 80 percent of AMGI. |
A3 | 40 percent of AMGI. |
A4 | 40 percent of AMGI. |
A5 | 40 percent of AMGI. |
Building B, Unit No. | |
B1 | 40 percent of AMGI. |
B2 | 40 percent of AMGI. |
B3 | 80 percent of AMGI. |
B4 | 80 percent of AMGI. |
B5 | 80 percent of AMGI. |
(B) In the first taxable year of the credit period (Year 1), the project is fully leased and occupied. Also, for the first credit year, the taxpayer follows proper procedure in identifying all 10 units as a qualified group of units for the minimum set-aside and the applicable fraction determination.
(ii) Analysis. For Year 1, the identified group is a qualified group under paragraph (b)(2) of this section. All 10 units in the group are described in paragraphs (b)(1)(i) through (iii) of this section, and the average of the imputed income limitations of the 10 units in the group of units does not exceed 60 percent of AMGI.
(A) Average income test. The multiple-building project meets the average income test as the project contains a qualified group of units that comprises at least 40% of the residential units in the project. The fact that the average of the income limitations of the units in Building B exceeds 60 percent of AMGI does not impact this result.
(B) Qualified basis. To determine qualified basis, all 10 units in the identified qualified group of units across Building A and Building B are used in the applicable fraction determination when calculating qualified basis of each building for purposes of determining the annual credit amount under section 42(a). The fact that the average of the units in Building B exceeds 60 percent of AMGI does not impact the applicable fraction of Building B because the average of the identified group of units across both buildings does not exceed 60 percent of AMGI.
(5) Example 5—(i) Facts. A single-building housing project received an allocation of housing credit dollar amount, and the taxpayer who owns the project elects the average income test. During Year 2 of the credit period, the tenant residing in a unit with a designated imputed income limitation of 40 percent of AMGI moves to a market-rate unit within the same project. The tenant’s income continues to be at or below 40 percent of AMGI.
(ii) Analysis. Under the rule in paragraph (d)(1)(iv) of this section, when the current income-qualified tenant moves to a different unit in the project, the unit to which the tenant moves is eligible for the taxpayer to designate as a unit with a designated imputed income limitation of 40 percent of AMGI. If the taxpayer makes those designations, the unit vacated by the tenant takes on the prior limitation, if any, of the tenant’s new unit. In this situation, the vacated unit formerly occupied by the tenant is now a market-rate unit.
(6) Example 6—(i) Facts. A single-building housing project received an allocation of housing credit dollar amount, and the taxpayer who owns the project elects the average income test. During Year 2 of the credit period, the disability status under the ADA of a tenant changes, and therefore under the provisions of the ADA, the tenant now needs to reside in a different unit with different accommodations. The tenant currently resides in a unit with a designated imputed income limitation of 40 percent of AMGI. A unit that would meet the tenant’s needs is available on the first-floor of the building, but it was previously a low-income unit with a designated imputed income limitation of 70 percent of AMGI and thus a higher maximum gross rent than the tenant’s current unit. The tenant moves to the first-floor unit.
(ii) Analysis. The tenant’s move was required under the ADA. Accordingly, the taxpayer is permitted to change the designation of the imputed income limitation of the first-floor unit so that the unit’s designation is 40 percent of AMGI. Under paragraph (d)(1)(iv) of this section, the vacated unit takes on the prior limitation of 70 percent of AMGI of the tenant’s new unit.
(f) Applicability dates-(1) In general. Except as provided in paragraph (f)(3) of this section, this section applies to taxable years beginning after December 31, 2022.
(2) Designations of occupied units. (i) If a residential unit is occupied at the end of the most recent taxable year ending before the first taxable year to which this section applies and if the unit is to be taken into account as a low-income unit under this section as of the beginning of the first taxable year to which this section applies, then not later than the first day of such first taxable year, the taxpayer must designate an imputed income limitation for the unit. The first taxable year to which this section applies means the first taxable year beginning after December 31, 2022, if paragraph (f)(1) of this section applies, or the taxable year described in paragraph (f)(3) of this section if the taxpayer chooses to apply paragraph (f)(3) of this section.
(ii) The designation required by paragraph (f)(2)(i) of this section must comply with paragraph (c)(3)(ii) of this section and § 1.42-19T(c)(3)(iv), without taking into account § 1.42-19T(c)(4). Section 1.42-19T(c)(2) applies to these designations, except that the Agency may allow the notification to be made along with any other notifications for the first taxable year beginning after December 31, 2022.
(iii) The designated imputed income limitation for the unit may not be less than the income that the current occupant of the unit had when that occupancy began.
(3) Applicability of this section to taxable years beginning before January 1, 2023. A taxpayer may choose to apply this section to a taxable year beginning after October 12, 2022, and before January 1, 2023, provided that the taxpayer chooses to apply § 1.42-15 to the same taxable year.
§ 1.42-19T Average income test (temporary).
(a)-(b) [Reserved]
(c) Procedures—(1) Identification of low-income units for use in the average income set-aside test or the applicable fraction determination—(i) In general. For a taxable year, a taxpayer must follow the procedures described in paragraph (c)(1)(ii) of this section to identify—
(A) A qualified group of units that satisfy the average income set-aside test; and
(B) A qualified group of units used to determine the applicable fraction.
(ii) Recording and communicating. The procedures described in this paragraph (c)(1)(ii) are—
(A) Recording the identification in its books and records, where the identification must be retained for a period not shorter than the record retention requirement under § 1.42-5(b)(2); and
(B) Communicating the annual identifications to the applicable housing credit agency (Agency) as provided in paragraph (c)(2) of this section.
(2) Notifications to the Agency with jurisdiction over a project—(i) Agency flexibility. An Agency may establish the time and manner in which information is annually provided to it.
(ii) Example. An Agency may allow a taxpayer to describe a current year’s information by reporting differences from the previous year’s information or by reporting that there are no such differences. Various Agencies may choose to apply this manner of reporting to the identity of a qualified group of units for use in the average income set-aside or applicable fraction determination, or the imputed income limits designated for the various units in a project.
(3) Designation of imputed income limitations. (i)-(iii) [Reserved]
(iv) Recording, retention, and annual communications related to designations. A taxpayer designates a unit’s imputed income limitation by recording the limitation in its books and records, where it must be retained for a period not shorter than the record retention requirement under § 1.42-5(b)(2). The preceding sentence applies both to units whose first occupancy is as a low-income unit and to previously market-rate units that are converted to low-income status. The designation must also be communicated annually to the applicable Agency as provided in paragraph (c)(2) of this section.
(4) Waiver for failure to comply with procedural requirements. On a case-by-case basis, the Agency has the discretion to waive in writing any failure to comply with the requirements of paragraph (c)(1) or (2) or (c)(3)(iv) of this section up to 180 days after discovery of the failure, whether by taxpayer or Agency. If an Agency exercises this discretion, then the relevant requirements are treated as having been satisfied. In such a case, the tax consequences under this section correspond to that deemed satisfaction.
(d) Changing a unit’s designated imputed income limitation. (1) [Reserved]
(2) Process for changing a unit’s designated imputed income limitation. The taxpayer effects a change in a unit’s imputed income limitation by recording the limitation in its books and records, where it must be retained for a period not shorter than the record retention requirement under § 1.42-5(b)(2). The new designation must also be communicated to the applicable Agency as provided in paragraph (c)(2) of this section and must become part of the annual report to the Agency of income designations. The prior designation must be retained in the books and records for the period specified in paragraph (c)(3)(iv) of this section. A designation under this paragraph (d)(2) is considered to be made in a manner consistent with paragraph (c)(3) of this section.
(e) [Reserved]
(f) Applicability dates—(1) In general. Except as provided in paragraph (f)(3) of this section, this section applies to taxable years beginning after December 31, 2022.
(2) Designations of occupied units. (i) If a residential unit is occupied at the end of the most recent taxable year ending before the first taxable year to which this section applies and if the unit is to be taken into account as a low-income unit under this section as of the beginning of the first taxable year to which this section applies, then not later than the first day of such first taxable year, the taxpayer must designate an imputed income limitation for the unit. The first taxable year to which this section applies means the first taxable year beginning after December 31, 2022, if paragraph (f)(1) of this section applies, or the taxable year described in paragraph (f)(3) of this section if the taxpayer chooses to apply paragraph (f)(3) of this section.
(ii) The designation required by paragraph (f)(2)(i) of this section must comply with § 1.42-19(c)(3)(ii) and paragraph (c)(3)(iv) of this section, without taking into account paragraph (c)(4) of this section. Paragraph (c)(2) of this section applies to these designations, except that the Agency may allow the notification to be made along with any other notifications for the first taxable year beginning after December 31, 2022.
(iii) The designated imputed income limitation for the unit may not be less than the income that the current occupant of the unit had when that occupancy began.
(3) Applicability of this section to taxable years beginning before January 1, 2023. A taxpayer may choose to apply this section to a taxable year beginning after October 12, 2022, and before January 1, 2023, provided that the taxpayer chooses to apply § 1.42-15 to the same taxable year.
(4) Expiration date. The applicability of this section expires on October 7, 2025.
§ 1.42A-1 General tax credit for taxable years ending after December 31, 1975, and before January 1, 1979.
(a)(1) Allowance of credit for taxable years ending after December 31, 1975, and beginning before January 1, 1977. Subject to the special rules of paragraphs (b)(1), (c) and (d) and the limitation of paragraph (e)(1) of this section, an individual is allowed as a credit against the tax imposed by chapter 1 for the taxable year in the case of taxable years ending after December 31, 1975, and beginning before January 1, 1977, an amount equal to the greater of—
(i) 2 percent of so much of the individual’s taxable income as does not exceed $9,000, or
(ii) $35 multiplied by the total number of deductions for personal exemptions to which the individual is entitled for the taxable year under section 151 (b) and (e) and the regulations thereunder (relating to allowance of deductions for personal exemptions with respect to the individual, the individual’s spouse, and dependents).
(2) Allowance of credit for taxable years beginning after December 31, 1976, and ending before January 1, 1979. Subject to the special rules of paragraphs (b)(2), (c) and (d) and the limitation of paragraph (e)(2) of this section, an individual is allowed as a credit against the tax imposed by section 1, or against the tax imposed in lieu of the tax imposed by section 1, for the taxable year in the case of taxable years beginning after December 31, 1976, and ending before January 1, 1979, an amount equal to the greater of—
(i) 2 percent of so much of the individual’s taxable income for the taxable year, reduced by the zero bracket amount determined under section 63 (d), as does not exceed $9,000, or
(ii) $35 multiplied by the total number of deductions for personal exemptions to which the individual is entitled for the taxable year under section 151 and the regulations thereunder (relating to allowance of deductions for personal exemptions).
(b) Married individuals filing separate returns—(1) For taxable years ending after December 31, 1975, and beginning before January 1, 1977. In the case of taxable years ending after December 31, 1975, and beginning before January 1, 1977, a married individual who files a separate return for the taxable year is allowed as a credit for the taxable year an amount equal to either—
(i) 2 percent of so much of the individual’s taxable income as does not exceed $4,500, or
(ii) $35 multiplied by the total number of deductions for personal exemptions to which the individual is entitled for the taxable year under section 151 (b) and (e) and the regulations thereunder, but only if both the individual and the individual’s spouse elect to have the credit determined in the manner described in this subdivision (ii) for their corresponding taxable years. The elections shall be made by both married individuals separately calculating and claiming the credit in the manner and amount described in this subdivision (ii) on their separate returns for their corresponding taxable years. The rules of section 142 (a) and the regulations thereunder (relating to individuals not eligible for the standard deduction) in effect for taxable years beginning before January 1, 1977, apply to determine whether the taxable years of the individual and the individual’s spouse correspond to each other. For purposes of applying this subdivision (ii), the total number of deductions for personal exemptions shall not include any additional exemptions to which the individual may be entitled based upon age of 65 or more or blindness under section 151 (c) or (d) and the regulations thereunder.
(2) For taxable years beginning after December 31, 1976, and ending before January 1, 1979. In the case of taxable years beginning after December 31, 1976, and ending before January 1, 1979, a married individual who files a separate return for the taxable year shall determine the amount of the credit for the taxable year under section 42(a)(2) and § 1.42A-1(a)(2)(ii).
(3) Determination of marital status. For purposes of this paragraph, the determination of marital status shall be made as provided by section 143 and the regulations thereunder (relating to the determination of marital status).
(c) Return for short period on change of annual accounting period. In computing the credit provided by section 42 and this section for a period of less than 12 months (hereinafter referred to as a “short period”), where income is to be annualized under section 443(b)(1) in order to determine the tax—
(1) The credit allowed by paragraphs (a) (1)(i) and (2)(i) of this section shall be computed based upon the amount of the taxable income annualized under the rules of section 443(b)(1) and § 1.443-1(b)(1), or
(2)(i) The credit allowed by paragraph (a)(1)(ii) of this section shall be computed based upon the total number of deductions for personal exemptions to which the individual is entitled for the short period under section 151 (b) and (e) and the regulations thereunder (relating to allowance of deductions for personal exemptions with respect to the individual, the individual’s spouse, and dependents), and
(ii) The credit allowed by paragraph (a)(2)(ii) of this section shall be computed based upon the total number of deductions for personal exemptions to which the individual is entitled for the short period under section 151 and the regulations thereunder (relating to allowance of deductions for personal exemptions).
(d) Certain persons not eligible—(1) Estates and trusts. The credit provided by section 42 and this section shall not be allowed in the case of any estate or trust. Thus, the credit shall not be allowed to an estate of an individual in bankruptcy or to an estate of a deceased individual. However, in the case of a deceased individual, the credit shall be allowed on the decedent’s final return filed by his executor or other representative. Also, the credit provided by section 42 and this section shall be allowed in the case of a return filed by an estate of an infant, incompetent, or an individual under a disability.
(2) Nonresident alien individuals. The credit provided by section 42 and this section shall not be allowed in the case of any nonresident alien individual. As used in this subparagraph, the term “nonresident alien individual” has the meaning provided by § 1.871-2. See, however, section 6013(g) for election to treat nonresident alien individual as resident of the United States. The credit shall be allowed to an alien individual who is a resident of the United States for part of the taxable year. See § 1.871-2(b) for rules relating to the determination of residence of an alien individual. For purposes of paragraphs (a) (1)(i) and (2)(i) of this section, the credit allowed shall be computed by taking into account only that portion of the individual’s taxable income which is attributable to the period of his residence in the United States. For purposes of paragraph (a)(1)(ii) of this section, the credit allowed shall be computed by taking into account only the total number of deductions for personal exemptions to which the individual is entitled under section 151 (b) and (e) for the period of his residence in the United States. For purposes of paragraph (a)(2)(ii) of this section, the credit allowed shall be computed by taking into account only the total number of deductions for personal exemptions to which the individual is entitled under section 151 for the period of his residence in the United States. See § 1.871-13 for rules relating to changes of residence status during a taxable year.
(e) Limitation—(1) For taxable years ending after December 31, 1975, and beginning before January 1, 1977. For taxable years ending after December 31, 1975, and beginning before January 1, 1977, the credit allowed by section 42 and this section shall not exceed the amount of tax imposed by chapter 1 for the taxable year. In the case of an alien individual who is a resident of the United States for a part of the taxable year, the credit allowed by section 42 and this section shall not exceed the amount of tax imposed by chapter 1 for that portion of the taxable year during which the alien individual was a resident of the United States. See § 1.871-13.
(2) For taxable years beginning after December 31, 1976, and ending before January 1, 1979. For taxable years beginning after December 31, 1976, and ending before January 1, 1979, the credit allowed by section 42 and this section shall not exceed the amount of tax imposed by section 1, or the amount of tax imposed in lieu of the tax imposed by section 1, for the taxable year. In the case of an alien individual who is a resident of the United States for a part of the taxable year, the credit allowed by section 42 and this section shall not exceed the amount of tax imposed by section 1, or the amount of tax imposed in lieu of the tax imposed by section 1, for that portion of the taxable year during which the alien individual was a resident of the United States. See § 1.871-13.
(f) Application with other credits. In determining the credits allowed under—
(1) Section 33 (relating to foreign tax credit),
(2) Section 37 (relating to credit for the elderly),
(3) Section 38 (relating to investment in certain depreciable property),
(4) Section 40 (relating to expenses of work incentive programs), and
(5) Section 41 (relating to contributions to candidates for public office),
(g) Income tax tables to reflect credit. The tables prescribed under section 3 shall reflect the credit allowed by section 42 and this section.
(h) Effective dates. The credit allowed by section 42 and this section applies only for taxable years ending after December 31, 1975, and before January 1, 1979.
§ 1.43-0 Table of contents.
This section lists the captions contained in §§ 1.43-0 through 1.43-7.
(1) In general.
(2) Examples.
(1) In general.
(2) Inflation adjustment.
(3) Examples.
(1) In general.
(2) Certain deductions by an integrated oil company.
(1) Partners’ interests in a partnership.
(2) Shareholders’ stock in an S corporation.
(1) In general.
(2) Example.
(1) In general.
(2) Substantially unaffected reservoir volume.
(3) Terminated projects.
(4) Change in tertiary recovery method.
(5) Examples.
(1) In general.
(2) Tertiary recovery methods that qualify.
(3) Recovery methods that do not qualify.
(4) Examples.
(1) In general.
(2) Timing of certification.
(3) Content of certification.
(1) In general.
(2) Timing of certification.
(3) Content of certification.
(1) In general.
(2) Timing of notice.
(3) Content of notice.
(1) In general.
(2) Costs paid or incurred for an asset which is used to implement more than one qualified enhanced oil recovery project or for other activities.
(1) Qualified tertiary injectant expenses.
(2) Intangible drilling and development costs.
(3) Tangible property costs.
(4) Examples.
(1) In general.
(2) Tertiary injectant costs.
(3) Intangible drilling and development costs.
(4) Tangible property costs.
(5) Offshore drilling platforms.
(6) Examples.
(1) In general.
(2) First injection after filing of return for taxable year costs are allowable.
(3) First injection more than 36 months after close of taxable year costs are paid or incurred.
(4) Injections in volumes less than the volumes specified in the project plan.
(5) Examples.
(1) Anti-abuse rule.
(2) Costs paid or incurred to acquire a project.
(3) Examples.
(1) In general.
(2) Time for making the election.
(3) Manner of making the election.
§ 1.43-1 The enhanced oil recovery credit—general rules.
(a) Claiming the credit—(1) In general. The enhanced oil recovery credit (the “credit”) is a component of the section 38 general business credit. A taxpayer that owns an operating mineral interest (as defined in § 1.614-2(b)) in a property may claim the credit for qualified enhanced oil recovery costs (as described in § 1.43-4) paid or incurred by the taxpayer in connection with a qualified enhanced oil recovery project (as described in § 1.43-2) undertaken with respect to the property. A taxpayer that does not own an operating mineral interest in a property may not claim the credit. To the extent a credit included in the current year business credit under section 38(b) is unused under section 38, the credit is carried back or forward under the section 39 business credit carryback and carryforward rules.
(2) Examples. The following examples illustrate the principles of this paragraph (a).
(b) Amount of the credit. A taxpayer’s credit is an amount equal to 15 percent of the taxpayer’s qualified enhanced oil recovery costs for the taxable year, reduced by the phase-out amount, if any, determined under paragraph (c) of this section.
(c) Phase-out of the credit as crude oil prices increase—(1) In general. The amount of the credit (determined without regard to this paragraph (c)) for any taxable year is reduced by an amount which bears the same ratio to the amount of the credit (determined without regard to this paragraph (c)) as—
(i) The amount by which the reference price determined under section 29(d)(2)(C) for the calendar year immediately preceding the calendar year in which the taxable year begins exceeds $28 (as adjusted under paragraph (c)(2) of this section); bears to
(ii) $6.
(2) Inflation adjustment—(i) In general. For any taxable year beginning in a calendar year after 1991, an amount equal to $28 multiplied by the inflation adjustment factor is substituted for the $28 amount under paragraph (c)(1)(i) of this section.
(ii) Inflation adjustment factor. For purposes of this paragraph (c), the inflation adjustment factor for any calendar year is a fraction, the numerator of which is the GNP implicit price deflator for the preceding calendar year and the denominator of which is the GNP implicit price deflator for 1990. The “GNP implicit price deflator” is the first revision of the implicit price deflator for the gross national product as computed and published by the Secretary of Commerce. As early as practicable, the inflation adjustment factor for each calendar year will be published by the Internal Revenue Service in the Internal Revenue Bulletin.
(3) Examples. The following examples illustrate the principles of this paragraph (c).
(d) Reduction of associated deductions—(1) In general. Any deduction allowable under chapter 1 for an expenditure taken into account in computing the amount of the credit determined under paragraph (b) of this section is reduced by the amount of the credit attributable to the expenditure.
(2) Certain deductions by an integrated oil company. For purposes of determining the intangible drilling and development costs that an integrated oil company must capitalize under section 291(b), the amount allowable as a deduction under section 263(c) is the deduction allowable after paragraph (d)(1) of this section is applied. See § 1.43-4(b)(2) (extent to which integrated oil company intangible drilling and development costs are qualified enhanced oil recovery costs).
(e) Basis adjustment. For purposes of subtitle A, the increase in the basis of property which would (but for this paragraph (e)) result from an expenditure with respect to the property is reduced by the amount of the credit determined under paragraph (b) of this section attributable to the expenditure.
(f) Passthrough entity basis adjustment—(1) Partners’ interests in a partnership. To the extent a partnership expenditure is not deductible under paragraph (d)(1) of this section or does not increase the basis of property under paragraph (e) of this section, the expenditure is treated as an expenditure described in section 705(a)(2)(B) (concerning decreases to basis of partnership interests). Thus, the adjusted bases of the partners’ interests in the partnership are decreased (but not below zero).
(2) Shareholders’ stock in an S corporation. To the extent an S corporation expenditure is not deductible under paragraph (d)(1) of this section or does not increase the basis of property under paragraph (e) of this section, the expenditure is treated as an expenditure described in section 1367(a)(2)(D) (concerning decreases to basis of S corporation stock). Thus, the bases of the shareholders’ S corporation stock are decreased (but not below zero).
(g) Examples. The following examples illustrate the principles of paragraphs (d) through (f) of this section.
§ 1.43-2 Qualified enhanced oil recovery project.
(a) Qualified enhanced oil recovery project. A “qualified enhanced oil recovery project” is any project that meets all of the following requirements—
(1) The project involves the application (in accordance with sound engineering principles) of one or more qualified tertiary recovery methods (as described in paragraph (e) of this section) that is reasonably expected to result in more than an insignificant increase in the amount of crude oil that ultimately will be recovered;
(2) The project is located within the United States (within the meaning of section 638(1));
(3) The first injection of liquids, gases, or other matter for the project (as described in paragraph (c) of this section) occurs after December 31, 1990; and
(4) The project is certified under § 1.43-3.
(b) More than insignificant increase. For purposes of paragraph (a)(1) of this section, all the facts and circumstances determine whether the application of a tertiary recovery method can reasonably be expected to result in more than an insignificant increase in the amount of crude oil that ultimately will be recovered. Certain information submitted as part of a project certification is relevant to this determination. See § 1.43-3(a)(3)(i)(D). In no event is the application of a recovery method that merely accelerates the recovery of crude oil considered an application of one or more qualified tertiary recovery methods that can reasonably be expected to result in more than an insignificant increase in the amount of crude oil that ultimately will be recovered.
(c) First injection of liquids, gases, or other matter—(1) In general. The “first injection of liquids, gases, or other matter” generally occurs on the date a tertiary injectant is first injected into the reservoir. The “first injection of liquids, gases, or other matter” does not include—
(i) The injection into the reservoir of any liquids, gases, or other matter for the purpose of pretreating or preflushing the reservoir to enhance the efficiency of the tertiary recovery method; or
(ii) Test or experimental injections.
(2) Example. The following example illustrates the principles of this paragraph (c).
(d) Significant expansion exception—(1) In general. If a project for which the first injection of liquids, gases, or other matter (within the meaning of paragraph (c)(1) of this section) occurred before January 1, 1991, is significantly expanded after December 31, 1990, the expansion is treated as a separate project for which the first injection of liquids, gases, or other matter occurs after December 31, 1990.
(2) Substantially unaffected reservoir volume. A project is considered significantly expanded if the injection of liquids, gases, or other matter after December 31, 1990, is reasonably expected to result in more than an insignificant increase in the amount of crude oil that ultimately will be recovered from reservoir volume that was substantially unaffected by the injection of liquids, gases, or other matter before January 1, 1991.
(3) Terminated projects. Except as otherwise provided in this paragraph (d)(3), a project is considered significantly expanded if each qualified tertiary recovery method implemented in the project prior to January 1, 1991, terminated more than 36 months before implementing an enhanced oil recovery project that commences after December 31, 1990. Notwithstanding the provisions of the preceding sentence, if a project implemented prior to January 1, 1991, is terminated for less than 36 months before implementing an enhanced oil recovery project that commences after December 31, 1990, a taxpayer may request permission to treat the project that commences after December 31, 1990, as a significant expansion. Permission will not be granted if the Internal Revenue Service determines that a project was terminated to make an otherwise nonqualifying project eligible for the credit. For purposes of section 43, a qualified tertiary recovery method terminates at the point in time when the method no longer results in more than an insignificant increase in the amount of crude oil that ultimately will be recovered. All the facts and circumstances determine whether a tertiary recovery method has terminated. Among the factors considered is the project plan, the unit plan of development, or other similar plan. A tertiary recovery method is not necessarily terminated merely because the injection of the tertiary injectant has ceased. For purposes of this paragraph (d)(1), a project is implemented when costs that will be taken into account in determining the credit with respect to the project are paid or incurred.
(4) Change in tertiary recovery method. If the application of a tertiary recovery method or methods with respect to an enhanced oil recovery project for which the first injection of liquids, gases, or other matter occurred before January 1, 1991, has not been terminated for more than 36 months, a taxpayer may request a private letter ruling from the Internal Revenue Service whether the application of a different tertiary recovery method or methods after December 31, 1990, that does not affect reservoir volume substantially unaffected by the previous tertiary recovery method or methods, is treated as a significant expansion. All the facts and circumstances determine whether a change in tertiary recovery method is treated as a significant expansion. Among the factors considered are whether the change in tertiary recovery method is in accordance with sound engineering principles and whether the change in method will result in more than an insignificant increase in the amount of crude oil that would be recovered using the previous method. A more intensive application of a tertiary recovery method after December 31, 1990, is not treated as a significant expansion.
(5) Examples. The following examples illustrate the principles of this paragraph (d).
(e) Qualified tertiary recovery methods—(1) In general. For purposes of paragraph (a)(1) of this section, a “qualified tertiary recovery method” is any one or any combination of the tertiary recovery methods described in paragraph (e)(2) of this section. To account for advances in enhanced oil recovery technology, the Internal Revenue Service may by revenue ruling prescribe that a method not described in paragraph (e)(2) of this section is a “qualified tertiary recovery method.” In addition, a taxpayer may request a private letter ruling that a method not described in paragraph (e)(2) of this section or in a revenue ruling is a qualified tertiary recovery method. Generally, the methods identified in revenue rulings or private letter rulings will be limited to those methods that involve the displacement of oil from the reservoir rock by means of modifying the properties of the fluids in the reservoir or providing the energy and drive mechanism to force the oil to flow to a production well. The recovery methods described in paragraph (e)(3) of this section are not “qualified tertiary recovery methods.”
(2) Tertiary recovery methods that qualify—(i) Thermal recovery methods—(A) Steam drive injection. The continuous injection of steam into one set of wells (injection wells) or other injection source to effect oil displacement toward and production from a second set of wells (production wells);
(B) Cyclic steam injection—The alternating injection of steam and production of oil with condensed steam from the same well or wells; and
(C) In situ combustion. The combustion of oil or fuel in the reservoir sustained by injection of air, oxygen-enriched air, oxygen, or supplemental fuel supplied from the surface to displace unburned oil toward producing wells. This process may include the concurrent, alternating, or subsequent injection of water.
(ii) Gas Flood recovery methods—(A) Miscible fluid displacement. The injection of gas (e.g., natural gas, enriched natural gas, a liquified petroleum slug driven by natural gas, carbon dioxide, nitrogen, or flue gas) or alcohol into the reservoir at pressure levels such that the gas or alcohol and reservoir oil are miscible;
(B) Carbon dioxide augmented waterflooding. The injection of carbonated water, or water and carbon dioxide, to increase waterflood efficiency;
(C) Immiscible carbon dioxide displacement. The injection of carbon dioxide into an oil reservoir to effect oil displacement under conditions in which miscibility with reservoir oil is not obtained. This process may include the concurrent, alternating, or subsequent injection of water; and
(D) Immiscible nonhydrocarbon gas displacement. The injection of nonhydrocarbon gas (e.g., nitrogen) into an oil reservoir, under conditions in which miscibility with reservoir oil is not obtained, to obtain a chemical or physical reaction (other than pressure) between the oil and the injected gas or between the oil and other reservoir fluids. This process may include the concurrent, alternating, or subsequent injection of water.
(iii) Chemical flood recovery methods—(A) Microemulsion flooding. The injection of a surfactant system (e.g., a surfactant, hydrocarbon, cosurfactant, electrolyte, and water) to enhance the displacement of oil toward producing wells; and
(B) Caustic flooding—The injection of water that has been made chemically basic by the addition of alkali metal hydroxides, silicates, or other chemicals.
(iv) Mobility control recovery method—Polymer augmented waterflooding. The injection of polymeric additives with water to improve the areal and vertical sweep efficiency of the reservoir by increasing the viscosity and decreasing the mobility of the water injected. Polymer augmented waterflooding does not include the injection of polymers for the purpose of modifying the injection profile of the wellbore or the relative permeability of various layers of the reservoir, rather than modifying the water-oil mobility ratio.
(3) Recovery methods that do not qualify. The term “qualified tertiary recovery method” does not include—
(i) Waterflooding—The injection of water into an oil reservoir to displace oil from the reservoir rock and into the bore of the producing well;
(ii) Cyclic gas injection—The increase or maintenance of pressure by injection of hydrocarbon gas into the reservoir from which it was originally produced;
(iii) Horizontal drilling—The drilling of horizontal, rather than vertical, wells to penetrate hydrocarbon bearing formations;
(iv) Gravity drainage—The production of oil by gravity flow from drainholes that are drilled from a shaft or tunnel dug within or below the oil bearing zones; and
(v) Other methods—Any recovery method not specifically designated as a qualified tertiary recovery method in either paragraph (e)(2) of this section or in a revenue ruling or private letter ruling described in paragraph (e)(1) of this section.
(4) Examples. The following examples illustrate the principles of this paragraph (e).
§ 1.43-3 Certification
(a) Petroleum engineer’s certification of a project—(1) In general. A petroleum engineer must certify, under penalties of perjury, that an enhanced oil recovery project meets the requirements of section 43(c)(2)(A). A petroleum engineer’s certification must be submitted for each project. The petroleum engineer certifying a project must be duly registered or certified in any State.
(2) Timing of certification. The operator of an enhanced oil recovery project or any other operating mineral interest owner designated by the operator (“designated owner”) must submit a petroleum engineer’s certification to the Internal Revenue Service Center, Austin, Texas, or such other place as may be designated by revenue procedure or other published guidance, not later than the last date prescribed by law (including extensions) for filing the operator’s or designated owner’s federal income tax return for the first taxable year for which the enhanced oil recovery credit (the “credit”) is allowable. The operator may designate any other operating mineral interest owner (the “designated owner”) to file the petroleum engineer’s certification.
(3) Content of certification—(i) In general. A petroleum engineer’s certification must contain the following information—
(A) The name and taxpayer identification number of the operator or the designated owner submitting the certification;
(B) A statement identifying the project, including its geographic location;
(C) A statement that the project involves a tertiary recovery method (as defined in section 43(c)(2)(A)(i)) and a description of the process used, including—
(1) A description of the implementation and operation of the project sufficient to establish that it is implemented and operated in accordance with sound engineering practices;
(2) If the project involves the application of a tertiary recovery method approved in a private letter ruling described in paragraph (e)(1) of § 1.43-2, a copy of the private letter ruling, and
(3) The date on which the first injection of liquids, gases, or other matter occurred or is expected to occur.
(D) A statement that the application of a qualified tertiary recovery method or methods is expected to result in more than an insignificant increase in the amount of crude oil that ultimately will be recovered, including—
(1) Data on crude oil reserve estimates covering the project area with and without the enhanced oil recovery process,
(2) Production history prior to implementation of the project and estimates of production after implementation of the project, and
(3) An adequate delineation of the reservoir, or portion of the reservoir, from which the ultimate recovery of crude oil is expected to be increased as a result of the implementation and operation of the project; and
(E) A statement that the petroleum engineer believes that the project is a qualified enhanced oil recovery project within the meaning of section 43(c)(2)(A).
(ii) Additional information for significantly expanded projects. The petroleum engineer’s certification for a project that is significantly expanded must in addition contain—
(A) If the expansion affects reservoir volume that was substantially unaffected by a previously implemented project, an adequate delineation of the reservoir volume affected by the previously implemented project;
(B) If the expansion involves the implementation of an enhanced oil recovery project more than 36 months after the termination of a qualified tertiary recovery method that was applied before January 1, 1991, the date on which the previous tertiary recovery method terminated and an explanation of the data or assumptions relied upon to determine the termination date;
(C) If the expansion involves the implementation of an enhanced oil recovery project less than 36 months after the termination of a qualified tertiary recovery method that was applied before January 1, 1991, a copy of a private letter ruling from the Internal Revenue Service that the project implemented after December 31, 1990 is treated as a significant expansion; or
(D) If the expansion involves the application after December 31, 1990, of a tertiary recovery method or methods that do not affect reservoir volume that was substantially unaffected by the application of a different tertiary recovery method or methods before January 1, 1991, a copy of a private letter ruling from the Internal Revenue Service that the change in tertiary recovery method is treated as a significant expansion.
(b) Operator’s continued certification of a project—(1) In general. For each taxable year following the taxable year for which the petroleum engineer’s certification is submitted, the operator or designated owner must certify, under penalties of perjury, that an enhanced oil recovery project continues to be implemented substantially in accordance with the petroleum engineer’s certification submitted for the project. An operator’s certification must be submitted for each project.
(2) Timing of certification. The operator or designated owner of an enhanced oil recovery project must submit an operator’s certification to the Internal Revenue Service Center, Austin, Texas, or such other place as may be designated by revenue procedure or other published guidance, not later than the last date prescribed by law (including extensions) for filing the operator’s or designated owner’s federal income tax return for any taxable year after the taxable year for which the petroleum engineer’s certification is filed.
(3) Content of certification. An operator’s certification must contain the following information—
(i) The name and taxpayer identification number of the operator or the designated owner submitting the certification;
(ii) A statement identifying the project including its geographic location and the date on which the petroleum engineer’s certification was filed;
(iii) A statement that the project continues to be implemented substantially in accordance with the petroleum engineer’s certification (as described in paragraph (a) of this section) submitted for the project; and
(iv) A description of any significant change or anticipated change in the information submitted under paragraph (a)(3) of this section, including a change in the date on which the first injection of liquids, gases, or other matter occurred or is expected to occur.
(c) Notice of project termination—(1) In general. If the application of a tertiary recovery method is terminated, the operator or designated owner must submit a notice of project termination to the Internal Revenue Service.
(2) Timing of notice. The operator or designated owner of an enhanced oil recovery project must submit the notice of project termination to the Internal Revenue Service Center, Austin, Texas, or such other place as may be designated by revenue procedure or other published guidance, not later than the last date prescribed by law (including extensions) for filing the operator’s or designated owner’s federal income tax return for the taxable year in which the project terminates.
(3) Content of notice. A notice of project termination must contain the following information—
(i) The name and taxpayer identification number of the operator or the designated owner submitting the notice;
(ii) A statement identifying the project including its geographic location and the date on which the petroleum engineer’s certification was filed; and
(iii) The date on which the application of the tertiary recovery method was terminated.
(d) Failure to submit certification. If a petroleum engineer’s certification (as described in paragraph (a) of this section) or an operator’s certification (as described in paragraph (b) of this section) is not submitted in the time or manner prescribed by this section, the credit will be allowed only after the appropriate certifications are submitted.
§ 1.43-4 Qualified enhanced oil recovery costs.
(a) Qualifying costs—(1) In general. Except as provided in paragraph (e) of this section, amounts paid or incurred in any taxable year beginning after December 31, 1990, that are qualified tertiary injectant expenses (as described in paragraph (b)(1) of this section), intangible drilling and development costs (as described in paragraph (b)(2) of this section), and tangible property costs (as described in paragraph (b)(3) of this section) are “qualified enhanced oil recovery costs” if the amounts are paid or incurred with respect to an asset which is used for the primary purpose (as described in paragraph (c) of this section) of implementing an enhanced oil recovery project. Any amount paid or incurred in any taxable year beginning before January 1, 1991, in connection with an enhanced oil recovery project is not a qualified enhanced oil recovery cost.
(2) Costs paid or incurred for an asset which is used to implement more than one qualified enhanced oil recovery project or for other activities. Any cost paid or incurred during the taxable year for an asset which is used to implement more than one qualified enhanced oil recovery project is allocated among the projects in determining the qualified enhanced oil recovery costs for each qualified project for the taxable year. Similarly, any cost paid or incurred during the taxable year for an asset which is used to implement a qualified enhanced oil recovery project and which is also used for other activities (for example, an enhanced oil recovery project that is not a qualified enhanced oil recovery project) is allocated among the qualified enhanced oil recovery project and the other activities to determine the qualified enhanced oil recovery costs for the taxable year. See § 1.613-5(a). Any cost paid or incurred for an asset which is used to implement a qualified enhanced oil recovery project and which is also used for other activities is not required to be allocated under this paragraph (a)(2) if the use of the property for nonqualifying activities is de minimis (e.g., not greater than 10%). Costs are allocated under this paragraph (a)(2) only if the asset with respect to which the costs are paid or incurred is used for the primary purpose of implementing an enhanced oil recovery project. See paragraph (c) of this section. Any reasonable allocation method may be used. A method that allocates costs based on the anticipated use in a project or activity is a reasonable method.
(b) Costs defined—(1) Qualified tertiary injectant expenses. For purposes of this section, “qualified tertiary injectant expenses” means any costs that are paid or incurred in connection with a qualified enhanced oil recovery project and that are deductible under section 193 for the taxable year. See section 193 and § 1.193-1. Qualified tertiary injectant expenses are taken into account in determining the credit with respect to the taxable year in which the tertiary injectant expenses are deductible under section 193.
(2) Intangible drilling and development costs. For purposes of this section, “intangible drilling and development costs” means any intangible drilling and development costs that are paid or incurred in connection with a qualified enhanced oil recovery project and for which the taxpayer may make an election under section 263(c) for the taxable year. Intangible drilling and development costs are taken into account in determining the credit with respect to the taxable year in which the taxpayer may deduct the intangible drilling and development costs under section 263(c). For purposes of this paragraph (b)(2), the amount of the intangible drilling and development costs for which an integrated oil company may make an election under section 263(c) is determined without regard to section 291(b).
(3) Tangible property costs—(i) In general. For purposes of this section, “tangible property costs” means an amount paid or incurred during a taxable year for tangible property that is an integral part of a qualified enhanced oil recovery project and that is depreciable or amortizable under chapter 1. An amount paid or incurred for tangible property is taken into account in determining the credit with respect to the taxable year in which the cost is paid or incurred.
(ii) Integral part. For purposes of this paragraph (b), tangible property is an integral part of a qualified enhanced oil recovery project if the property is used directly in the project and is essential to the completeness of the project. All the facts and circumstances determine whether tangible property is used directly in a qualified enhanced oil recovery project and is essential to the completeness of the project. Generally, property used to acquire or produce the tertiary injectant or property used to transport the tertiary injectant to a project site is property that is an integral part of the project.
(4) Examples. The following examples illustrate the principles of this paragraph (b). Assume for each of these examples that the qualified enhanced oil recovery costs are paid or incurred with respect to an asset which is used for the primary purpose of implementing an enhanced oil recovery project.
(ii) The leasehold acquisition costs are not qualified enhanced oil recovery costs. However, the costs of the permit to drill are intangible drilling and development costs that are qualified costs. The costs associated with hiring the contractor to drill, constructing roads, and clearing and draining the ground are intangible drilling and development costs that are qualified enhanced oil recovery costs. The downhole equipment, the pumping units, the steam generator, and the equipment to remove the gas and water from the oil after it is produced are used directly in the project and are essential to the completeness of the project. Therefore, this equipment is an integral part of the project and the costs of the equipment are qualified enhanced oil recovery costs. Although the building that X constructs as an office and the cars and trucks X purchases to provide transportation for monitoring the wellsites are used directly in the project, they are not essential to the completeness of the project. Therefore, the building and the cars and trucks are not an integral part of the project and their costs are not qualified enhanced oil recovery costs. The cost of the water X purchases from Y is a tertiary injectant expense that is a qualified enhanced oil recovery cost. The storage tanks X acquires to store the water are required to provide a proximate source of water for the production of steam. Therefore, the water storage tank are an integral part of the project and the costs of the water storage tanks are qualified enhanced oil recovery costs.
(c) Primary purpose—(1) In general. For purposes of this section, a cost is a qualified enhanced oil recovery cost only if the cost is paid or incurred with respect to an asset which is used for the primary purpose of implementing one or more enhanced oil recovery projects, at least one of which is a qualified enhanced oil recovery project. All the facts and circumstances determine whether an asset is used for the primary purpose of implementing an enhanced oil recovery project. For purposes of this paragraph (c), an enhanced oil recovery project is a project that satisfies the requirements of paragraphs (a) (1) and (2) of section 1.43-2.
(2) Tertiary injectant costs. Tertiary injectant costs generally satisfy the primary purpose test of this paragraph (c).
(3) Intangible drilling and development costs. Intangible drilling and development costs paid or incurred with respect to a well that is used in connection with the recovery of oil by primary or secondary methods are not qualified enhanced oil recovery costs. Except as provided in this paragraph (c)(3), a well used for primary or secondary recovery is not used for the primary purpose of implementing an enhanced oil recovery project. A well drilled for the primary purpose of implementing an enhanced oil recovery project is not considered to be used for primary or secondary recovery, notwithstanding that some primary or secondary production may result when the well is drilled, provided that such primary or secondary production is consistent with the unit plan of development or other similar plan. All the facts and circumstances determine whether primary or secondary recovery is consistent with the unit plan of development or other similar plan.
(4) Tangible property costs. Tangible property costs must be paid or incurred with respect to property which is used for the primary purpose of implementing an enhanced oil recovery project.
If tangible property is used partly in a qualified enhanced oil recovery project and partly in another activity, the property must be primarily used to implement the qualified enhanced oil recovery project.
(5) Offshore drilling platforms. Amounts paid or incurred in connection with the acquisition, construction, transportation, erection, or installation of an offshore drilling platform (regardless of whether the amounts are intangible drilling and development costs) that is used in connection with the recovery of oil by primary or secondary methods are not qualified enhanced oil recovery costs. An offshore drilling platform used for primary or secondary recovery is not used for the primary purpose of implementing an enhanced oil recovery project.
(6) Examples. The following examples illustrate the principles of this paragraph (c).
Because the offshore drilling platform was used in the primary and secondary development of the field and was not used for the primary purpose of implementing tertiary development of the field, costs incurred by K in connection with the acquisition, construction, transportation, erection, or installation of the offshore drilling platform are not qualified enhanced oil recovery costs. However, the costs K incurs for the additional separator are qualified enhanced oil recovery costs because the separator is used for the primary purpose of implementing tertiary development of the field. In addition, the intangible drilling and development costs K incurs in connection with drilling the injection wells are qualified enhanced oil recovery costs with respect to which K may claim the enhanced oil recovery credit.
(d) Costs paid or incurred prior to first injection—(1) In general. Qualified enhanced oil recovery costs may be paid or incurred prior to the date of the first injection of liquids, gases, or other matter (within the meaning of § 1.43-2(c)). If the first injection of liquids, gases, or other matter occurs on or before the date the taxpayer files the taxpayer’s federal income tax return for the taxable year with respect to which the costs are allowable, the costs may be taken into account on that return. If the first injection of liquids, gases, or other matter is expected to occur after the date the taxpayer files that return, costs may be taken into account on that return if the Internal Revenue Service issues a private letter ruling to the taxpayer that so permits.
(2) First injection after filing of return for taxable year costs are allowable. Except as provided in paragraph (d)(3) of this section, if the first injection of liquids, gases, or other matter occurs or is expected to occur after the date the taxpayer files the taxpayer’s federal income tax return for the taxable year with respect to which the costs are allowable, the costs may be taken into account on an amended return (or in the case of a Coordinated Examination Program taxpayer, on a written statement treated as a qualified return) after the earlier of—
(i) The date the first injection of liquids, gases, or other matter occurs; or
(ii) The date the Internal Revenue Service issues a private letter ruling that provides that the taxpayer may take costs into account prior to the first injection of liquids, gases, or other matter.
(3) First injection more than 36 months after close of taxable year costs are paid or incurred. If the first injection of liquids, gases, or other matter occurs more than 36 months after the close of the taxable year in which costs are paid or incurred, the taxpayer may take the costs into account in determining the credit only if the Internal Revenue Service issues a private letter ruling to the taxpayer that so provides.
(4) Injections in volumes less than the volumes specified in the project plan. For purposes of this paragraph (d), injections in volumes significantly less than the volumes specified in the project plan, the unit plan of development, or another similar plan do not constitute the first injection of liquids, gases, or other matter.
(5) Examples. The following examples illustrate the provisions of paragraph (d) of this section.
(e) Other rules—(1) Anti-abuse rule. Costs paid or incurred with respect to an asset that is acquired, used, or transferred in a manner designed to duplicate or otherwise unreasonably increase the amount of the credit are not qualified enhanced oil recovery costs, regardless of whether the costs would otherwise be creditable for a single taxpayer or more than one taxpayer.
(2) Costs paid or incurred to acquire a project. A purchaser of an existing qualified enhanced oil recovery project may claim the credit for any section 43 costs in excess of the acquisition cost. However, costs paid or incurred to acquire an existing qualified enhanced oil recovery project (or an interest in an existing qualified enhanced oil recovery project) are not eligible for the credit.
(3) Examples. The following examples illustrate the principles of paragraph (e) of this section.
§ 1.43-5 At-risk limitation. [Reserved]
§ 1.43-6 Election out of section 43.
(a) Election to have the credit not apply—(1) In general. A taxpayer may elect to have section 43 not apply for any taxable year. The taxpayer may revoke an election to have section 43 not apply for any taxable year. An election to have section 43 not apply (or a revocation of an election to have section 43 not apply) for any taxable year is effective only for the taxable year to which the election relates.
(2) Time for making the election. A taxpayer may make an election under paragraph (a) of this section to have section 43 not apply (or revoke an election to have section 43 not apply) for any taxable year at any time before the expiration of the 3-year period beginning on the last date prescribed by law (determined without regard to extensions) for filing the return for the taxable year. The time for making the election (or revoking the election) is prescribed by section 43(e)(2) and may not be extended under § 1.9100-1.
(3) Manner of making the election. An election (or revocation) under paragraph (a)(1) of this section is made by attaching a statement to the taxpayer’s federal income tax return or an amended return (or, in the case of a Coordinated Examination Program taxpayer, on a written statement treated as a qualified amended return) for the taxable year for which the election (or revocation) applies. The taxpayer must indicate whether the taxpayer is electing to not have section 43 apply or is revoking such an election and designate the project or projects to which the election (or revocation) applies. For any taxable year, the last election (or revocation) made by a taxpayer within the period prescribed in paragraph (a)(2) of this section determines whether section 43 applies for that taxable year.
(b) Election by partnerships and S corporations. For partnerships and S corporations, an election to have section 43 not apply (or a revocation of an election to have section 43 not apply) for any taxable year is made, in accordance with the requirements of paragraph (a) of this section, by the partnership or S corporation with respect to the qualified enhanced oil recovery costs paid or incurred by the partnership or S corporation for the taxable year to which the election relates.
§ 1.43-7 Effective date of regulations.
The provisions of §§ 1.43-1, 1.43-2 and 1.43-4 through 1.43-7 are effective with respect to costs paid or incurred after December 31, 1991, in connection with a qualified enhanced oil recovery project. The provisions of § 1.43-3 are effective for taxable years beginning after December 31, 1990. For costs paid or incurred after December 31, 1990, and before January 1, 1992, in connection with a qualified enhanced oil recovery project, taxpayers must take reasonable return positions taking into consideration the statute and its legislative history.
§ 1.44-1 Allowance of credit for purchase of new principal residence after March 12, 1975, and before January 1, 1977.
(a) General rule. Section 44 provides a credit against the tax imposed by chapter 1 of the Internal Revenue Code of 1954 in the case of an individual who purchases a new principal residence (as defined in paragraph (a) of § 1.44-5) which is property to which section 44 applies (as provided in § 1.44-2). Subject to the limitations set forth in paragraph (b) of this section, the credit is in an amount equal to 5 percent of the purchase price (as defined in paragraph (b) of § 1.44-5).
(b) Limitations—(1) Maximum credit. The credit allowed under section 44 and this section may not exceed $2,000.
(2) Limitation to one residence. Such credit shall be allowed with respect to only one residence of the taxpayer; the combined purchase prices of more than one new principal residence cannot be aggregated to increase the credit allowed.
(3) Married individuals. In the case of a husband and wife who file a joint return under section 6013, the maximum credit allowed on the joint return is $2,000. In the case of married individuals filing separate returns the maximum credit allowable to each spouse is $1,000. Where a husband and wife do not make equal contributions with respect to the purchase price of the new principal residence, allocation of the credit is to be made in proportion to their respective ownership interests in such residence. For this purpose, tenants by the entirety or joint tenants with right of survivorship are treated as equal owners.
(4) Certain other taxpayers. Where a new principal residence is purchased by two or more taxpayers (other than a husband and wife), the amount of the credit allowed will be allocated among the taxpayers in proportion to their respective ownership interests in such residence, with the limitation that the sum of the credits allowed to all such taxpayers shall not exceed $2,000. For this purpose, joint tenants with right of survivorship are treated as equal owners. For an example of the operation of this provision see Example (2) of § 1.44-5(b)(2)(ii).
(5) Application with other credits. The credit allowed by this section shall not exceed the amount of the tax imposed by chapter 1 of the Code for the taxable year, reduced by the sum of the credits allowable under—
(i) Section 33 (relating to taxes of foreign countries and possessions of the United States),
(ii) Section 37 (relating to retirement income),
(iii) Section 38 (relating to investment in certain depreciable property),
(iv) Section 40 (relating to expenses of work incentive program),
(v) Section 41 (relating to contributions to candidates for public office), and
(vi) Section 42 (relating to personal exemptions).
§ 1.44-2 Property to which credit for purchase of new principal residence applies.
The provisions of section 44 and the regulations thereunder apply to a new principal residence which satisfies the following conditions:
(a) Construction. The construction of the residence must have begun before March 26, 1975. For this purpose construction is considered to have commenced in the following circumstances:
(1)(i) Except as provided in subparagraph (2) of this paragraph, construction is considered to commence when actual physical work of a significant amount has occurred on the building site of the residence. A significant amount of construction requires more than drilling to determine soil conditions, preparation of an architect’s sketches, securing of a building permit, or grading of the land. Land preparation and improvements such as the clearing and grading (excavation or filling), construction of roads and sidewalks, and installation of sewers and utilities are not considered commencement of construction of the residence even though they might involve a significant expenditure. However, driving pilings for the foundation, digging of the footings, excavation of the building foundation, pouring of floor slabs, or construction of compacted earthen pads when specifically prepared and designed for a particular residential structure and not merely as a part of the overall land preparation, constitute a significant amount of construction of the residence. In the case of a housing or condominium development construction of recreational facilities no matter how extensive does not by itself constitute commencement of construction of any residential unit. However, where residential units are part of a building structure, as in the case of certain condominium and cooperative housing units, then digging of the footings or excavation of the building foundation constitutes commencement of construction for all units in that building.
(ii) The rules in subdivision (i) of this subparagraph are illustrated by the following examples:
(2) Construction of a factory-made home (as defined in paragraph (e) of § 1.44-5) is considered to have commenced when construction of important parts of the factory-made home has commenced. For this purpose, commencement of construction of important parts means the cutting and shaping or welding of structural components for a specific identifiable factory-made home, whether the work was done by the manufacturer of the home or by a subcontractor thereof.
(b) Acquisition and occupancy. The residence must be acquired and occupied by the taxpayer after March 12, 1975, and before January 1, 1977. For this purpose a taxpayer “acquires” a residence when legal title to it is conveyed to him at settlement, or he has possession of it pursuant to a binding purchase contract under which he makes periodic payments until he becomes entitled under the contract to demand conveyance of title. A taxpayer “occupies” a residence when he or his spouse physically occupies it. Thus, for example, moving of furniture or other household effects into the residence or physical occupancy by a dependent child of the taxpayer is not “occupancy” for purposes of this paragraph. The credit may be claimed when both the acquisition and occupancy tests have been satisfied. Thus, where a taxpayer meets the acquisition and occupancy tests set forth above after March 12, 1975, and before January 1, 1976, the credit is allowable for 1975. Where a taxpayer occupied a residence prior to March 13, 1975, without having acquired it (as where his occupancy was pursuant to a leasing arrangement pending settlement under a binding contract to purchase or pursuant to a leasing arrangement where a written option to purchase was contained in the original lease agreement) he will nonetheless satisfy the acquisition and occupancy tests set forth above if he acquires the residence and continues to occupy it after March 12, 1975, and before January 1, 1977.
(c) Binding contract. Except in the case of self-construction, the new principal residence must be acquired by the taxpayer (within the meaning of paragraph (b) of this section) under a binding contract entered into by the taxpayer before January 1, 1976. An otherwise binding contract for the purchase of a residence which is conditioned upon the purchaser’s obtaining a loan for the purchase of the residence (including conditions as to the amount or interest rate of such loan) is considered binding notwithstanding that condition.
(d) Self-constructed residence. A self-constructed residence (as defined in paragraph (d) of § 1.44-5) must be occupied by the taxpayer before January 1, 1977. Where self-construction of a principal residence was begun before March 13, 1975, only that portion of the basis of the property allocable to construction after March 12, 1975, and before January 1, 1977, shall be taken into consideration in determining the amount of the credit allowable. For this purpose, the portion of the basis attributable to the pre-March 13 period includes the total cost of land acquired (as defined in paragraph (b) of this section) prior to March 13, 1975, on which the new principal residence is constructed and the cost of expenditures with respect to construction work performed prior to March 13, 1975. The costs incurred in stockpiling materials for later stages of construction, however, are not allocated to the pre-March 13 period. Thus, for example, if prior to March 13, 1975, a taxpayer who qualifies for the credit has constructed a portion of a residence at a cost of $10,000 (including the cost of the land purchased prior to March 13, 1975) and the total cost of the residence is $40,000 and the taxpayer’s basis after the application of section 1034(e) (relating to the reduction of basis of new principal residence where gain is not recognized upon the sale of the old residence) is $36,000, the amount subject to the credit will be $27,000:
§ 1.44-3 Certificate by seller.
(a) Requirement of certification by seller. Taxpayers claiming the credit should attach Form 5405, Credit for Purchase or Construction of New Principal Residence, to their tax returns on which the credit is claimed. Except in the case of self-construction (as defined in § 1.44-5(d)), taxpayers must attach a certification by the seller that construction of the residence began before March 26, 1975, and that the purchase price is the lowest price at which the residence was offered for sale after February 28, 1975. For purposes of section 44(e)(4) and this section, the term “price” generally does not include costs of acquisition other than the amount of the consideration from the purchaser to the seller. However, for rules relating to adjustments in price due to changes in financing terms and closing costs see paragraph (d)(2) of this section.
(b) Form of certification. The following form of the certification statement is suggested:
I certify that the construction of the residence at (specify address) was begun before March 26, 1975, and that this residence has not been offered for sale after February 28, 1975 in a listing, a written private offer, or an offer by means of advertisement at a lower purchase price than (state price), the price at which I sold the residence to (state name, present address, and social security number of purchaser) by contract dated (give date).
(Date, seller’s signature and taxpayer identification number.)
(c) Offer to sell. (1) For purposes of section 44(e)(4) and this section, an offer to sell is limited to an offer to sell a specified residence at a specified purchase price.
(2) An “offer” includes any written offer, whether made to a particular purchaser or to the public, and any offer by means of advertising. Advertising includes an offer to sell published by billboards, flyers, brochures, price lists (unless the lists are exclusively for the internal use of the seller and are not made available to the public), mailings, newspapers, periodicals, radio, or television. The listing of a property with a real estate agency, the filing of a prospectus and the registration of construction plans and price lists with the appropriate authorities (in the case of condominiums or cooperative housing developments) are to be considered offers made to the public.
(3) An offer to sell a specified residence includes:
(i) Both an offer to sell an existing residence and an offer to build and sell a residence of substantially the same design or model as that purchased by the taxpayer on the same lot as that on which the taxpayer’s new principal residence was constructed. It does not include an offer to sell the same model residence on a different lot. Where a residence of a particular design or model is offered at a specific base price, additions of property to the residence, no matter how extensive, will not result in the residence being treated as a different residence for the purpose of determining the lowest offer (as defined in paragraph (f) of § 1.44-5).
(ii) In the case of a condominium or cooperative housing development where units are offered for sale on the basis of models (e.g., all Model C two-bedroom apartments sell at a specified base price), an offer to sell a specified residence includes an offer to sell a specific type of unit (with appropriate adjustments to be made for the location of such unit and as provided in paragraph (d) of this section).
(iii) In the case of a factory-made home, an offer to sell a specified residence includes an offer to sell the same model home as that purchased by the taxpayer, provided that the offer is made after the seller has the right to sell the home purchased by the taxpayer (i.e., has that specific home in his inventory). However, it does not include an offer to sell such home with land which is not included in the taxpayer’s purchase nor an offer to sell such home without land which is included in the taxpayer’s purchase. Appropriate adjustments to a prior offer shall be made as provided in paragraph (d) of this section, including adjustments for any delivery and installation charges as provided in paragraph (d)(3).
(iv) The rules of this subparagraph may be illustrated by the following examples:
(4) A specified purchase price means a stated definite price for a particular residence or a specific base price for a residence of a particular model or design. An offer to sell for an indefinite price (e.g., an advertisement that all houses sell in the $40,000’s) is not considered an offer to sell at a specified purchase price.
(5) An offer to sell includes an offer to sell subject to special conditions imposed by the seller. Thus, if the lowest price at which a house was advertised was “at $40,000 for March only”, the $40,000 price would be the lowest offer. However, certain conditions may necessitate adjustments in determining the lowest offer. See paragraph (d) of this section.
(6) An offer to sell two or more residences together as for example, in a bulk sale shall be disregarded, even though each residence is assigned a specific purchase price for the purpose of such a sale. With regard to factory-made homes an offer to sell does not include an offer made by the manufacturer to a dealer in such homes.
(7)(i) Where new residences are purchased at a foreclosure sale (including a conveyance by the owner in lieu of foreclosure) and prior to the foreclosure sale such residences had been offered for sale by the foreclosure seller at specified prices, the foreclosure purchaser is bound by such prices in determining the lowest offer. He is not bound by the prices paid to the foreclosure seller since such prices do not constitute voluntary offers.
(ii) For this purpose, if the foreclosure seller and foreclosure purchaser are not related parties (as defined in subdivision (iii) of this subparagraph), and if the foreclosure purchaser does not have knowledge of the date of commencement of construction and the lowest offer made by such seller with respect to each of the foreclosed residences, the foreclosure purchaser must request and try to obtain from the foreclosure seller a certificate specifying such facts. Upon a subsequent sale of a particular residence by the foreclosure purchaser, he must certify whether the price is the lowest offer for that particular residence based on the certification of the foreclosure seller, a copy of which must be attached to the certification of the foreclosure purchaser. If the foreclosure seller refuses to so certify, the foreclosure purchaser must make a reasonable effort to determine the date construction commenced and the lowest offer made by the foreclosure seller. For this purpose, reasonable effort includes the effort to locate and examine advertising and listings published or used by the foreclosure seller. If the foreclosure seller and foreclosure purchaser are related parties (as defined in subdivision (iii) of this subparagraph), the foreclosure purchaser will be considered as having knowledge of the date of the commencement of construction and the lowest offer made by such seller with respect to each of the foreclosed residences, and, upon a subsequent sale of a particular residence by the foreclosure purchaser, he must comply with the certification requirements prescribed by paragraphs (a) and (b) of this section.
(iii) For purposes of this subparagraph related parties shall include the relationships described in subparagraph (2) of § 1.44-5(c), and the constructive ownership rules of section 318 shall apply, but family members for this purpose shall include spouses, ancestors, and lineal descendants.
(d) Adjustments in determining lowest price. (1)(i) In determining whether a residence was sold at the lowest offer appropriate adjustment shall be made for differences in the property offered and in the terms of the sale. Where the sale to the taxpayer includes property which was not the subject of the prior offer or excludes property which was included in the prior offer, the amount of the prior offer shall be adjusted to reflect the fair market value of such property, provided that, in the case of property included in the sale which was not a part of the residence at the time of execution of the contract of purchase, the taxpayer had the option to require inclusion or exclusion of such property. The fair market value of any excluded property is to be determined at the time of the prior offer, while all additions are to be valued at their fair market value on the date of execution of the contract of sale. If a seller increases his present offer to include financing or other costs of the seller in connection with his ownership of the residence, the present offer does not qualify as being the lowest offer.
(ii) The rules in subdivision (i) of this subparagraph are illustrated by the following examples:
(2) Appropriate adjustment to a prior offer to sell shall be made for differences in financing terms and closing costs which increase the seller’s actual net proceeds and the purchaser’s actual costs. A seller may pass on to the purchaser without affecting the purchase price only those additional amounts he is required to expend in connection with such differences. The seller may not by changing the financing terms or closing costs indirectly increase the purchase price. For these purposes closing costs include all charges paid at settlement for obtaining the mortgage loan and transferring real estate title. Thus, for example, where a seller previously offered a residence for sale for $40,000 and agreed to pay financing “points” required by the mortgagee, and now offers the same residence also for $40,000 but requires the purchaser to pay the points, the present offer does not constitute the lowest offer. On the other hand, a prior offer to sell based upon a large down payment by the prospective purchaser may be adjusted to reflect the additional costs to the seller of accepting a small down payment from the taxpayer. For purposes of determining the seller’s net proceeds, proceeds received by all related parties within the meaning of section 318 must be taken into account. For purposes of determining the lowest offer, where an offer provided for a rebate (e.g., of cash or of a contribution toward mortgage payments) or included, without additional charge or at less than fair market value, property not normally included in the sale of a residence (e.g., an automobile), such offer must be reduced by the amount of such rebate or by the amount by which the fair market value of such property at the time of the offer exceeds the amount paid for it by the purchaser. Thus, where a residence was advertised for sale at $40,000, but the seller agreed to pay $200 a month on the purchaser’s mortgage for 10 months, such residence is considered to have been offered for sale at $38,000.
(3) In the case of a factory-made home, where delivery and installation costs are included in the specified base price of such home an appropriate adjustment is to be made in such specified base price for differences in the fair market value of the delivery and installation in determining the lowest offer.
(e) Civil and criminal penalties. If a person certifies that the price for which the residence was sold does not exceed the lowest offer and if it is found that the price for which the residence was sold exceeded the lowest offer, then such person is liable (under section 208(b) of the Tax Reduction Act of 1975) to the purchaser for damages in an amount equal to three times the excess of the certified price over the lowest offer plus reasonable attorney’s fees. No income tax deduction shall be allowed for two-thirds of any amount paid or incurred pursuant to a judgment entered against any person in a suit based on such liability. However, attorney’s fees, court costs, and other such amounts paid or incurred with respect to such suit which meet the requirements of section 162 are deductible under that section. In addition, an individual who falsely certifies may be subject to criminal penalties. For example, section 1001 of title 18 of the United States Code provides as follows:
Whoever, in any matter within the jurisdiction of any department or agency of the United States knowingly and willfully falsifies, conceals or covers up by any trick, scheme, or device a material fact, or makes any false, fictitious or fraudulent statements or representations, or makes or uses any false writing or document knowing the same to contain any false, fictitious or fraudulent statement or entry, shall be fined not more than $10,000 or imprisoned not more than five years, or both.
(f) Denial of credit. In the absence of the taxpayer’s participation in, or knowledge of, a false certification by the seller, the credit is not denied to a taxpayer who otherwise qualifies for the credit solely because the seller has falsely certified that the new principal residence was sold at the lowest offer. However, if certification as to the commencement of construction is false, no credit is allowed since such residence does not qualify as a new principal residence construction of which began before March 26, 1975.
§ 1.44-4 Recapture for certain dispositions.
(a) In general. (1) Under section 44(d) except as provided in paragraphs (b) and (c) of this section, if the taxpayer disposes of property, with respect to the purchase of which a credit was allowed under section 44(a), at any time within 36 months after the date on which he acquired it (or, in the case of construction by the taxpayer, the date on which he first occupied it as his principal residence), then the tax imposed under chapter 1 of the Code for the taxable year in which the replacement period (as provided under subparagraph (2) of this paragraph) terminates is increased by an amount equal to the amount allowed as a credit for the purchase of such property.
(2) The replacement period is the period provided for purchase of a new principal residence under section 1034 of the Code without recognition of gain on the sale of the old residence. In the case of residences sold or exchanged after December 31, 1974, it is generally 18 months in the case of acquisition by purchase and 2 years in the case of construction by the taxpayer provided, however, that such construction has commenced within the 18-month period. Thus, a calendar-year taxpayer who disposes of his old principal residence in December 1975 and does not qualify under paragraph (b) or (c) of this section will include the amount previously allowed as additional tax on his 1977 tax return.
(3) Except as provided in paragraphs (b) and (c) of this section, section 44(d) applies to all dispositions of property, including sales (including foreclosure sales), exchanges (including tax-free exchanges such as those under sections 351, 721, and 1031), and gifts.
(4) In the case of a husband and wife who were allowed a credit under section 44(a) claimed on a joint return, for the purpose of section 44(d) and this section the credit shall be allocated between the spouses in accordance with the provisions of paragraph (b)(3) of § 1.44-1.
(b) Acquisition of a new residence. (1) Section 44(d)(1) and paragraph (a) of this section shall not apply to a disposition of property with respect to the purchase of which a credit was allowed under section 44(a) in the case of a taxpayer who purchases or constructs a new principal residence (within the meaning of § 1.44-5(a)) within the applicable replacement period provided in section 1034. In determining whether a new principal residence qualifies for purposes of this section the rules relating to construction, acquisition, and occupancy under § 1.44-2 do not apply. Where a disposition has occurred and the taxpayer’s purchase (or construction) costs of a new principal residence are less than the adjusted sales price (as defined in section 1034(b)) of the old residence, the tax imposed by chapter 1 of the Code for the taxable year following the taxable year during which disposition occurs is increased by an amount which bears the same ratio to the amount allowed as a credit for the purchase of the old residence as (i) the adjusted sales price of the old residence (within the meaning of section 1034), reduced (but not below zero) by the taxpayer’s cost of purchasing (or constructing) the new residence (within the meaning of such section) bears to (ii) the adjusted sales price of the old residence.
(2) The rules of subparagraph (1) of this paragraph may be illustrated by the following example:
(c) Certain involuntary dispositions. Section 44(d)(1) and paragraph (a) of this section shall not apply to the following:
(1) A disposition of a residence made on account of the death of any individual having a legal or equitable interest therein occurring during the 36-month period described in paragraph (a) of this section,
(2) A disposition of the residence if it is substantially or completely destroyed by a casualty described in section 165(c)(3),
(3) A disposition of the residence if it is compulsorily and involuntarily converted within the meaning of section 1033(a), or
(4) A disposition of the residence pursuant to a settlement in a divorce or legal separation proceeding where the other spouse retains the residence as principal residence (as defined in § 1.44-5(a)).
§ 1.44-5 Definitions.
For purposes of section 44 and the regulations thereunder—
(a) New principal residence. The term “new principal residence” means a principal residence, the original use of which commences with the taxpayer. The term “principal residence” has the same meaning as under section 1034 of the Code. For this purpose, the term “residence” includes, without being limited to, a single family structure, a residential unit in a condominium or cooperative housing project, a townhouse, and a factory-made home. In the case of a tenant-stockholder in a cooperative housing corporation references to property used by the taxpayer as his principal residence and references to the residence of a taxpayer shall include stock held by the tenant-stockholder in a cooperative housing project provided, however, that the taxpayer used as his principal residence the house or apartment which he was entitled as such stockholder to occupy. “Original use” of the new principal residence by the taxpayer means that such residence has never been used as a residence prior to its use as such by the taxpayer. For this purpose, a residence will qualify if the first occupancy was by the taxpayer pursuant to a lease arrangement pending settlement under a binding contract to purchase or pursuant to a lease arrangement where a written option to purchase the then existing residence was contained in the original lease agreement.
(b) Purchase price—(1) General rule. For purposes of section 44(a) and § 1.44-1, the term “purchase price” means the adjusted basis of the new principal residence on the date of acquisition and includes all amounts attributable to the acquisition or construction, but only to the extent that such amounts constitute capital expenditures and are not allowable as deductions in computing taxable income. Such capital expenditures include but are not limited to the cost of acquisition or construction, title insurance, attorney’s fees, transfer taxes, and other costs of transfer. For these purposes the adjusted basis of a factory-made home includes the cost of moving the home and setting it up as the taxpayer’s principal residence only where such cost is included in the base price of the residence; it also includes the purchase price of the land on which the home is located, but only if such land was purchased by the taxpayer after March 12, 1975 and only if the taxpayer acquired the land prior to or in conjunction with the acquisition of such factory-made home. However, the adjusted basis does not include any expenditures involved in connection with the leasing of land on which the factory-made home is located. In the case of factory-made homes the adjusted basis includes furniture only where it is included in the base price of the unit.
(2) Sale of old principal residence. (i) The adjusted basis is reduced by any gain from the sale or involuntary conversion of an old principal residence, which is not recognized due to the application of section 1033 or section 1034. However, no reduction will be made for any gain excluded from tax by reason of the special treatment provided under the tax laws in the case of a sale by a taxpayer who has attained age 65 (section 121 of the code).
(ii) The rules in subdivision (i) of this subparagraph are illustrated by the following examples:
(3) Tie-in sales. In the case of a purchase of a new principal residence which is tied in to the transfer of other property by the seller to the purchaser, whether purportedly by sale or gift, the adjusted basis of the residence is reduced by the amount of the excess of the fair market value of such other property received over the amount, if any, purportedly paid for it by the purchaser of the residence. For example, if a taxpayer receives a new car with a fair market value of $2,500 upon the purchase of a condominium apartment for a total purchase price of $40,000 (including settlement costs which are capital in nature) his adjusted basis in the residence for computation of the credit is $37,500.
(4) Basis of new principal residence. The taxpayer’s basis in his new principal residence is not in any way affected by the allowance of the credit.
(c) Purchase—(1) General rule. Except as provided in subparagraph (2) of this paragraph, the term “purchase” means any acquisition of property.
(2) Exceptions. (i) An acquisition does not qualify as a purchase for the purpose of this paragraph if the property is acquired from a person whose relationship to the person acquiring it would result in the disallowance of losses under section 267 or 707(b). Such persons include—
(A) The purchaser’s spouse, ancestors and lineal descendants,
(B) Related corporations as provided under section 267(b)(2),
(C) Related trusts as provided under section 267(b), (4), (5), (6), and (7),
(D) Related charitable organizations as provided under section 267(b)(9), and
(E) Related partnerships as provided under section 707(b)(1).
(ii) An acquisition does not qualify as a purchase for the purpose of this paragraph if the basis of the property in the hands of the person acquiring such property is determined—
(A) In whole or in part by reference to the adjusted basis of such property in the hands of the person from whom acquired (e.g., a gift under section 1015), or
(B) Under section 1014(a) (relating to property acquired from a decedent).
(d) Self-construction. The term “self-construction” means the construction of a residence (other than a factory-made home) to the taxpayer’s specifications on land already owned or leased by the taxpayer at the time of commencement of construction. Thus, where a taxpayer purchases land and either builds a residence himself or hires an architect and a contractor to build a residence on that land, the taxpayer has “self-constructed” the residence.
(e) Factory-made home. The term “factory-made homes” includes mobile homes, houseboats and prefabricated and modular homes.
(f) Lowest offer. The term “lowest offer” means the lowest price at which the residence was offered for sale after February 28, 1975.
§ 1.44B-1 Credit for employment of certain new employees.
(a) In general—(1) Targeted jobs credit. Under section 44B a taxpayer may elect to claim a credit for wages (as defined in section 51(c) paid or incurred to members of a targeted group (as defined in section 51(d)). Generally, to qualify for the credit, the wages must be paid or incurred to members of a targeted group first hired after September 26, 1978. However, wages paid of incurred to a vocational rehabilitation referral (as defined in section 51(d)(2)) hired before September 27, 1978, may qualify for the credit if a credit under section 44B (as in effect prior to enactment of the Revenue Act of 1978) was claimed for the individual by the taxpayer for a taxable year beginning before January 1, 1979. The amount of the credit shall be determined under section 51. Section 280C(b) (relating to the requirement that the deduction for wages be reduced by the amount of the credit) and the regulations thereunder will not apply to taxpayers who do not elect to claim the credit.
(2) New jobs credit. Under section 44B (as in effect prior to enactment of the Revenue Act of 1978) a taxpayer may elect to claim as a credit the amount determined under sections 51, 52, and 53 (as in effect prior to enactment of the Revenue Act of 1978). Section 280C(b) (relating to the requirement that the deduction for wages be reduced by the amount of the credit) and the regulations thereunder will not apply to taxpayers who do not elect to claim the credit.
(b) Time and manner of making election. The election to claim the targeted jobs credit and the new jobs credit is made by claiming the credit on an original return, or on an amended return, at any time before the expiration of the 3-year period beginning on the last date prescribed by law for filing the return for the taxable year (determined without regard to extensions). The election may be revoked within the above-described 3-year period by filing an amended return on which the credit is not claimed.
(c) Election by partnership, electing small business corporation, and members of a controlled group. In the case of a partnership, the election shall be made by the partnership. In the case of an electing small business corporation (as defined in section 1371(a)), the election shall be made by the corporation. In the case of a controlled group of corporations (within the meaning of section 52(a) and the regulations issued thereunder) not filing a consolidlated return under section 1501, the election shall be made by each member of the group. In the case of an affiliated group filing a consolidated return under section 1501, the election shall be made by the group.
Research Credit—For Taxable Years Beginning Before January 1, 1990
§ 1.41-0A Table of contents.
This section lists the paragraphs contained in §§ 1.41-0A, 1.41-3A, 1.41-4A and 1.41-5A.
(a) Number of years in base period.
(b) New taxpayers.
(c) Definition of base period research expenses.
(d) Special rules for short taxable years.
(1) Short determination year.
(2) Short base period year.
(3) Years overlapping the effective dates of section 41 (section 44F).
(i) Determination years.
(ii) Base period years.
(4) Number of months in a short taxable year.
(e) Examples.
(a) General rule.
(b) Activities outside the United States.
(1) In-house research.
(2) Contract research.
(c) Social sciences or humanities.
(d) Research funded by any grant, contract, or otherwise.
(1) In general.
(2) Research in which taxpayer retains no rights.
(3) Research in which the taxpayer retains substantial rights.
(i) In general.
(ii) Pro rata allocation.
(iii) Project-by-project determination.
(4) Independent research and development under the Federal Acquisition Regulations System and similar provisions.
(5) Funding determinable only in subsequent taxable year.
(6) Examples.
(a) In general.
(b) Trade or business requirement.
(c) Prepaid amounts.
(1) In general.
(2) Transfers of property.
(d) Written research agreement.
(1) In general.
(2) Agreement between a corporation and a qualified organization after June 30, 1983.
(i) In general.
(ii) Transfers of property.
(3) Agreement between a qualified fund and a qualified educational organization after June 30, 1983.
(e) Exclusions.
(1) Research conducted outside the United States.
(2) Research in the social sciences or humanities.
(f) Procedure for making an election to be treated as a qualified fund.
§ 1.41-3A Base period research expense.
(a) Number of years in base period. The term “base period” generally means the 3 taxable years immediately preceding the year for which a credit is being determined (“determination year”). However, if the first taxable year of the taxpayer ending after June 30, 1981, ends in 1981 or 1982, then with respect to that taxable year the term “base period” means the immediately preceding taxable year. If the second taxable year of the taxpayer ending after June 30, 1981, ends in 1982 or 1983, then with respect to that taxable year the term “base period” means the 2 immediately preceding taxable years.
(b) New taxpayers. If, with respect to any determination year, the taxpayer has not been in existence for the number of preceding taxable years that are included under paragraph (a) of this section in the base period for that year, then for purposes of paragraph (c)(1) of this section (relating to the determination of average qualified research expenses during the base period), the taxpayer shall be treated as—
(1) Having been in existence for that number of additional 12-month taxable years that is necessary to complete the base period specified in paragraph (a) of this section, and
(2) Having had qualified research expenses of zero in each of those additional years.
(c) Definition of base period research expenses. For any determination year, the term “base period research expenses” means the greater of—
(1) The average qualified research expenses for taxable years during the base period, or
(2) Fifty percent of the qualified research expenses for the determination year.
(d) Special rules for short taxable years—(1) Short determination year. If the determination year for which a research credit is being taken is a short taxable year, the amount taken into account under paragraph (c)(1) of this section shall be modified by multiplying that amount by the number of months in the short taxable year and dividing the result by 12.
(2) Short base period year. For purposes of paragraph (c)(1) of this section, if a year in the base period is a short taxable year, the qualified research expenses paid or incurred in the short taxable year are deemed to be equal to the qualified research expenses actually paid or incurred in that year multiplied by 12 and divided by the number of months in that year.
(3) Years overlapping the effective dates of section 41 (section 44F)—(i) Determination years. If a determination year includes months before July 1981, the determination year is deemed to be a short taxable year including only the months after June 1981. Accordingly, paragraph (d)(1) of this section is applied for purposes of determining the base period expenses for such year. See section 221(d)(2) of the Economic Recovery Tax Act of 1981.
(ii) Base period years. No adjustment is required in the case of a base period year merely because it overlaps June 30, 1981.
(4) Number of months in a short taxable year. The number of months in a short taxable year is equal to the number of whole calendar months contained in the year plus fractions for any partially included months. The fraction for a partially included month is equal to the number of days in the month that are included in the short taxable year divided by the total number of days in that month. Thus, if a short taxable year begins on January 1, 1982, and ends on June 9, 1982, it consists of 5 and 9/30 months.
(e) Examples. The following examples illustrate the application of this section.
1979 | $10x |
1980 | 150x |
1/1/81-6/30/81 | 90x |
7/1/81-12/31/81 | 110x |
1982 | 250x |
1983 | 450x |
(ii) Determination year 1982. For determination year 1982, the base period consists of the 2 immediately preceding taxable years, 1980 and 1981. The amount determined under paragraph (c)(1) of this section (the average qualified research expenses for taxable years during the base period) is $175x (($150x + $90x + $110x)/2). This amount is greater than the amount determined under paragraph (c)(2) of this section, (50 percent of $250x, or $125x). Accordingly, the amount of base period research expenses is $175x. The credit for determination year 1982 is equal to 25 percent of the excess of $250x (the qualified research expenses incurred during the determination year) over $175x (the base period research expenses).
(iii) Determination year 1983. For determination year 1983, the base period consists of the 3 immediately preceding taxable years 1980, 1981 and 1982. The amount determined under paragraph (c)(1) of this section (the average qualified research expenses for taxable years during the base period) is $200x (($150x + $200x + $250x)/3). The amount determined under paragraph (c)(2) of this section is $225x (50 percent of the $450x of qualified research expenses in 1983). Accordingly, the amount of base period research expenses is $225x. The credit for determination year 1983 is equal to 25 percent of the excess of $450x (the qualified research expenses incurred during the determination year) over $225x (the base period research expenses).
7/1/83—12/31/83 | $80x |
1984 | 200x |
1985 | 200x |
(ii) Determination year 1984. For determination year 1984, the base period consists of the 3 immediately preceding taxable years: 1981, 1982, and 1983. Under paragraph (b) of this section, Y is treated as having been in existence during years 1981 and 1982 with qualified research expenses of zero. Because July 1 through December 31, 1983 is a short taxable year, paragraph (d)(2) of this section requires that the qualified research expenses for that year be adjusted to $160x for purposes of determining the average qualified research expenses during the base period. The $160x results from the actual qualified research expenses for that year ($80x) multiplied by 12 and divided by 6 (the number of months in the short taxable year). Accordingly, the amount determined under paragraph (c)(1) of this section (the average qualified research expenses for taxable years during the base period) is $53
(iii) Determination year 1985. For determination year 1985, the base period consists of the 3 immediately preceding taxable years: 1982, 1983, and 1984. Pursuant to paragraph (b) of this section, Y is treated as having been in existence during 1982 with qualified research expenses of zero. Because July 1 through December 31, 1982, is a short taxable year, paragraph (d)(2) of this section requires that the qualified research expense for that year be adjusted to $160x for purposes of determining the average qualified research expenses for taxable years during the base period. This $160x is the actual qualified research expense for that year ($80x) multiplied by 12 and divided by 6 (the number of months in the short taxable year). Accordingly, the amount determined under paragraph (c)(1) of this section (the average qualified research expenses for taxable years during the base period) is $120x (($0x + $160x + $200x)/3). The amount determined under paragraph (c)(2) of this section is $100x (50 percent of $200x). The amount of base period research expenses is $120x. The credit for determination year 1985 is equal to 25 percent of the excess of $200x (the qualified research expenses incurred during the determination year) over $120x (the base period research expenses).
rules for computing credit for investment in certain depreciable property
§ 1.45D-0 Table of contents.
This section lists the paragraphs contained in § 1.45D-1.
(a) Current year credit.
(b) Allowance of credit.
(1) In general.
(2) Credit allowance date.
(3) Applicable percentage.
(4) Amount paid at original issue.
(c) Qualified equity investment.
(1) In general.
(2) Equity investment.
(3) Equity investments made prior to allocation.
(i) In general.
(ii) Exceptions.
(A) Allocation applications submitted by August 29, 2002.
(B) Other allocation applications.
(iii) Failure to receive allocation.
(iv) Initial investment date.
(4) Limitations.
(i) In general.
(ii) Allocation limitation.
(5) Substantially all.
(i) In general.
(ii) Direct-tracing calculation.
(iii) Safe harbor calculation.
(iv) Time limit for making investments.
(v) Reduced substantially-all percentage.
(vi) Examples.
(6) Aggregation of equity investments.
(7) Subsequent purchasers.
(8) Non-real estate qualified equity investment.
(d) Qualified low-income community investments.
(1) In general.
(i) Investment in a qualified active low-income community business or a non-real estate qualified active low-income community business.
(ii) Purchase of certain loans from CDEs.
(A) In general.
(B) Certain loans made before CDE certification.
(C) Intermediary CDEs.
(D) Examples.
(iii) Financial counseling and other services.
(iv) Investments in other CDEs.
(A) In general.
(B) Examples.
(2) Payments of, or for, capital, equity or principal.
(i) In general.
(ii) Subsequent reinvestments.
(iii) Special rule for loans.
(iv) Example.
(3) Special rule for reserves.
(4) Qualified active low-income community business.
(i) In general.
(A) Gross-income requirement.
(B) Use of tangible property.
(1) In general.
(2) Example.
(C) Services performed.
(D) Collectibles.
(E) Nonqualified financial property.
(1) In general.
(2) Construction of real property.
(ii) Proprietorships.
(iii) Portions of business.
(A) In general.
(B) Examples.
(iv) Active conduct of a trade or business.
(A) Special rule.
(B) Example.
(5) Qualified business.
(i) In general.
(ii) Rental of real property.
(iii) Exclusions.
(A) Trades or businesses involving intangibles.
(B) Certain other trades or businesses.
(C) Farming.
(6) Qualifications.
(i) In general.
(ii) Control.
(A) In general.
(B) Definition of control.
(C) Disregard of control.
(7) Financial counseling and other services.
(8) Special rule for certain loans.
(i) In general.
(ii) Example.
(9) Targeted populations.
(i) Low-income persons.
(A) Definition.
(1) In general.
(2) Area median family income.
(3) Individual’s family income.
(B) Qualified active low-income community business requirements for low-income targeted populations.
(1) In general.
(2) Employee.
(3) Owner.
(4) Derived from.
(5) Fair market value of sales, rentals, services, or other transactions.
(C) 120-percent-income restriction.
(1) In general.
(2) Population census tract location.
(D) Rental of real property for low-income targeted populations.
(1) In general.
(2) Special rule for entities whose sole business is the rental to others of real property.
(ii) Individuals who otherwise lack adequate access to loans or equity investments.
(A) In general.
(B) GO Zone Targeted Population.
(C) Qualified active low-income community business requirements for the GO Zone Targeted Population.
(1) In general.
(2) Location.
(i) In general.
(ii) Determination.
(D) 200-percent-income restriction.
(1) In general.
(2) Population census tract location.
(E) Rental of real property for the GO Zone Targeted Population.
(10) Non-real estate qualified active low-income community business.
(i) Definition.
(ii) Payments of, or for, capital, equity or principal with respect to a non-real estate qualified active low-income community business.
(A) In general.
(B) Seventh year of the 7-year credit period.
(C) Amounts received from a qualifying entity.
(D) Definition of qualifying entity.
(e) Recapture.
(1) In general.
(2) Recapture event.
(3) Redemption.
(i) Equity investment in a C corporation.
(ii) Equity investment in an S corporation.
(iii) Capital interest in a partnership.
(4) Bankruptcy.
(5) Waiver of requirement or extension of time.
(i) In general.
(ii) Manner for requesting a waiver or extension.
(iii) Terms and conditions.
(6) Cure period.
(7) Example.
(f) Basis reduction.
(1) In general.
(2) Adjustment in basis of interest in partnership or S corporation.
(g) Other rules.
(1) Anti-abuse.
(2) Reporting requirements.
(i) Notification by CDE to taxpayer.
(A) Allowance of new markets tax credit.
(B) Recapture event.
(ii) CDE reporting requirements to Secretary.
(iii) Manner of claiming new markets tax credit.
(iv) Reporting recapture tax.
(3) Other Federal tax benefits.
(i) In general.
(ii) Low-income housing credit.
(4) Bankruptcy of CDE.
(h) Effective/applicability dates.
(1) In general.
(2) Exception for certain provisions.
(3) Targeted populations.
(4) Investments in non-real estate businesses.
§ 1.45D-1 New markets tax credit.
(a) Current year credit. The current year general business credit under section 38(b)(13) includes the new markets tax credit under section 45D(a).
(b) Allowance of credit—(1) In general. A taxpayer holding a qualified equity investment on a credit allowance date which occurs during the taxable year may claim the new markets tax credit determined under section 45D(a) and this section for such taxable year in an amount equal to the applicable percentage of the amount paid to a qualified community development entity (CDE) for such investment at its original issue. Qualified equity investment is defined in paragraph (c) of this section. Credit allowance date is defined in paragraph (b)(2) of this section. Applicable percentage is defined in paragraph (b)(3) of this section. A CDE is a qualified community development entity as defined in section 45D(c). The amount paid at original issue is determined under paragraph (b)(4) of this section.
(2) Credit allowance date. The term credit allowance date means, with respect to any qualified equity investment—
(i) The date on which the investment is initially made; and
(ii) Each of the 6 anniversary dates of such date thereafter.
(3) Applicable percentage. The applicable percentage is 5 percent for the first 3 credit allowance dates and 6 percent for the other 4 credit allowance dates.
(4) Amount paid at original issue. The amount paid to the CDE for a qualified equity investment at its original issue consists of all amounts paid by the taxpayer to, or on behalf of, the CDE (including any underwriter’s fees) to purchase the investment at its original issue.
(c) Qualified equity investment—(1) In general. The term qualified equity investment means any equity investment (as defined in paragraph (c)(2) of this section) in a CDE if—
(i) The investment is acquired by the taxpayer at its original issue (directly or through an underwriter) solely in exchange for cash;
(ii) Substantially all (as defined in paragraph (c)(5) of this section) of such cash is used by the CDE to make qualified low-income community investments (as defined in paragraph (d)(1) of this section); and
(iii) The investment is designated for purposes of section 45D and this section as a qualified equity investment or a non-real estate qualified equity investment (as defined in paragraph (c)(8) of this section) by the CDE on its books and records using any reasonable method.
(2) Equity investment. The term equity investment means any stock (other than nonqualified preferred stock as defined in section 351(g)(2)) in an entity that is a corporation for Federal tax purposes and any capital interest in an entity that is a partnership for Federal tax purposes. See §§ 301.7701-1 through 301.7701-3 of this chapter for rules governing when a business entity, such as a business trust or limited liability company, is classified as a corporation or a partnership for Federal tax purposes.
(3) Equity investments made prior to allocation—(i) In general. Except as provided in paragraph (c)(3)(ii) of this section, an equity investment in an entity is not eligible to be designated as a qualified equity investment if it is made before the entity enters into an allocation agreement with the Secretary. An allocation agreement is an agreement between the Secretary and a CDE relating to a new markets tax credit allocation under section 45D(f)(2).
(ii) Exceptions. Notwithstanding paragraph (c)(3)(i) of this section, an equity investment in an entity is eligible to be designated as a qualified equity investment or a non-real estate qualified equity investment under paragraph (c)(1)(iii) of this section if—
(A) Allocation applications submitted by August 29, 2002. (1) The equity investment is made on or after April 20, 2001;
(2) The designation of the equity investment as a qualified equity investment is made for a credit allocation received pursuant to an allocation application submitted to the Secretary no later than August 29, 2002; and
(3) The equity investment otherwise satisfies the requirements of section 45D and this section; or
(B) Other allocation applications. (1) The equity investment is made on or after the date the Secretary publishes a Notice of Allocation Availability (NOAA) in the
(2) The designation of the equity investment as a qualified equity investment is made for a credit allocation received pursuant to an allocation application submitted to the Secretary under that NOAA; and
(3) The equity investment otherwise satisfies the requirements of section 45D and this section.
(iii) Failure to receive allocation. For purposes of paragraph (c)(3)(ii)(A) of this section, if the entity in which the equity investment is made does not receive an allocation pursuant to an allocation application submitted no later than August 29, 2002, the equity investment will not be eligible to be designated as a qualified equity investment. For purposes of paragraph (c)(3)(ii)(B) of this section, if the entity in which the equity investment is made does not receive an allocation under the NOAA described in paragraph (c)(3)(ii)(B)(1) of this section, the equity investment will not be eligible to be designated as a qualified equity investment.
(iv) Initial investment date. If an equity investment is designated as a qualified equity investment in accordance with paragraph (c)(3)(ii) of this section, the investment is treated as initially made on the effective date of the allocation agreement between the CDE and the Secretary.
(4) Limitations—(i) In general. The term qualified equity investment does not include—
(A) Any equity investment issued by a CDE more than 5 years after the date the CDE enters into an allocation agreement (as defined in paragraph (c)(3)(i) of this section) with the Secretary; and
(B) Any equity investment by a CDE in another CDE, if the CDE making the investment has received an allocation under section 45D(f)(2).
(ii) Allocation limitation. The maximum amount of equity investments issued by a CDE that may be designated under paragraph (c)(1)(iii) of this section by the CDE may not exceed the portion of the limitation amount allocated to the CDE by the Secretary under section 45D(f)(2).
(5) Substantially all—(i) In general. Except as provided in paragraph (c)(5)(v) of this section, the term substantially all means at least 85 percent. The substantially-all requirement must be satisfied for each annual period in the 7-year credit period using either the direct-tracing calculation under paragraph (c)(5)(ii) of this section, or the safe harbor calculation under paragraph (c)(5)(iii) of this section. For the first annual period, the substantially-all requirement is treated as satisfied if either the direct-tracing calculation under paragraph (c)(5)(ii) of this section, or the safe-harbor calculation under paragraph (c)(5)(iii) of this section, is performed on a single testing date and the result of the calculation is at least 85 percent. For each annual period other than the first annual period, the substantially-all requirement is treated as satisfied if either the direct-tracing calculation under paragraph (c)(5)(ii) of this section, or the safe harbor calculation under paragraph (c)(5)(iii) of this section, is performed every six months and the average of the two calculations for the annual period is at least 85 percent. For example, the CDE may choose the same two testing dates for all qualified equity investments regardless of the date each qualified equity investment was initially made under paragraph (b)(2)(i) of this section, provided the testing dates are six months apart. The use of the direct-tracing calculation under paragraph (c)(5)(ii) of this section (or the safe harbor calculation under paragraph (c)(5)(iii) of this section) for an annual period does not preclude the use of the safe harbor calculation under paragraph (c)(5)(iii) of this section (or the direct-tracing calculation under paragraph (c)(5)(ii) of this section) for another annual period, provided that a CDE that switches to a direct-tracing calculation must substantiate that the taxpayer’s investment is directly traceable to qualified low-income community investments from the time of the CDE’s initial investment in a qualified low-income community investment. For purposes of this paragraph (c)(5)(i), the 7-year credit period means the period of 7 years beginning on the date the qualified equity investment is initially made. See paragraph (c)(6) of this section for circumstances in which a CDE may treat more than one equity investment as a single qualified equity investment.
(ii) Direct-tracing calculation. The substantially-all requirement is satisfied if at least 85 percent of the taxpayer’s investment is directly traceable to qualified low-income community investments as defined in paragraph (d)(1) of this section. The direct-tracing calculation is a fraction the numerator of which is the CDE’s aggregate cost basis determined under section 1012 in all of the qualified low-income community investments that are directly traceable to the taxpayer’s cash investment, and the denominator of which is the amount of the taxpayer’s cash investment under paragraph (b)(4) of this section. For purposes of this paragraph (c)(5)(ii), cost basis includes the cost basis of any qualified low-income community investment that becomes worthless. See paragraph (d)(2) of this section for the treatment of amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment.
(iii) Safe harbor calculation. The substantially-all requirement is satisfied if at least 85 percent of the aggregate gross assets of the CDE are invested in qualified low-income community investments as defined in paragraph (d)(1) of this section. The safe harbor calculation is a fraction the numerator of which is the CDE’s aggregate cost basis determined under section 1012 in all of its qualified low-income community investments, and the denominator of which is the CDE’s aggregate cost basis determined under section 1012 in all of its assets. For purposes of this paragraph (c)(5)(iii), cost basis includes the cost basis of any qualified low-income community investment that becomes worthless. See paragraph (d)(2) of this section for the treatment of amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment.
(iv) Time limit for making investments. The taxpayer’s cash investment received by a CDE is treated as invested in a qualified low-income community investment as defined in paragraph (d)(1) of this section only to the extent that the cash is so invested within the 12-month period beginning on the date the cash is paid by the taxpayer (directly or through an underwriter) to the CDE.
(v) Reduced substantially-all percentage. For purposes of the substantially-all requirement (including the direct-tracing calculation under paragraph (c)(5)(ii) of this section and the safe harbor calculation under paragraph (c)(5)(iii) of this section), 85 percent is reduced to 75 percent for the seventh year of the 7-year credit period (as defined in paragraph (c)(5)(i) of this section).
(vi) Examples. The following examples illustrate an application of this paragraph (c)(5):
(1) X does not satisfy the substantially-all requirement using the safe harbor calculation under paragraph (c)(5)(iii) of this section;
(2) A’s equity investment satisfies the substantially-all requirement using the direct-tracing calculation because A’s equity investment is directly traceable to Y; and
(3) B’s equity investment does not satisfy the substantially-all requirement because B’s equity investment is traceable to Z.
(6) Aggregation of equity investments. A CDE may treat any qualified equity investments issued on the same day as one qualified equity investment. If a CDE aggregates equity investments under this paragraph (c)(6), the rules in this section shall be construed in a manner consistent with that treatment.
(7) Subsequent purchasers. A qualified equity investment includes any equity investment that would (but for paragraph (c)(1)(i) of this section) be a qualified equity investment in the hands of the taxpayer if the investment was a qualified equity investment in the hands of a prior holder.
(8) Non-real estate qualified equity investment. If a qualified equity investment is designated as a non-real estate qualified equity investment under paragraph (c)(1)(iii) of this section, then the qualified equity investment may only satisfy the substantially-all requirement under paragraph (c)(5) of this section if the CDE makes qualified low-income community investments that are directly traceable (including investments made through one or more CDEs) to non-real estate qualified active low-income community businesses (as defined in paragraph (d)(10) of this section). The proceeds of a non-real estate qualified equity investment cannot be used for transactions involving a qualified active low-income community business that is not a non-real estate qualified active low-income community business.
(d) Qualified low-income community investments—(1) In general. The term qualified low-income community investment means any of the following:
(i) Investment in a qualified active low-income community business or a non-real estate qualified active low-income community business. Any capital or equity investment in, or loan to, any qualified active low-income community business (as defined in paragraph (d)(4) of this section) or any non-real estate qualified active low-income community business (as defined in paragraph (d)(10) of this section).
(ii) Purchase of certain loans from CDEs—(A) In general. The purchase by a CDE (the ultimate CDE) from another CDE (whether or not that CDE has received an allocation from the Secretary under section 45D(f)(2)) of any loan made by such entity that is a qualified low-income community investment. A loan purchased by the ultimate CDE from another CDE is a qualified low-income community investment if it qualifies as a qualified low-income community investment either—
(1) At the time the loan was made; or
(2) At the time the ultimate CDE purchases the loan.
(B) Certain loans made before CDE certification. For purposes of paragraph (d)(1)(ii)(A) of this section, a loan by an entity is treated as made by a CDE, notwithstanding that the entity was not a CDE at the time it made the loan, if the entity is a CDE at the time it sells the loan.
(C) Intermediary CDEs. For purposes of paragraph (d)(1)(ii)(A) of this section, the purchase of a loan by the ultimate CDE from a CDE that did not make the loan (the second CDE) is treated as a purchase of the loan by the ultimate CDE from the CDE that made the loan (the originating CDE) if—
(1) The second CDE purchased the loan from the originating CDE (or from another CDE); and
(2) Each entity that sold the loan was a CDE at the time it sold the loan.
(D) Examples. The following examples illustrate an application of this paragraph (d)(1)(ii):
(iii) Financial counseling and other services. Financial counseling and other services (as defined in paragraph (d)(7) of this section) provided to any qualified active low-income community business, or to any residents of a low-income community (as defined in section 45D(e)).
(iv) Investments in other CDEs—(A) In general. Any equity investment in, or loan to, any CDE (the second CDE) by a CDE (the primary CDE), but only to the extent that the second CDE uses the proceeds of the investment or loan—
(1) In a manner—
(i) That is described in paragraph (d)(1)(i) or (iii) of this section; and
(ii) That would constitute a qualified low-income community investment if it were made directly by the primary CDE;
(2) To make an equity investment in, or loan to, a third CDE that uses such proceeds in a manner described in paragraph (d)(1)(iv)(A)(1) of this section; or
(3) To make an equity investment in, or loan to, a third CDE that uses such proceeds to make an equity investment in, or loan to, a fourth CDE that uses such proceeds in a manner described in paragraph (d)(1)(iv)(A)(1) of this section.
(B) Examples. The following examples illustrate an application of paragraph (d)(1)(iv)(A) of this section:
(2) Payments of, or for, capital, equity or principal—(i) In general. Except as otherwise provided in this paragraph (d)(2), amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment must be reinvested by the CDE in a qualified low-income community investment no later than 12 months from the date of receipt to be treated as continuously invested in a qualified low-income community investment. If the amounts received by the CDE are equal to or greater than the cost basis of the original qualified low-income community investment (or applicable portion thereof), and the CDE reinvests, in accordance with this paragraph (d)(2)(i), an amount at least equal to such original cost basis, then an amount equal to such original cost basis will be treated as continuously invested in a qualified low-income community investment. In addition, if the amounts received by the CDE are equal to or greater than the cost basis of the original qualified low-income community investment (or applicable portion thereof), and the CDE reinvests, in accordance with this paragraph (d)(2)(i), an amount less than such original cost basis, then only the amount so reinvested will be treated as continuously invested in a qualified low-income community investment. If the amounts received by the CDE are less than the cost basis of the original qualified low-income community investment (or applicable portion thereof), and the CDE reinvests an amount in accordance with this paragraph (d)(2)(i), then the amount treated as continuously invested in a qualified low-income community investment will equal the excess (if any) of such original cost basis over the amounts received by the CDE that are not so reinvested. Amounts received by a CDE in payment of, or for, capital, equity or principal with respect to a qualified low-income community investment during the seventh year of the 7-year credit period (as defined in paragraph (c)(5)(i) of this section) do not have to be reinvested by the CDE in a qualified low-income community investment in order to be treated as continuously invested in a qualified low-income community investment.
(ii) Subsequent reinvestments. In applying paragraph (d)(2)(i) of this section to subsequent reinvestments, the original cost basis is reduced by the amount (if any) by which the original cost basis exceeds the amount determined to be continuously invested in a qualified low-income community investment.
(iii) Special rule for loans. Periodic amounts received during a calendar year as repayment of principal on a loan that is a qualified low-income community investment are treated as continuously invested in a qualified low-income community investment if the amounts are reinvested in another qualified low-income community investment by the end of the following calendar year.
(iv) Example. The application of paragraphs (d)(2)(i) and (ii) of this section is illustrated by the following example:
(3) Special rule for reserves. Reserves (not in excess of 5 percent of the taxpayer’s cash investment under paragraph (b)(4) of this section) maintained by the CDE for loan losses or for additional investments in existing qualified low-income community investments are treated as invested in a qualified low-income community investment under paragraph (d)(1) of this section. Reserves include fees paid to third parties to protect against loss of all or a portion of the principal of, or interest on, a loan that is a qualified low-income community investment.
(4) Qualified active low-income community business—(i) In general. The term qualified active low-income community business means, with respect to any taxable year, a corporation (including a nonprofit corporation) or a partnership engaged in the active conduct of a qualified business (as defined in paragraph (d)(5) of this section), if the requirements of paragraphs (d)(4)(i)(A), (B), (C), (D), and (E) of this section are met (or in the case of an entity serving targeted populations, if the requirements of paragraphs (d)(4)(i)(D), (E), and (d)(9)(i) or (ii) of this section are met). Solely for purposes of this section, a nonprofit corporation will be deemed to be engaged in the active conduct of a trade or business if it is engaged in an activity that furthers its purpose as a nonprofit corporation.
(A) Gross-income requirement. At least 50 percent of the total gross income of such entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within any low-income community (as defined in section 45D(e)). An entity is deemed to satisfy this paragraph (d)(4)(i)(A) if the entity meets the requirements of either paragraph (d)(4)(i)(B) or (C) of this section, if “50 percent” is applied instead of 40 percent. In addition, an entity may satisfy this paragraph (d)(4)(i)(A) based on all the facts and circumstances. See paragraph (d)(4)(iv) of this section for certain circumstances in which an entity will be treated as engaged in the active conduct of a trade or business. See paragraph (d)(9) of this section for rules relating to targeted populations.
(B) Use of tangible property—(1) In general. At least 40 percent of the use of the tangible property of such entity (whether owned or leased) is within any low-income community. This percentage is determined based on a fraction the numerator of which is the average value of the tangible property owned or leased by the entity and used by the entity during the taxable year in a low-income community and the denominator of which is the average value of the tangible property owned or leased by the entity and used by the entity during the taxable year. Property owned by the entity is valued at its cost basis as determined under section 1012. Property leased by the entity is valued at a reasonable amount established by the entity. See paragraph (d)(9) of this section for rules relating to targeted populations.
(2) Example. The application of paragraph (d)(4)(i)(B)(1) of this section is illustrated by the following example:
(C) Services performed. At least 40 percent of the services performed for such entity by its employees are performed in a low-income community. This percentage is determined based on a fraction the numerator of which is the total amount paid by the entity for employee services performed in a low-income community during the taxable year and the denominator of which is the total amount paid by the entity for employee services during the taxable year. If the entity has no employees, the entity is deemed to satisfy this paragraph (d)(4)(i)(C), and paragraph (d)(4)(i)(A) of this section, if the entity meets the requirement of paragraph (d)(4)(i)(B) of this section if “85 percent” is applied instead of 40 percent. See paragraph (d)(9) of this section for rules relating to targeted populations.
(D) Collectibles. Less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to collectibles (as defined in section 408(m)(2)) other than collectibles that are held primarily for sale to customers in the ordinary course of business.
(E) Nonqualified financial property—(1) In general. Less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property. For purposes of the preceding sentence, the term nonqualified financial property means debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, annuities, and other similar property except that such term does not include—
(i) Reasonable amounts of working capital held in cash, cash equivalents, or debt instruments with a term of 18 months or less (because the definition of nonqualified financial property includes debt instruments with a term in excess of 18 months, banks, credit unions, and other financial institutions are generally excluded from the definition of a qualified active low-income community business); or
(ii) Debt instruments described in section 1221(a)(4).
(2) Construction of real property. For purposes of paragraph (d)(4)(i)(E)(1)(i) of this section, the proceeds of a capital or equity investment or loan by a CDE that will be expended for construction of real property within 12 months after the date the investment or loan is made are treated as a reasonable amount of working capital.
(ii) Proprietorships. Any business carried on by an individual as a proprietor is a qualified active low-income community business if the business would meet the requirements of paragraph (d)(4)(i) of this section if the business were incorporated.
(iii) Portions of business—(A) In general. A CDE may treat any trade or business (or portion thereof) as a qualified active low-income community business if the trade or business (or portion thereof) would meet the requirements of paragraph (d)(4)(i) of this section if the trade or business (or portion thereof) were separately incorporated and a complete and separate set of books and records is maintained for that trade or business (or portion thereof). However, the CDE’s capital or equity investment or loan is not a qualified low-income community investment under paragraph (d)(1)(i) of this section to the extent the proceeds of the investment or loan are not used for the trade or business (or portion thereof) that is treated as a qualified active low-income community business under this paragraph (d)(4)(iii)(A).
(B) Examples. The following examples illustrate an application of paragraph (d)(4)(iii) of this section:
(iv) Active conduct of a trade or business—(A) Special rule. For purposes of paragraph (d)(4)(i) of this section, an entity will be treated as engaged in the active conduct of a trade or business if, at the time the CDE makes a capital or equity investment in, or loan to, the entity, the CDE reasonably expects that the entity will generate revenues (or, in the case of a nonprofit corporation, engage in an activity that furthers its purpose as a nonprofit corporation) within 3 years after the date the investment or loan is made. This paragraph (d)(4)(iv) applies only for purposes of determining whether an entity is engaged in the active conduct of a trade or business and does not apply for purposes of determining whether the gross-income requirement under paragraph (d)(4)(i)(A), (d)(9)(i)(B)(1)(i), or (d)(9)(ii)(C)(1)(i) of this section is satisfied.
(B) Example. The application of paragraph (d)(4)(iv)(A) of this section is illustrated by the following example:
(5) Qualified business—(i) In general. Except as otherwise provided in this paragraph (d)(5), the term qualified business means any trade or business. There is no requirement that employees of a qualified business be residents of a low-income community.
(ii) Rental of real property. The rental to others of real property located in any low-income community (as defined in section 45D(e)) is a qualified business if and only if the property is not residential rental property (as defined in section 168(e)(2)(A)) and there are substantial improvements located on the real property. However, a CDE’s investment in or loan to a business engaged in the rental of real property is not a qualified low-income community investment under paragraph (d)(1)(i) of this section to the extent a lessee of the real property is described in paragraph (d)(5)(iii)(B) of this section.
(iii) Exclusions—(A) Trades or businesses involving intangibles. The term qualified business does not include any trade or business consisting predominantly of the development or holding of intangibles for sale or license.
(B) Certain other trades or businesses. The term qualified business does not include any trade or business consisting of the operation of any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.
(C) Farming. The term qualified business does not include any trade or business the principal activity of which is farming (within the meaning of section 2032A(e)(5)(A) or (B)) if, as of the close of the taxable year of the taxpayer conducting such trade or business, the sum of the aggregate unadjusted bases (or, if greater, the fair market value) of the assets owned by the taxpayer that are used in such a trade or business, and the aggregate value of the assets leased by the taxpayer that are used in such a trade or business, exceeds $500,000. For purposes of this paragraph (d)(5)(iii)(C), two or more trades or businesses will be treated as a single trade or business under rules similar to the rules of section 52(a) and (b).
(6) Qualifications—(i) In general. Except as provided in paragraph (d)(6)(ii) of this section, an entity is treated as a qualified active low-income community business for the duration of the CDE’s investment in the entity if the CDE reasonably expects, at the time the CDE makes the capital or equity investment in, or loan to, the entity, that the entity will satisfy the requirements to be a qualified active low-income community business under paragraph (d)(4)(i) of this section throughout the entire period of the investment or loan.
(ii) Control—(A) In general. If a CDE controls or obtains control of an entity at any time during the 7-year credit period (as defined in paragraph (c)(5)(i) of this section), the entity will be treated as a qualified active low-income community business only if the entity satisfies the requirements of paragraph (d)(4)(i) of this section throughout the entire period the CDE controls the entity.
(B) Definition of control. Control means, with respect to an entity, direct or indirect ownership (based on value) or control (based on voting or management rights) of more than 50 percent of the entity. For purposes of the preceding sentence, the term management rights means the power to influence the management policies or investment decisions of the entity.
(C) Disregard of control. For purposes of paragraph (d)(6)(ii)(A) of this section, the acquisition of control of an entity by a CDE is disregarded during the 12-month period following such acquisition of control (the 12-month period) if—
(1) The CDE’s capital or equity investment in, or loan to, the entity met the requirements of paragraph (d)(6)(i) of this section when initially made;
(2) The CDE’s acquisition of control of the entity is due to financial difficulties of the entity that were unforeseen at the time the investment or loan described in paragraph (d)(6)(ii)(C)(1) of this section was made; and
(3) If the acquisition of control occurs before the seventh year of the 7-year credit period (as defined in paragraph (c)(5)(i) of this section), either—
(i) The entity satisfies the requirements of paragraph (d)(4) of this section by the end of the 12-month period; or
(ii) The CDE sells or causes to be redeemed the entire amount of the investment or loan described in paragraph (d)(6)(ii)(C)(1) of this section and, by the end of the 12-month period, reinvests the amount received in respect of the sale or redemption in a qualified low-income community investment under paragraph (d)(1) of this section. For this purpose, the amount treated as continuously invested in a qualified low-income community investment is determined under paragraphs (d)(2)(i) and (ii) of this section.
(7) Financial counseling and other services. The term financial counseling and other services means advice provided by the CDE relating to the organization or operation of a trade or business.
(8) Special rule for certain loans—(i) In general. For purposes of paragraphs (d)(1)(i), (ii), and (iv) of this section, a loan is treated as made by a CDE to the extent the CDE purchases the loan from the originator (whether or not the originator is a CDE) within 30 days after the date the originator makes the loan if, at the time the loan is made, there is a legally enforceable written agreement between the originator and the CDE which—
(A) Requires the CDE to approve the making of the loan either directly or by imposing specific written loan underwriting criteria; and
(B) Requires the CDE to purchase the loan within 30 days after the date the loan is made.
(ii) Example. The application of paragraph (d)(8)(i) of this section is illustrated by the following example:
(ii) On November 1, 2004, W makes an $825,000 loan to Z pursuant to the agreement between Y and W. Z is a qualified active low-income community business under paragraph (d)(4) of this section. On November 15, 2004, Y purchases the loan from W for $840,000. On December 31, 2004, X purchases the loan from Y for $850,000.
(iii) Under paragraph (d)(8)(i) of this section, the loan to Z is treated as made by Y. Y’s loan to Z is a qualified low-income community investment under paragraph (d)(1)(i) of this section. Accordingly, under paragraph (d)(1)(ii)(A) of this section, X’s purchase of the loan from Y is a qualified low-income community investment in the amount of $850,000.
(9) Targeted populations. For purposes of section 45D(e)(2), targeted populations that will be treated as a low-income community are individuals, or an identifiable group of individuals, including an Indian tribe, who are low-income persons as defined in paragraph (d)(9)(i) of this section or who are individuals who otherwise lack adequate access to loans or equity investments as defined in paragraph (d)(9)(ii) of this section.
(i) Low-income persons—(A) Definition—(1) In general. For purposes of section 45D(e)(2) and this paragraph (d)(9), an individual shall be considered to be low-income if the individual’s family income, adjusted for family size, is not more than—
(i) For metropolitan areas, 80 percent of the area median family income; and
(ii) For non-metropolitan areas, the greater of 80 percent of the area median family income, or 80 percent of the statewide non-metropolitan area median family income.
(2) Area median family income. For purposes of paragraph (d)(9)(i)(A)(1) of this section, area median family income is determined in a manner consistent with the determinations of median family income under section 8 of the Housing Act of 1937, as amended. Taxpayers must use the annual estimates of median family income released by the Department of Housing and Urban Development (HUD) and may rely on those figures until 45 days after HUD releases a new list of income limits, or until HUD’s effective date for the new list, whichever is later.
(3) Individual’s family income. For purposes of paragraph (d)(9)(i)(A)(1) of this section, an individual’s family income is determined using any one of the following three methods for measuring family income:
(i) Household income as measured by the U.S. Census Bureau,
(ii) Adjusted gross income under section 62 as reported on Internal Revenue Service Form 1040. Adjusted gross income must include the adjusted gross income of any member of the individual’s family (as defined in section 267(c)(4)) if the family member resides with the individual regardless of whether the family member files a separate return,
(iii) Household income determined under section 8 of the Housing Act of 1937, as amended.
(B) Qualified active low-income community business requirements for low-income targeted populations—(1) In general. An entity will not be treated as a qualified active low-income community business for low-income targeted populations unless—
(i) Except as provided in paragraph (d)(9)(i)(D)(2) of this section, at least 50 percent of the entity’s total gross income for any taxable year is derived from sales, rentals, services, or other transactions with individuals who are low-income persons for purposes of section 45D(e)(2) and this paragraph (d)(9);
(ii) At least 40 percent of the entity’s employees are individuals who are low-income persons for purposes of section 45D(e)(2) and this paragraph (d)(9); or
(iii) At least 50 percent of the entity is owned by individuals who are low-income persons for purposes of section 45D(e)(2) and this paragraph (d)(9).
(2) Employee. The determination of whether an employee is a low-income person must be made at the time the employee is hired. If the employee is a low-income person at the time of hire, that employee is considered a low-income person for purposes of section 45D(e)(2) and this paragraph (d)(9) throughout the time of employment, without regard to any increase in the employee’s income after the time of hire.
(3) Owner. The determination of whether an owner is a low-income person must be made at the time the qualified low-income community investment is made, or at the time the ownership interest is acquired by the owner, whichever is later. If an owner is a low-income person at the time the qualified low-income community investment is made or at the time the ownership interest is acquired by the owner, whichever is later, that owner is considered a low-income person for purposes of section 45D(e)(2) and this paragraph (d)(9) throughout the time the ownership interest is held by that owner.
(4) Derived from. For purposes of paragraph (d)(9)(i)(B)(1)(i) of this section, the term derived from includes gross income derived from:
(i) Payments made directly by low-income persons to the entity; and
(ii) Money and the fair market value of property or services provided to the entity primarily for the benefit of low-income persons, but only if the persons providing the money, property, or services do not receive a direct benefit from the entity (for this purpose, a contribution that benefits the general public is not a direct benefit).
(5) Fair market value of sales, rentals, services, or other transactions. For purposes of paragraph (d)(9)(i)(B)(1)(i) of this section, an entity with gross income that is derived from sales, rentals, services, or other transactions with both non low-income persons and low-income persons may treat the gross income derived from the sales, rentals, services, or other transactions with low-income persons as including the full fair market value even if the low-income persons do not pay fair market value.
(C) 120-percent-income restriction—(1) In general—(i) In no case will an entity be treated as a qualified active low-income community business under paragraph (d)(9)(i) of this section if the entity is located in a population census tract for which the median family income exceeds 120 percent of, in the case of a tract not located within a metropolitan area, the statewide median family income, or in the case of a tract located within a metropolitan area, the greater of statewide median family income or metropolitan area median family income (120-percent-income restriction).
(ii) The 120-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is not located in a metropolitan area.
(iii) The 120-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is located in a metropolitan area and more than 75 percent of the tract is zoned for commercial or industrial use. For this purpose, the 75 percent calculation should be made using the area of the population census tract. For purposes of this paragraph (d)(9)(i)(C)(1)(iii), property for which commercial or industrial use is a permissible zoning use will be treated as zoned for commercial or industrial use.
(2) Population census tract location—(i) For purposes of the 120-percent-income restriction, an entity will be considered to be located in a population census tract for which the median family income exceeds 120 percent of the applicable median family income under paragraph (d)(9)(i)(C)(1)(i) of this section (non-qualifying population census tract) if at least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within one or more non-qualifying population census tracts (non-qualifying gross income amount); at least 40 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts (non-qualifying tangible property usage); and at least 40 percent of the services performed for the entity by its employees are performed in one or more non-qualifying population census tracts (non-qualifying services performance).
(ii) The entity is considered to have the non-qualifying gross income amount if the entity has non-qualifying tangible property usage or non-qualifying services performance of at least 50 percent instead of 40 percent.
(iii) If the entity has no employees, the entity is considered to have the non-qualifying gross income amount and non-qualifying services performance if at least 85 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts.
(D) Rental of real property for low-income targeted populations—(1) In general. An entity that rents to others real property for low-income targeted populations and that otherwise satisfies the requirements to be a qualified business under paragraph (d)(5) of this section will be treated as located in a low-income community for purposes of paragraph (d)(5)(ii) of this section if at least 50 percent of the entity’s total gross income is derived from rentals to individuals who are low-income persons for purposes of section 45D(e)(2) and this paragraph (d)(9) or rentals to a qualified active low-income community business that meets the requirements for low-income targeted populations under paragraphs (d)(9)(i)(B)(1)(i) or (ii) and (d)(9)(i)(B)(2) of this section.
(2) Special rule for entities whose sole business is the rental to others of real property. If an entity’s sole business is the rental to others of real property under paragraph (d)(9)(i)(D)(1) of this section, then the gross income requirement in paragraph (d)(9)(i)(B)(1)(i) of this section will be considered satisfied if the entity is treated as being located in a low-income community under paragraph (d)(9)(i)(D)(1) of this section.
(ii) Individuals who otherwise lack adequate access to loans or equity investments—(A) In general. Paragraph (d)(9)(ii) of this section may be applied only with regard to qualified low-income community investments made under the increase in the new markets tax credit limitation pursuant to section 1400N(m)(2). Therefore, only CDEs with a significant mission of recovery and redevelopment of the Gulf Opportunity Zone (GO Zone) that receive an allocation from the increase described in section 1400N(m)(2) may make qualified low-income community investments from that allocation pursuant to the rules in paragraph (d)(9)(ii) of this section.
(B) GO Zone Targeted Population. For purposes of the targeted populations rules under section 45D(e)(2), an individual otherwise lacks adequate access to loans or equity investments only if the individual was displaced from his or her principal residence as a result of Hurricane Katrina or the individual lost his or her principal source of employment as a result of Hurricane Katrina (GO Zone Targeted Population). In order to meet this definition, the individual’s principal residence or principal source of employment, as applicable, must have been located in a population census tract within the GO Zone that contains one or more areas designated by the Federal Emergency Management Agency (FEMA) as flooded, having sustained extensive damage, or having sustained catastrophic damage as a result of Hurricane Katrina.
(C) Qualified active low-income community business requirements for the GO Zone Targeted Population—(1) In general. An entity will not be treated as a qualified active low-income community business for the GO Zone Targeted Population unless—
(i) At least 50 percent of the entity’s total gross income for any taxable year is derived from sales, rentals, services, or other transactions with the GO Zone Targeted Population, low-income persons as defined in paragraph (d)(9)(i) of this section, or some combination thereof;
(ii) At least 40 percent of the entity’s employees consist of the GO Zone Targeted Population, low-income persons as defined in paragraph (d)(9)(i) of this section, or some combination thereof; or
(iii) At least 50 percent of the entity is owned by the GO Zone Targeted Population, low-income persons as defined in paragraph (d)(9)(i) of this section, or some combination thereof.
(2) Location—(i) In general. In order to be a qualified active low-income community business under paragraph (d)(9)(ii)(C) of this section, the entity must be located in a population census tract within the GO Zone that contains one or more areas designated by FEMA as flooded, having sustained extensive damage, or having sustained catastrophic damage as a result of Hurricane Katrina (qualifying population census tract).
(ii) Determination—For purposes of the preceding paragraph, an entity will be considered to be located in a qualifying population census tract if at least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within one or more qualifying population census tracts (gross income requirement); at least 40 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more qualifying population census tracts (use of tangible property requirement); and at least 40 percent of the services performed for the entity by its employees are performed in one or more qualifying population census tracts (services performed requirement). The entity is deemed to satisfy the gross income requirement if the entity satisfies the use of tangible property requirement or the services performed requirement on the basis of at least 50 percent instead of 40 percent. If the entity has no employees, the entity is deemed to satisfy the services performed requirement and the gross income requirement if at least 85 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more qualifying population census tracts.
(D) 200-percent-income restriction—(1) In general—(i) In no case will an entity be treated as a qualified active low-income community business under paragraph (d)(9)(ii) of this section if the entity is located in a population census tract for which the median family income exceeds 200 percent of, in the case of a tract not located within a metropolitan area, the statewide median family income, or, in the case of a tract located within a metropolitan area, the greater of statewide median family income or metropolitan area median family income (200-percent-income restriction).
(ii) The 200-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is not located in a metropolitan area.
(iii) The 200-percent-income restriction shall not apply to an entity located within a population census tract with a population of less than 2,000 if such tract is located in a metropolitan area and more than 75 percent of the tract is zoned for commercial or industrial use. For this purpose, the 75 percent calculation should be made using the area of the population census tract. For purposes of this paragraph (d)(9)(ii)(D)(1)(iii), property for which commercial or industrial use is a permissible zoning use will be treated as zoned for commercial or industrial use.
(2) Population census tract location—(i) For purposes of the 200-percent-income restriction, an entity will be considered to be located in a population census tract for which the median family income exceeds 200 percent of the applicable median family income under paragraph (d)(9)(ii)(D)(1)(i) of this section (non-qualifying population census tract) if—at least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business (as defined in paragraph (d)(5) of this section) within one or more non-qualifying population census tracts (non-qualifying gross income amount); at least 40 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts (non-qualifying tangible property usage); and at least 40 percent of the services performed for the entity by its employees are performed in one or more non-qualifying population census tracts (non-qualifying services performance).
(ii) The entity is considered to have the non-qualifying gross income amount if the entity has non-qualifying tangible property usage or non-qualifying services performance of at least 50 percent instead of 40 percent.
(iii) If the entity has no employees, the entity is considered to have the non-qualifying gross income amount and non-qualifying services performance if at least 85 percent of the use of the tangible property of the entity (whether owned or leased) is within one or more non-qualifying population census tracts.
(E) Rental of real property for the GO Zone Targeted Population. The rental to others of real property for the GO Zone Targeted Population that otherwise satisfies the requirements to be a qualified business under paragraph (d)(5) of this section will be treated as located in a low-income community for purposes of paragraph (d)(5)(ii) of this section if at least 50 percent of the entity’s total gross income is derived from rentals to the GO Zone Targeted Population, rentals to low-income persons as defined in paragraph (d)(9)(i) of this section, or rentals to a qualified active low-income community business that meets the requirements for the GO Zone Targeted Population under paragraph (d)(9)(ii)(C)(1)(i) or (ii) of this section.
(10) Non-real estate qualified active low-income community business—(i) Definition. The term non-real estate qualified active low-income community business means any qualified active low-income community business (as defined in paragraph (d)(4) of this section) whose predominant business activity does not include the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate. For purposes of the preceding sentence, predominant business activity means a business activity that generates more than 50 percent of the business’ gross income. The purpose of the capital or equity investment in, or loan to, the non-real estate qualified active low-income community business must not be connected to the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate.
(ii) Payments of, or for, capital, equity or principal with respect to a non-real estate qualified active low-income community business—(A) In general. For purposes of paragraph (d)(2)(i) of this section, a portion of the amounts received by a CDE in payment of, or for, capital, equity, or principal with respect to a non-real estate qualified active low-income community business after year one of the 7-year credit period (as defined by paragraph (c)(5)(i) of this section) may be reinvested by the CDE in a qualifying entity (as defined in paragraph (d)(10)(ii)(D)). Any portion that the CDE chooses to reinvest in a qualifying entity must be reinvested by the CDE no later than 30 days from the date of receipt to be treated as continuously invested in a qualified low-income community investment for purposes of paragraph (d)(2)(i) of this section. If the amount reinvested in a qualifying entity exceeds the maximum aggregate portion of the non-real estate qualified equity investment, then the excess will not be treated as invested in a qualified low-income community investment. The maximum aggregate portion of the non-real estate qualified equity investment that may be reinvested into a qualifying entity, which will be treated as continuously invested in a qualified low-income community investment, may not exceed the following percentages of the non-real estate qualified equity investment in the following years:
(1) 15 percent in Year 2 of the 7-year credit period.
(2) 30 percent in Year 3 of the 7-year credit period.
(3) 50 percent in Year 4 of the 7-year credit period.
(4) 85 percent in Year 5 and Year 6 of the 7-year credit period.
(B) Seventh year of the 7-year credit period. Amounts received by a CDE in payment of, or for, capital, equity, or principal with respect to a non-real estate qualified active low-income community business (as defined in paragraph (d)(10)(i) of this section) during the seventh year of the 7-year credit period do not have to be reinvested by the CDE in a qualified low-income community investment to be treated as continuously invested in a qualified low-income community investment.
(C) Amounts received from qualifying entity. Except for the seventh year of the 7-year credit period under paragraph (d)(10)(ii)(B) of this section, amounts received from a qualifying entity must be reinvested by the CDE no later than 30 days from the date of receipt to be treated as continuously invested in a qualified low-income community investment.
(D) Definition of qualifying entity. For purposes of paragraphs (d)(10)(ii) and (d)(10)(iii) of this section, a qualifying entity is—
(1) A certified community development financial institution (certified CDFI) that is a CDE under section 45D(c)(2)(B) (as defined by 12 CFR 1805.201), which is unrelated to the CDE making the investment in the certified CDFI within the meaning of section 267(b) or section 707(b)(1); or
(2) An entity designated by the Secretary by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter).
(e) Recapture—(1) In general. If, at any time during the 7-year period beginning on the date of the original issue of a qualified equity investment in a CDE, there is a recapture event under paragraph (e)(2) of this section with respect to such investment, then the tax imposed by Chapter 1 of the Internal Revenue Code for the taxable year in which the recapture event occurs is increased by the credit recapture amount under section 45D(g)(2). A recapture event under paragraph (e)(2) of this section requires recapture of credits allowed to the taxpayer who purchased the equity investment from the CDE at its original issue and to all subsequent holders of that investment.
(2) Recapture event. There is a recapture event with respect to an equity investment in a CDE if—
(i) The entity ceases to be a CDE;
(ii) The proceeds of the investment cease to be used in a manner that satisfies the substantially-all requirement of paragraph (c)(1)(ii) of this section; or
(iii) The investment is redeemed or otherwise cashed out by the CDE.
(3) Redemption—(i) Equity investment in a C corporation. For purposes of paragraph (e)(2)(iii) of this section, an equity investment in a CDE that is treated as a C corporation for Federal tax purposes is redeemed when section 302(a) applies to amounts received by the equity holder. An equity investment is treated as cashed out when section 301(c)(2) or section 301(c)(3) applies to amounts received by the equity holder. An equity investment is not treated as cashed out when only section 301(c)(1) applies to amounts received by the equity holder.
(ii) Equity investment in an S corporation. For purposes of paragraph (e)(2)(iii) of this section, an equity investment in a CDE that is an S corporation is redeemed when section 302(a) applies to amounts received by the equity holder. An equity investment in an S corporation is treated as cashed out when a distribution to a shareholder described in section 1368(a) exceeds the accumulated adjustments account determined under § 1.1368-2 and any accumulated earnings and profits of the S corporation.
(iii) Capital interest in a partnership. In the case of an equity investment that is a capital interest in a CDE that is a partnership for Federal tax purposes, a pro rata cash distribution by the CDE to its partners based on each partner’s capital interest in the CDE during the taxable year will not be treated as a redemption for purposes of paragraph (e)(2)(iii) of this section if the distribution does not exceed the CDE’s operating income for the taxable year. In addition, a non-pro rata de minimis cash distribution by a CDE to a partner or partners during the taxable year will not be treated as a redemption. A non-pro rata de minimis cash distribution may not exceed the lesser of 5 percent of the CDE’s operating income for that taxable year or 10 percent of the partner’s capital interest in the CDE. For purposes of this paragraph (e)(3)(iii), with respect to any taxable year, operating income is the sum of:
(A) The CDE’s taxable income as determined under section 703, except that—
(1) The items described in section 703(a)(1) shall be aggregated with the non-separately stated tax items of the partnership; and
(2) Any gain resulting from the sale of a capital asset under section 1221(a) or section 1231 property shall not be included in taxable income;
(B) Deductions under section 165, but only to the extent the losses were realized from qualified low-income community investments under paragraph (d)(1) of this section;
(C) Deductions under sections 167 and 168, including the additional first-year depreciation under section 168(k);
(D) Start-up expenditures amortized under section 195; and
(E) Organizational expenses amortized under section 709.
(4) Bankruptcy. Bankruptcy of a CDE is not a recapture event.
(5) Waiver of requirement or extension of time—(i) In general. The Commissioner may waive a requirement or extend a deadline if such waiver or extension does not materially frustrate the purposes of section 45D and this section.
(ii) Manner for requesting a waiver or extension. A CDE that believes it has good cause for a waiver or an extension may request relief from the Commissioner in a ruling request. The request should set forth all the relevant facts and include a detailed explanation describing the event or events relating to the request for a waiver or an extension. For further information on the application procedure for a ruling, see Rev. Proc. 2005-1 (2005-1 I.R.B. 1) or its successor revenue procedure (see § 601.601(d)(2) of this chapter).
(iii) Terms and conditions. The granting of a waiver or an extension to a CDE under this section may require adjustments of the CDE’s requirements under section 45D and this section as may be appropriate.
(6) Cure period. If a qualified equity investment fails the substantially-all requirement under paragraph (c)(5)(i) of this section, the failure is not a recapture event under paragraph (e)(2)(ii) of this section if the CDE corrects the failure within 6 months after the date the CDE becomes aware (or reasonably should have become aware) of the failure. Only one correction is permitted for each qualified equity investment during the 7-year credit period under this paragraph (e)(6).
(7) Example. The application of this paragraph (e) is illustrated by the following example:
(f) Basis reduction—(1) In general. A taxpayer’s basis in a qualified equity investment is reduced by the amount of any new markets tax credit determined under paragraph (b)(1) of this section with respect to the investment. A basis reduction occurs on each credit allowance date under paragraph (b)(2) of this section. This paragraph (f) does not apply for purposes of sections 1202, 1400B, and 1400F.
(2) Adjustment in basis of interest in partnership or S corporation. The adjusted basis of either a partner’s interest in a partnership, or stock in an S corporation, must be appropriately adjusted to take into account adjustments made under paragraph (f)(1) of this section in the basis of a qualified equity investment held by the partnership or S corporation (as the case may be).
(g) Other rules—(1) Anti-abuse. If a principal purpose of a transaction or a series of transactions is to achieve a result that is inconsistent with the purposes of section 45D and this section, the Commissioner may treat the transaction or series of transactions as causing a recapture event under paragraph (e)(2) of this section.
(2) Reporting requirements—(i) Notification by CDE to taxpayer—(A) Allowance of new markets tax credit. A CDE must provide notice to any taxpayer who acquires a qualified equity investment in the CDE at its original issue that the equity investment is a qualified equity investment entitling the taxpayer to claim the new markets tax credit. The notice must be provided by the CDE to the taxpayer no later than 60 days after the date the taxpayer makes the investment in the CDE. The notice must contain the amount paid to the CDE for the qualified equity investment at its original issue and the taxpayer identification number of the CDE.
(B) Recapture event. If, at any time during the 7-year period beginning on the date of the original issue of a qualified equity investment in a CDE, there is a recapture event under paragraph (e)(2) of this section with respect to such investment, the CDE must provide notice to each holder, including all prior holders, of the investment that a recapture event has occurred. The notice must be provided by the CDE no later than 60 days after the date the CDE becomes aware of the recapture event.
(ii) CDE reporting requirements to Secretary. Each CDE must comply with such reporting requirements to the Secretary as the Secretary may prescribe.
(iii) Manner of claiming new markets tax credit. A taxpayer may claim the new markets tax credit for each applicable taxable year by completing Form 8874, “New Markets Credit,” and by filing Form 8874 with the taxpayer’s Federal income tax return.
(iv) Reporting recapture tax. If there is a recapture event with respect to a taxpayer’s equity investment in a CDE, the taxpayer must include the credit recapture amount under section 45D(g)(2) on the line for recapture taxes on the taxpayer’s Federal income tax return for the taxable year in which the recapture event under paragraph (e)(2) of this section occurs (or on the line for total tax, if there is no such line for recapture taxes) and write NMCR (new markets credit recapture) next to the entry space.
(3) Other Federal tax benefits—(i) In general. Except as provided in paragraph (g)(3)(ii) of this section, the availability of Federal tax benefits does not limit the availability of the new markets tax credit. Federal tax benefits that do not limit the availability of the new markets tax credit include, for example:
(A) The rehabilitation credit under section 47;
(B) All deductions under sections 167 and 168, including the additional first-year depreciation under section 168(k), and the expense deduction for certain depreciable property under section 179; and
(C) All tax benefits relating to certain designated areas such as empowerment zones and enterprise communities under sections 1391 through 1397D, the District of Columbia Enterprise Zone under sections 1400 through 1400B, renewal communities under sections 1400E through 1400J, and the New York Liberty Zone under section 1400L.
(ii) Low-income housing credit. If a CDE makes a capital or equity investment or a loan with respect to a qualified low-income building under section 42, the investment or loan is not a qualified low-income community investment under paragraph (d)(1) of this section to the extent the building’s eligible basis under section 42(d) is financed by the proceeds of the investment or loan.
(4) Bankruptcy of CDE. The bankruptcy of a CDE does not preclude a taxpayer from continuing to claim the new markets tax credit on the remaining credit allowance dates under paragraph (b)(2) of this section.
(h) Effective/applicability dates—(1) In general. Except as provided in paragraphs (h)(2), (h)(3), and (h)(4) of this section, this section applies on or after December 22, 2004, and may be applied by taxpayers before December 22, 2004. The provisions that apply before December 22, 2004, are contained in § 1.45D-1T (see 26 CFR part 1 revised as of April 1, 2003, and April 1, 2004).
(2) Exception. Paragraph (d)(5)(ii) of this section as it relates to the restriction on lessees described in paragraph (d)(5)(iii)(B) of this section applies to qualified low-income community investments made on or after June 22, 2005.
(3) Targeted populations. The rules in paragraph (d)(9) of this section and the last sentence in paragraph (d)(4)(iv)(A) of this section apply to taxable years ending on or after December 5, 2011. A taxpayer may apply the rules in paragraph (d)(9) of this section to taxable years ending before December 5, 2011 for designations made by the Secretary after October 22, 2004.
(4) Investments in non-real estate businesses. Paragraphs (c)(8) and (d)(10) of this section apply to equity investments in CDEs made on or after September 28, 2012.
§ 1.45G-0 Table of contents for the railroad track maintenance credit rules.
This section lists the table of contents for § 1.45G-1.
(a) In general.
(b) Definitions.
(1) Class II railroad and Class III railroad.
(2) Eligible railroad track.
(3) Eligible taxpayer.
(4) Qualifying railroad structure.
(5) Qualified railroad track maintenance expenditures.
(6) Rail facilities.
(7) Railroad-related property.
(8) Railroad-related services.
(9) Railroad track.
(10) Form 8900.
(11) Examples.
(c) Determination of amount of railroad track maintenance credit for the taxable year.
(1) General amount.
(2) Limitation on the credit.
(i) Eligible taxpayer is a Class II railroad or Class III railroad.
(ii) Eligible taxpayer is not a Class II railroad or Class III railroad.
(iii) No carryover of amount that exceeds limitation.
(3) Determination of amount of QRTME paid or incurred.
(i) In general.
(ii) Effect of reimbursements received from persons other than a Class II or Class III railroad.
(4) Examples.
(d) Assignment of track miles.
(1) In general.
(2) Assignment eligibility.
(3) Effective date of assignment.
(4) Assignment information statement.
(i) In general.
(ii) Assignor.
(iii) Assignee.
(iv) Special rule for returns filed prior to November 9, 2007.
(5) Special rules.
(i) Effect of subsequent dispositions of eligible railroad track during the assignment year.
(ii) Effect of multiple assignments of eligible railroad track miles during the same taxable year.
(6) Examples.
(e) Adjustments to basis.
(1) In general.
(2) Basis adjustment made to railroad track.
(3) Examples.
(f) Controlled groups.
(1) In general.
(2) Definitions.
(i) Trade or business.
(ii) Group and controlled group.
(iii) Group credit.
(iv) Consolidated group.
(v) Credit year.
(3) Computation of the group credit.
(4) Allocation of the group credit.
(5) Special rules for consolidated groups.
(i) In general.
(ii) Special rule for allocation of group credit among consolidated group members.
(6) Tax accounting periods used.
(i) In general.
(ii) Special rule when timing of QRTME is manipulated.
(7) Membership during taxable year in more than one group.
(8) Intra-group transactions.
(i) In general.
(ii) Payment for QRTME.
(g) Effective/applicability date.
(1) In general.
(2) Taxable years ending before September 7, 2006.
(3) Special rules for returns filed prior to November 9, 2007.
(4) Taxable years beginning after December 31, 2011.
(5) Taxable years beginning before January 1, 2012.
§ 1.45G-1 Railroad track maintenance credit.
(a) In general. For purposes of section 38, the railroad track maintenance credit (RTMC) for qualified railroad track maintenance expenditures (QRTME) paid or incurred by an eligible taxpayer during the taxable year is determined under this section. A taxpayer claiming the RTMC must do so by filing Form 8900, “Qualified Railroad Track Maintenance Credit,” with its timely filed (including extensions) Federal income tax return for the taxable year the RTMC is claimed. Paragraph (b) of this section provides definitions of terms. Paragraph (c) of this section provides rules for computing the RTMC, including rules regarding limitations on the amount of the credit. Paragraph (d) of this section provides rules for assigning miles of railroad track. Paragraph (e) of this section contains rules for adjusting basis for the amount of the RTMC claimed by an eligible taxpayer. Paragraph (f) of this section contains rules for computing the amount of the RTMC in the case of a controlled group, and for the allocation of the group credit among members of the controlled group.
(b) Definitions. For purposes of section 45G and this section, the following definitions apply:
(1) Class II railroad and Class III railroad have the respective meanings given to these terms by the Surface Transportation Board (STB) without regard to the controlled group rules under section 45G(e)(2).
(2) Eligible railroad track is railroad track (as defined in paragraph (b)(9) of this section) located within the United States that is owned or leased by a Class II railroad or Class III railroad at the close of its taxable year. For purposes of section 45G and this section, a Class II railroad or Class III railroad owns railroad track if the railroad track is subject to the allowance for depreciation under section 167 by the Class II railroad or Class III railroad.
(3) Eligible taxpayer is—
(i) A Class II railroad or Class III railroad during the taxable year;
(ii) Any person that transports property using the rail facilities (as defined in paragraph (b)(6) of this section) of a Class II railroad or Class III railroad during the taxable year, but only is an eligible taxpayer with respect to the miles of eligible railroad track assigned to the person for that taxable year by that Class II railroad or Class III railroad under paragraph (d) of this section; or
(iii) Any person that furnishes railroad-related property (as defined in paragraph (b)(7) of this section) or railroad-related services (as defined in paragraph (b)(8) of this section), to a Class II railroad or Class III railroad during the taxable year, but only is an eligible taxpayer with respect to the miles of eligible railroad track assigned to the person for that taxable year by that Class II railroad or Class III railroad under paragraph (d) of this section.
(4) Qualifying railroad structure is property located within the United States that is described in the following STB property accounts in 49 CFR Part 1201, Subpart A:
(i) Property Account 3, Grading.
(ii) Property Account 4, Other right-of-way expenditures.
(iii) Property Account 5, Tunnels and subways.
(iv) Property Account 6, Bridges, trestles, and culverts.
(v) Property Account 7, Elevated structures.
(vi) Property Account 8, Ties.
(vii) Property Account 9, Rails and other track material.
(viii) Property Account 11, Ballast.
(ix) Property Account 13, Fences, snowsheds, and signs.
(x) Property Account 27, Signals and interlockers.
(xi) Property Account 39, Public improvements; construction.
(5) Qualified railroad track maintenance expenditures (QRTME) are expenditures for maintaining, repairing, and improving qualifying railroad structure (as defined in paragraph (b)(4) of this section) that is owned or leased as of January 1, 2005, by a Class II railroad or Class III railroad. These expenditures may or may not be chargeable to a capital account.
(6) Rail facilities of a Class II railroad or Class III railroad are railroad yards, tracks, bridges, tunnels, wharves, docks, stations, and other related assets that are used in the transport of freight by a railroad and that are owned or leased by the Class II railroad or Class III railroad.
(7) Railroad-related property is property that is provided directly to, and is unique to, a railroad and that, in the hands of a Class II railroad or Class III railroad, is described in—
(i) The following STB property accounts in 49 CFR Part 1201, Subpart A:
(A) Property Account 3, Grading;
(B) Property Account 5, Tunnels and subways;
(C) Property Account 22, Storage warehouses; and
(ii) Asset classes 40.1 through 40.54 in the guidance issued by the Internal Revenue Service under section 168(i)(1) (for further guidance, for example, see Rev. Proc. 87-56 (1987-2 CB 674), and § 601.601(d)(2)(ii)(b) of this chapter), except that any office building, any passenger train car, and any miscellaneous structure if such structure is not provided directly to, and is not unique to, a railroad are excluded from the definition of railroad-related property.
(8) Railroad-related services are services that are provided directly to, and are unique to, a railroad and that relate to railroad shipping, loading and unloading of railroad freight, or repairs of rail facilities (as defined in paragraph (b)(6) of this section) or railroad-related property (as defined in paragraph (b)(7) of this section). Examples of railroad-related services are the transport of freight by rail; the loading and unloading of freight transported by rail; railroad bridge services; railroad track construction; providing railroad track material or equipment; locomotive leasing or rental; maintenance of railroad’s right-of-way (including vegetation control); piggyback trailer ramping; rail deramping services; and freight train cars repair services. Examples of services that are not railroad-related services are general business services, such as, accounting and bookkeeping, marketing, legal services; janitorial services; office building rental; banking services (including financing of railroad-related property); and purchasing of, or services performed on, property not described in paragraph (b)(7) of this section.
(9) Except as provided in paragraph (e)(2) of this section, railroad track is property described in STB property accounts 8 (ties), 9 (rails and other track material), and 11 (ballast) in 49 CFR part 1201, Subpart A. Double track is treated as multiple lines of railroad track, rather than as a single line of railroad track. Thus, one mile of single track is one mile, but one mile of double track is two miles.
(10) Form 8900. If Form 8900 is revised or renumbered, any reference in this section to that form shall be treated as a reference to the revised or renumbered form.
(11) Examples. The application of this paragraph (b) is illustrated by the following examples. In all examples, the taxpayers use a calendar taxable year, and are not members of a controlled group.
(c) Determination of amount of railroad track maintenance credit for the taxable year—(1) General amount. Except as provided in paragraph (c)(2) of this section, for purposes of section 38, the RTMC determined under section 45G(a) for the taxable year is equal to 50 percent of the QRTME paid or incurred (as determined under paragraph (c)(3) of this section) by an eligible taxpayer during the taxable year.
(2) Limitation on the credit—(i) Eligible taxpayer is a Class II railroad or Class III railroad. If an eligible taxpayer is a Class II railroad or Class III railroad, the RTMC determined under paragraph (c)(1) of this section for the Class II railroad or Class III railroad for any taxable year must not exceed $3,500 multiplied by the sum of—
(A) The number of miles of eligible railroad track owned or leased by the Class II railroad or Class III railroad, reduced by the number of miles of eligible railroad track assigned under paragraph (d) of this section by the Class II railroad or Class III railroad to another eligible taxpayer for that taxable year; and
(B) The number of miles of eligible railroad track owned or leased by another Class II railroad or Class III railroad that are assigned under paragraph (d) of this section to the Class II railroad or Class III railroad for the taxable year.
(ii) Eligible taxpayer is not a Class II railroad or Class III railroad. If an eligible taxpayer is not a Class II railroad or Class III railroad, the RTMC determined under paragraph (c)(1) of this section for the eligible taxpayer for any taxable year must not exceed $3,500 multiplied by the number of miles of eligible railroad track assigned under paragraph (d) of this section by a Class II railroad or Class III railroad to the eligible taxpayer for the taxable year.
(iii) No carryover of amount that exceeds limitation. Amounts that exceed the limitation under paragraph (c)(2)(i) of this section or paragraph (c)(2)(ii) of this section, may never be carried over to another taxable year.
(3) Determination of amount of QRTME paid or incurred—(i) In general. The term paid or incurred means, in the case of a taxpayer using an accrual method of accounting, a liability incurred (within the meaning of § 1.446-1(c)(1)(ii)). A liability may not be taken into account under section 45G and this section prior to the taxable year during which the liability is incurred. Any amount that an eligible taxpayer (assignee) pays a Class II railroad or Class III railroad (assignor) in exchange for an assignment of one or more miles of eligible railroad track under paragraph (d) of this section, is treated, for purposes of this section, as QRTME paid or incurred by the assignee, and not by the assignor, at the time and to the extent the assignor pays or incurs QRTME.
(ii) Effect of reimbursements received from persons other than a Class II or Class III railroad. The amount of QRTME treated as paid or incurred during the taxable year by an eligible taxpayer under paragraphs (b)(3)(ii) and (iii) of this section shall be reduced by any amount to which the eligible taxpayer is entitled to be reimbursed, directly or indirectly, from persons other than a Class II or Class III railroad.
(4) Examples. The application of this paragraph (c) is illustrated by the following examples. In all examples, the taxpayers use an accrual method of accounting and a calendar taxable year, and are not members of a controlled group.
(ii) For 2006, G determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $1,250,000 (50% multiplied by $2,500,000 QRTME incurred by G during 2006). G further determines G’s credit limitation under paragraph (c)(2)(i) of this section for 2006 to be $3,150,000 ($3,500 multiplied by 900 miles of eligible railroad track (1,000 miles owned by, or leased to, G on December 31, 2006, less 100 miles assigned by G to H in 2006)). Because G’s tentative amount of RTMC does not exceed G’s credit limitation amount for 2006, G may claim a RTMC for 2006 in the amount of $1,250,000.
(iii) For 2006, H determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $100,000 (50% multiplied by $200,000 QRTME incurred by H during 2006). H further determines H’s credit limitation under paragraph (c)(2)(ii) of this section for 2006 to be $350,000 ($3,500 multiplied by 100 miles of eligible railroad track assigned by G to H in 2006). Because H’s tentative amount of RTMC does not exceed H’s credit limitation amount for 2006, H may claim a RTMC in the amount of $100,000.
(ii) For 2006, G determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $1,250,000 (50% multiplied by $2,500,000 QRTME incurred by G during 2006). G further determines G’s credit limitation under paragraph (c)(2)(i) of this section for 2006 to be $3,325,000 ($3,500 multiplied by 950 miles of eligible railroad track (1,000 miles owned by, or leased to, G on December 31, 2006, less 50 miles assigned by G to H in 2006)). Because G’s tentative amount of RTMC does not exceed G’s credit limitation amount for 2006, G may claim a RTMC in the amount of $1,250,000.
(iii) For 2006, H determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $200,000 (50% multiplied by $400,000 QRTME incurred by H during 2006). H further determines H’s credit limitation under paragraph (c)(2)(ii) of this section for 2006 to be $175,000 ($3,500 multiplied by 50 miles of eligible railroad track assigned by G to H in 2006). Because H’s tentative amount of RTMC exceeds H’s credit limitation amount for 2006, H may claim a RTMC in the amount of $175,000 (the credit limitation amount). Under paragraph (c)(2)(iii) of this section, there is no carryover of the $25,000 (the tentative amount of $200,000 less the credit limitation amount of $175,000) that exceeds the limitation.
(ii) For 2006, in accordance with paragraph (c)(3)(ii) of this section, J is treated as having incurred QRTME in the amount of $200,000 ($1 million QRTME actually incurred by J less the $800,000 paid by K to J for the assignment of the railroad track miles in 2006). For 2006, J determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $100,000 (50% multiplied by $200,000 QRTME treated as incurred by J during 2006). J further determines J’s credit limitation amount under paragraph (c)(2)(i) of this section for 2006 to be $2,975,000 ($3,500 multiplied by 850 miles of eligible railroad track (1,000 miles owned by, or leased to, J on December 31, 2006, less 150 miles assigned by J to K in 2006)). Because J’s tentative amount of RTMC does not exceed J’s credit limitation amount for 2006, J may claim a RTMC in the amount of $100,000.
(iii) For 2006, K is an eligible taxpayer because, during 2006, K provided railroad-related property to J and received an assignment of eligible railroad track miles from J. Under paragraph (c)(3)(ii) of this section, K is treated as having incurred QRTME in the amount of $800,000 (the amount paid by K to J for the assignment of the railroad track miles in 2006). For 2006, K determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $400,000 (50% multiplied by $800,000 QRTME treated as incurred by K during 2006). K further determines K’s credit limitation amount under paragraph (c)(2)(ii) of this section for 2006 to be $525,000 ($3,500 multiplied by 150 miles of eligible railroad track assigned by J in 2006). Because K’s tentative amount of RTMC does not exceed K’s credit limitation amount for 2006, K may claim a RTMC in the amount of $400,000.
(iv) The results in this Example 3 would be the same if K sold the ties, ballast, and other track material with a fair market value of $1 million to J for $200,000 in exchange for the assignment by J of 150 miles of eligible railroad track to K.
(ii) For 2006, M is an eligible taxpayer because, during 2006, M transported property using the rail facilities of L and received an assignment of eligible railroad track miles from L. The amount of QRTME paid or incurred by M during 2006 is $500,000 and is not reduced by the reimbursement of $250,000 by L to M because, under paragraph (c)(3)(ii) of this section, QRTME is not reduced by reimbursements from Class II or Class III railroads. For 2006, M determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $250,000 (50% multiplied by $500,000 QRTME incurred by M during 2006). M further determines M’s credit limitation amount under paragraph (c)(2)(ii) of this section for 2006 to be $700,000 ($3,500 multiplied by 200 miles of eligible railroad track assigned by L to M in 2006). Because M’s tentative amount of RTMC does not exceed M’s credit limitation amount for 2006, M may claim a RTMC in the amount of $250,000.
(d) Assignment of track miles—(1) In general. An assignment of any mile of eligible railroad track under this paragraph (d) is a designation by a Class II railroad or Class III railroad that is made solely for purposes of section 45G and this section of a specific number of miles of eligible railroad track as being assigned to another eligible taxpayer for a taxable year. A designation must be in writing and must include the name and taxpayer identification number of the assignee, and the information required under the rules of paragraph (d)(4)(iii)(B) of this section. A designation requires no transfer of legal title or other indicia of ownership of the eligible railroad track, and need not specify the location of any assigned mile of eligible railroad track. Further, an assigned mile of eligible railroad track need not correspond to any specific mile of eligible railroad track with respect to which the eligible taxpayer actually pays or incurs the QRTME.
(2) Assignment eligibility. Only a Class II railroad or Class III railroad may assign a mile of eligible railroad track. If a Class II railroad or Class III railroad assigns a mile of eligible railroad track to an eligible taxpayer, the assignee is not permitted to reassign any mile of eligible railroad track to another eligible taxpayer. The maximum number of miles of eligible railroad track that may be assigned by a Class II railroad or Class III railroad for any taxable year is its total miles of eligible railroad track less the miles of eligible railroad track that the Class II railroad or Class III railroad retains for itself in determining its RTMC for the taxable year.
(3) Effective date of assignment. If a Class II railroad or Class III railroad assigns a mile of eligible railroad track, the assignment is treated as being made by the Class II railroad or Class III railroad at the close of its taxable year in which the assignment was made. With respect to the assignee, the assignment of a mile of eligible railroad track is taken into account for the taxable year of the assignee that includes the date the assignment is treated as being made by the assignor Class II railroad or Class III railroad under this paragraph (d)(3).
(4) Assignment information statement—(i) In general. A taxpayer must file Form 8900, “Qualified Railroad Track Maintenance Credit,” with its timely filed (including extensions) Federal income tax return for the taxable year for which the taxpayer assigns any mile of eligible railroad track, even if the taxpayer is not itself claiming the RTMC for that taxable year.
(ii) Assignor. Except as provided in paragraph (d)(4)(iv) of this section, a Class II railroad or Class III railroad (assignor) that assigns one or more miles of eligible railroad track during a taxable year to one or more eligible taxpayers must attach to the assignor’s Form 8900 for that taxable year an information statement providing—
(A) The name and taxpayer identification number of each assignee;
(B) The total number of miles of the assignor’s eligible railroad track;
(C) The number of miles of eligible railroad track assigned by the assignor to each assignee for the taxable year; and
(D) The total number of miles of eligible railroad track assigned by the assignor to all assignees for the taxable year.
(iii) Assignee. Except as provided in paragraph (d)(4)(iv) of this section, an eligible taxpayer (assignee) that has received an assignment of miles of eligible railroad track during its taxable year from a Class II railroad or Class III railroad, and that claims the RTMC for that taxable year, must attach to the assignee’s Form 8900 for that taxable year a statement—
(A) Providing the total number of miles of eligible railroad track assigned to the assignee for the assignee’s taxable year; and
(B) Attesting that the assignee has in writing, and has retained as part of the assignee’s records for purposes of § 1.6001-1(a), the following information from each assignor:
(1) The name and taxpayer identification number of each assignor.
(2) The date of each assignment made by each assignor (as determined under paragraph (d)(3) of this section) to the assignee;
(3) The number of miles of eligible railroad track assigned by each assignor to the assignee for the assignee’s taxable year.
(iv) Special rules for returns filed prior to November 9, 2007. If an eligible taxpayer’s Federal income tax return for a taxable year beginning after December 31, 2004, and ending before November 9, 2007, was filed before December 13, 2007, and the eligible taxpayer is not filing an amended Federal income tax return for that taxable year pursuant to paragraph (g)(2) of this section before the eligible taxpayer’s next filed original Federal income tax return, and the eligible taxpayer wants to apply paragraph (g)(2) of this section but did not include with that return the information specified in paragraph (d)(4)(ii) or (iii) of this section, as applicable, the eligible taxpayer must attach a statement containing the information specified in paragraph (d)(4)(ii) or (iii) of this section, as applicable, to either—
(A) The eligible taxpayer’s next filed original Federal income tax return; or
(B) The eligible taxpayer’s amended Federal income tax return that is filed pursuant to paragraph (g)(2) of this section, provided that amended Federal income tax return is filed by the eligible taxpayer before its next filed original Federal income tax return.
(5) Special rules—(i) Effect of subsequent dispositions of eligible railroad track during the assignment year. If a Class II railroad or Class III railroad assigns one or more miles of eligible railroad track that it owned or leased as of the actual date of the assignment, but does not own or lease any eligible railroad track at the close of the taxable year in which the assignment is made by the Class II railroad or Class III railroad, the assignment is not valid for that taxable year for purposes of section 45G and this section.
(ii) Effect of multiple assignments of eligible railroad track miles during the same taxable year. If a Class II railroad or Class III railroad assigns more miles of eligible railroad track than it owned or leased as of the close of the taxable year in which the assignment is made by the Class II railroad or Class III railroad, the assignment is valid for purposes of section 45G and this section only with respect to the name of the assignee and the number of miles listed by the assignor Class II railroad or Class III railroad on the statement required under paragraph (d)(4)(ii) of this section and only to the extent of the maximum miles of eligible railroad track that may be assigned by the assignor Class II railroad or Class III railroad as determined under paragraph (d)(2) of this section. If the total number of miles on this statement exceeds the maximum miles of eligible railroad track that may be assigned by the assignor Class II railroad or Class III railroad (as determined under paragraph (d)(2) of this section), the total number of miles on the statement shall be reduced by the excess amount of miles. This reduction is allocated among each assignee listed on the statement in proportion to the total number of miles listed on the statement for that assignee.
(6) Examples. The application of this paragraph (d) is illustrated by the following examples. In none of the examples are the taxpayers members of a controlled group:
(ii) The assignment of the 300 miles of eligible railroad track made by N to O on November 7, 2006, is treated as made on December 31, 2006 (at the close of the N’s taxable year). Consequently, the assignment is taken into account by O for O’s taxable year ending on December 31, 2006. For 2006, O is an eligible taxpayer because, during 2006, O provides railroad-related property to N and receives an assignment of 300 eligible railroad track miles from N. For 2006, O determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $50,000 (50% multiplied by $100,000 QRTME paid or incurred by O during 2006). O further determines the credit limitation amount under paragraph (c)(2)(i) of this section for 2006 to be $1,050,000 ($3,500 multiplied by 300 miles of eligible railroad track assigned by N to O on December 31, 2006). Because O’s tentative amount of RTMC does not exceed O’s credit limitation amount for 2006, O may claim a RMTC for 2006 in the amount of $50,000.
(ii) The assignment of the 300 miles of eligible railroad track made by N to O on November 7, 2006, is treated as made on December 31, 2006. As a result, the assignment is taken into account by O for O’s taxable year ending on March 31, 2007. Thus, for the taxable year ending on March 31, 2007, O determines the tentative amount of RMTC under paragraph (c)(1) of this section to be $75,000 (50% multiplied by $150,000 QRTME incurred by O during its taxable year ending March 31, 2007). Because O’s tentative amount of RTMC does not exceed O’s credit limitation amount for the taxable year ending March 31, 2007, O may claim a RMTC for the taxable year ending March 31, 2007, in the amount of $75,000.
(ii) For 2006, in accordance with paragraph (c)(3)(ii) of this section, P is treated as having incurred QRTME in the amount of $0 ($500,000 QRTME actually incurred by P less the $100,000 paid by R to P for the assignment of the 50 miles of eligible railroad track and the $400,000 paid by S to P for the assignment of the 150 miles of eligible railroad track). Further, P assigned all of its eligible railroad track miles to R and S for 2006. Accordingly, for 2006, P may not claim any RTMC.
(iii) For 2006, R is an eligible taxpayer because, during 2006, R ships property using the rail facilities of P and receives an assignment of 50 eligible railroad track miles from P. In accordance with paragraph (c)(3)(ii) of this section, R is treated as having incurred QRTME in the amount of $100,000 (the amount paid by R to P for the assignment of the eligible railroad track miles in 2006) even though no work was performed on the 50 miles of eligible railroad track that was assigned by P to R. For 2006, R determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $50,000 (50% multiplied by $100,000 QRTME treated as incurred by R during 2006). R further determines the credit limitation amount under paragraph (c)(2)(ii) of this section to be $175,000 ($3,500 multiplied by 50 miles of eligible railroad track assigned by P to R in 2006). Because R’s tentative amount of RTMC does not exceed R’s credit limitation amount for 2006, R may claim a RTMC for 2006 in the amount of $50,000.
(iv) For 2006, S is an eligible taxpayer because, during 2006, S provides railroad-related property to P and receives an assignment of 150 eligible railroad track miles from P. In accordance with paragraph (c)(3)(ii) of this section, S is treated as having incurred QRTME in the amount of $400,000 (amount paid by S to P for the assignment of the eligible railroad track miles in 2006). For 2006, S determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $200,000 (50% multiplied by $400,000 QRTME treated as incurred by S during 2006). S further determines the credit limitation amount under paragraph (c)(2)(ii) of this section to be $525,000 ($3,500 multiplied by 150 miles of eligible railroad track assigned by P to S in 2006). Because S’s tentative amount of RTMC does not exceed S’s credit limitation amount for 2006, S may claim a RTMC for 2006 in the amount of $200,000.
(ii) Because T did not retain any miles of eligible railroad track for itself for 2006, the maximum miles of eligible railroad track that may be assigned by T for 2006 is 200 miles pursuant to paragraph (d)(2) of this section. On the statement required by paragraph (d)(4)(ii) of this section, T assigned a total of 200 miles of eligible railroad track to W. Consequently, because T did not list V as an assignee on T’s statement required by paragraph (d)(4)(ii) of this section, V did not receive an assignment of eligible railroad track miles from T during 2006 and V is not an eligible taxpayer for 2006. Thus, for 2006, V may not claim any RTMC even though V incurred QRTME in the amount of $250,000.
(iii) For 2006, W is an eligible taxpayer because, during 2006, W provides railroad-related services to T and receives an assignment of 200 eligible railroad track miles from T. W determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $550,000 (50% multiplied by $1,100,000 QRTME incurred by W during 2006). W further determines the credit limitation amount under paragraph (c)(2)(ii) of this section to be $700,000 ($3,500 multiplied by the 200 miles of eligible railroad track assigned by T to W in 2006). Because W’s tentative amount of RTMC does not exceed W’s credit limitation amount for 2006, W may claim a RTMC for 2006 in the amount of $550,000.
(ii) Because T did not retain any miles of eligible railroad track for itself for 2006, the maximum miles of eligible railroad track that may be assigned by T for 2006 is 200 miles pursuant to paragraph (d)(2) of this section. However, on the statement required by paragraph (d)(4)(ii) of this section, T assigned a total of 400 miles of eligible railroad track (200 miles to W and 200 miles to V). Consequently, the 400 miles of eligible railroad track on this statement must be reduced to the 200 maximum miles of eligible railroad track available for assignment for 2006. Because the statement reports 200 miles of eligible railroad track assigned to each W and V, the reduction of 200 miles (400 total miles of eligible railroad track on the statement less 200 maximum miles of eligible railroad track available for assignment) is allocated pro-rata between W and V and, therefore, 100 miles each to W and V. Thus, pursuant to paragraph (d)(5)(ii) of this section, the number of miles of eligible railroad track assigned by T to W and V for 2006 is 100 miles each.
(iii) For 2006, V is an eligible taxpayer because, during 2006, V provides railroad-related services to T and receives an assignment of 100 eligible railroad track miles from T. V determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $125,000 (50% multiplied by $250,000 QRTME incurred by V during 2006). V further determines the credit limitation amount under paragraph (c)(2)(ii) of this section to be $350,000 ($3,500 multiplied by the 100 miles of eligible railroad track assigned by T to V in 2006). Because V’s tentative amount of RTMC does not exceed W’s credit limitation amount for 2006, V may claim a RTMC for 2006 in the amount of $125,000.
(iv) For 2006, W is an eligible taxpayer because, during 2006, W provides railroad-related services to T and receives an assignment of 100 eligible railroad track miles from T. W determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $550,000 (50% multiplied by $1,100,000 QRTME incurred by W during 2006). W further determines the credit limitation amount under paragraph (c)(2)(ii) of this section to be $350,000 ($3,500 multiplied by the 100 miles of eligible railroad track assigned by T to W in 2006). Because W’s tentative amount of RTMC exceeds W’s credit limitation amount for 2006, W may claim a RTMC for 2006 in the amount of $350,000 (the credit limitation). There is no carryover of the amount of $200,000 (the tentative amount of $550,000 less the credit limitation amount of $350,000).
(e) Adjustments to basis—(1) In general. All or some of the QRTME paid or incurred by an eligible taxpayer during the taxable year may be required to be capitalized under section 263(a) as a tangible asset or as an intangible asset. See, for example, § 1.263(a)-4(d)(8), which requires capitalization of amounts paid or incurred by a taxpayer to produce or improve real property owned by another (except to the extent the taxpayer is selling services at fair market value to produce or improve the real property) if the real property can reasonably be expected to produce significant economic benefits for the taxpayer. The basis of the tangible asset or intangible asset includes the capitalized amount of the QRTME.
(2) Basis adjustment made to railroad track. An eligible taxpayer must reduce the adjusted basis of any railroad track with respect to which the eligible taxpayer claims the RTMC. For purposes of section 45G(e)(3) and this paragraph (e)(2), the adjusted basis of any railroad track with respect to which the eligible taxpayer claims the RTMC is limited to the amount of QRTME, if any, that is required to be capitalized into the qualifying railroad structure or an intangible asset. The adjusted basis of the railroad track is reduced by the amount of the RTMC allowable (as determined under paragraph (c) of this section) by the eligible taxpayer for the taxable year, but not below zero. This reduction is taken into account at the time the QRTME is paid or incurred by an eligible taxpayer and before the depreciation deduction with respect to such railroad track is determined for the taxable year for which the RTMC is allowable. If all or some of the QRTME paid or incurred by an eligible taxpayer during the taxable year is capitalized under section 263(a) to more than one asset, whether tangible or intangible (for example, railroad track and bridges), the reduction to the basis of these assets under this paragraph (e)(2) is allocated among each of the assets subject to the reduction in proportion to the unadjusted basis of each asset at the time the QRTME is paid or incurred during that taxable year.
(3) Examples. The application of this paragraph (e) is illustrated by the following examples. In each example, all taxpayers use a calendar taxable year, and no taxpayers are members of a controlled group.
(ii) For 2006, X determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $500,000 (50% multiplied by $1 million QRTME incurred by X during 2006). X further determines the credit limitation amount under paragraph (c)(2)(i) of this section for 2006 to be $1,750,000 ($3,500 multiplied by 500 miles of eligible railroad track). Because X’s tentative amount of RTMC does not exceed X’s credit limitation amount for 2006, X may claim a RTMC for 2006 in the amount of $500,000.
(iii) Of the $1 million QRTME incurred by X during 2006, X determines under the track maintenance allowance method that $750,000 is the track maintenance allowance under section 162 and $250,000 is the capitalized amount for the track structure. In accordance with paragraph (e)(2) of this section, X reduces the capitalized amount of $250,000 by the RTMC of $500,000 claimed by X for 2006, but not below zero. Thus, the capitalized amount of $250,000 is reduced to zero. X also deducts under section 162 a track maintenance allowance of $750,000 on its 2006 Federal income tax return.
(ii) For 2006, Z determines the tentative amount of RTMC under paragraph (c)(1) of this section to be $500,000 (50% multiplied by $1 million QRTME incurred by Z during 2006). Z further determines the credit limitation amount under paragraph (c)(2)(ii) of this section for 2006 to be $1,050,000 ($3,500 multiplied by 300 miles of eligible railroad track assigned by Y to Z in 2006). Because Z’s tentative amount of RTMC does not exceed Z’s credit limitation amount for 2006, Z may claim a RTMC for 2006 in the amount of $500,000.
(iii) For 2006, Z also must determine the portion of the $1 million QRTME that Z incurs that is required to be capitalized under section 263(a), and the portion that is a section 162 expense. Because Z is not a Class II railroad or Class III railroad, Z cannot use the track maintenance allowance method. Assume that all of the QRTME constitutes an intangible asset under § 1.263(a)-4(d)(8) and, therefore, is required to be capitalized by Z under section 263(a) as an intangible asset. In accordance with paragraph (e)(2) of this section, Z reduces the capitalized amount of $1 million by the RTMC of $500,000 claimed by Z for 2006. Thus, the capitalized amount of $1 million for the intangible asset is reduced to $500,000. Further, pursuant to § 1.167(a)-3(b)(1)(iv), Z may treat this intangible asset with an adjusted basis of $500,000 as having a useful life of 25 years for purposes of the depreciation allowance under section 167(a).
(f) Controlled groups—(1) In general. Pursuant to section 45G(e)(2), if an eligible taxpayer is a member of a controlled group of corporations, rules similar to the rules in § 1.41-6T apply for determining the amount of the RTMC under section 45G(a) and this section. To determine the amount of RTMC (if any) allowable to a trade or business that at the end of its taxable year is a member of a controlled group, a taxpayer must—
(i) Compute the group credit in the manner described in paragraph (f)(3) of this section; and
(ii) Allocate the group credit among the members of the group in the manner described in paragraph (f)(4) of this section.
(2) Definitions. For purposes of section 45G(e)(2) and paragraph (f) of this section—
(i) A trade or business is a sole proprietorship, a partnership, a trust, an estate, or a corporation that is carrying on a trade or business (within the meaning of section 162). Any corporation that is a member of a commonly controlled group shall be deemed to be carrying on a trade or business if any other member of that group is carrying on any trade or business;
(ii) Group and controlled group means a controlled group of corporations, as defined in section 41(f)(5), or a group of trades or businesses under common control. For rules for determining whether trades or businesses are under common control, see § 1.52-1(b) through (g);
(iii) Group credit means the RTMC (if any) allowable to a controlled group;
(iv) Consolidated group has the meaning set forth in § 1.1502-1(h); and
(v) Credit year means the taxable year for which the member is computing the RTMC.
(3) Computation of the group credit. All members of a controlled group are treated as a single taxpayer for purposes of computing the RTMC. The group credit is computed by applying all of the section 45G computational rules (including the rules set forth in this section) on an aggregate basis.
(4) Allocation of the group credit. The group credit is allocated to each member of the controlled group on a proportionate basis to its share of the aggregate of the QRTMEs taken into account for the taxable year by such controlled group for purposes of the credit.
(5) Special rules for consolidated groups—(i) In general. For purposes of applying paragraph (f)(4) of this section, members of a consolidated group who are members of a controlled group are treated as a single member of the controlled group.
(ii) Special rule for allocation of group credit among consolidated group members. The portion of the group credit that is allocated to a consolidated group is allocated to each member of the consolidated group on a proportionate basis to its share of the aggregate of the QRTMEs taken into account for the taxable year by such consolidated group for purposes of the credit.
(6) Tax accounting periods used—(i) In general. The credit allowable to a member of a controlled group is that member’s share of the group credit computed as of the end of that member’s taxable year. In computing the group credit for a group whose members have different taxable years, a member generally should treat the taxable year of another member that ends with or within the credit year of the computing member as the credit year of that other member. For example, Q, R, and S are members of a controlled group of corporations. Both Q and R are calendar year taxpayers. S files a return using a fiscal year ending June 30. For purposes of computing the group credit at the end of Q’s and R’s taxable year on December 31, S’s fiscal year ending June 30, which ends within Q’s and R’s taxable year, is treated as S’s credit year.
(ii) Special rule when timing of QRTME is manipulated. If the timing of QRTME by members using different tax accounting periods is manipulated to generate a credit in excess of the amount that would be allowable if all members of the group used the same tax accounting period, then the appropriate Internal Revenue Service official in the operating division that has examination jurisdiction of the return may require each member of the group to calculate the credit in the current taxable year and all future years as if all members of the group had the same taxable year and base period as the computing member.
(7) Membership during taxable year in more than one group. A trade or business may be a member of only one group for a taxable year. If, without application of this paragraph (f)(7), a business would be a member of more than one group at the end of its taxable year, the business shall be treated as a member of the group in which it was included for its preceding taxable year. If the business was not included for its preceding taxable year in any group in which it could be included as of the end of its taxable year, the business shall designate in its timely filed (including extensions) federal income tax return for the taxable year the group in which it is being included. If the business does not so designate, then the appropriate Internal Revenue Service official in the operating division that has examination jurisdiction of the return will determine the group in which the business is to be included. If the Federal income tax return for a taxable year beginning after December 31, 2004, and ending before November 9, 2007, was filed before December 13, 2007, and the business wants to apply paragraph (g)(2) of this section but did not designate its group membership in that return, the business must designate its group membership for that year either—
(i) In its next filed original Federal income tax return; or
(ii) In its amended Federal income tax return that is filed pursuant to paragraph (g)(2) of this section, provided that amended Federal income tax return is filed by the business before its next filed original Federal income tax return.
(8) Intra-group transactions—(i) In general. Because all members of a group under common control are treated as a single taxpayer for purposes of determining the RTMC, transfers between members of the group are generally disregarded.
(ii) Payment for QRTME. Amounts paid or incurred by the owner (or lessor) of eligible railroad track to another member of the group for QRTME shall be taken into account as QRTME by the owner (or lessor) of the eligible railroad track for purposes of section 45G only to the extent of the lesser of—
(A) The amount paid or incurred to the other member; or
(B) The amount that would have been considered paid or incurred by the other member for the QRTME, if the QRTME was not reimbursed by the owner (or lessor) of the eligible railroad track.
(g) Effective/applicability date—(1) In general. Except as provided in paragraphs (g)(2) and (g)(3) of this section, this section applies to taxable years ending on or after September 7, 2006.
(2) Taxable years ending before September 7, 2006. A taxpayer may apply this section to taxable years beginning after December 31, 2004, and ending before September 7, 2006, provided that the taxpayer applies all provisions in this section to the taxable year.
(3) Special rules for returns filed prior to November 9, 2007. If a taxpayer’s Federal income tax return for a taxable year beginning after December 31, 2004, and ending before November 9, 2007, was filed before December 13, 2007, and the taxpayer is not filing an amended Federal income tax return for that taxable year pursuant to paragraph (g)(2) of this section before the taxpayer’s next filed original Federal income tax return, see paragraphs (d)(4)(iv) and (f)(7) of this section for the statements that must be attached to the taxpayer’s next filed original Federal income tax return.
(4) Taxable years beginning after December 31, 2011. Paragraphs (f)(4) and (5) and (g)(4) and (5) of this section apply to taxable years beginning on or after April 2, 2018. For taxable years ending before April 2, 2018, see § 1.45G-1T as contained in 26 CFR part 1, as revised April 1, 2017.
(5) Taxable years beginning before January 1, 2012. See § 1.45-1 as contained in 26 CFR part 1, revised April 1, 2014.
§ 1.45Q-0 Table of Contents
This section lists the captions contained in §§ 1.45Q-1 through 1.45Q-5.
(a) In general.
(b) Credit amount for carbon capture equipment originally placed in service before February 9, 2018.
(1) In general.
(2) Inflation adjustment.
(c) Credit amount for carbon capture equipment originally placed in service on or after February 9, 2018.
(d) Applicable dollar amount.
(1) Applicable dollar amount for any taxable year beginning in a calendar year after 2016 and before 2027 for qualified carbon oxide not used as a tertiary injectant or utilized.
(2) Applicable dollar amount for any taxable year beginning in a calendar year after 2026 for qualified carbon oxide not used as a tertiary injectant or utilized.
(3) Applicable dollar amount for any taxable year beginning in a calendar year after 2016 and before 2027 for qualified carbon oxide used as a tertiary injectant or utilized.
(4) Applicable dollar amount for any taxable year beginning in a calendar year after 2026 for qualified carbon oxide used as a tertiary injectant or utilized.
(e) Election to apply the $10 and $20 credit amounts in lieu of the applicable dollar amounts.
(f) Application of section 45Q for certain carbon capture equipment placed in service before February 9, 2018.
(g) Installation of additional carbon capture equipment.
(1) Allocation of section 45Q credits for facilities installing additional carbon capture equipment.
(2) Additional carbon capture equipment.
(3) New carbon capture equipment.
(4) Examples.
(i) Example 1.
(ii) Example 2.
(iii) Example 3.
(h) Eligibility for the section 45Q credit.
(1) Person to whom the section 45Q credit is attributable.
(i) Equipment placed in service before February 9, 2018.
(ii) Equipment placed in service on or after February 9, 2018.
(iii) Reporting.
(2) Contractually ensuring capture and disposal, injection, or utilization of qualified carbon oxide.
(i) Binding written contract.
(ii) Multiple binding written contracts permitted.
(iii) Contract provisions.
(iv) Pre-existing contracts.
(v) Reporting of contract information.
(vi) Relationship with election to allow section 45Q credit.
(3) Election to allow the section 45Q credit to another taxpayer.
(i) Example.
(ii) Time and manner of making election.
(iii) Annual election.
(iv) Required information.
(v) Requirements for section 45Q credit claimant.
(vi) Failure to satisfy reporting requirements.
(i) Applicability date.
(a) Qualified carbon oxide.
(b) Recycled carbon oxide.
(c) Carbon capture equipment.
(1) Use of carbon capture equipment.
(2) Carbon capture equipment components.
(3) Single process train.
(d) Industrial facility.
(1) Exclusion.
(2) Industrial source.
(3) Manufacturing process.
(4) Examples.
(i) Example 1.
(ii) Example 2.
(e) Electricity generating facility.
(f) Direct air capture facility.
(g) Qualified facility.
(1) Emissions and capture requirements.
(2) Examples.
(i) Example 1.
(ii) Example 2.
(iii) Example 3.
(iv) Example 4.
(v) Example 5.
(3) Annualization of first-year and last-year qualified carbon oxide emission and/or capture amounts.
(i) In general.
(ii) Calculation.
(iii) Consequences.
(4) Election for applicable facilities.
(i) Applicable facility.
(ii) Time and manner of making election.
(iii) Retroactive credit revocations.
(5) Retrofitted qualified facility or carbon capture equipment (80/20 Rule).
(h) Qualified enhanced oil or natural gas recovery project.
(1) Application of §§ 1.43-2 and 1.43-3.
(2) Required certification.
(3) Natural gas.
(4) Timely filing of petroleum engineer’s certification.
(5) Carbon oxide injected in oil reservoir.
(6) Tertiary injectant.
(i) Section 45Q credit.
(j) Form 8933.
(k) Applicability date.
(a) In general.
(b) Requirements for secure geological storage.
(c) Documentation.
(d) Certification.
(e) Failure to submit complete documentation or certification.
(f) Applicability date.
(a) In general.
(b) Amount utilized.
(1) In general.
(2) Limitation.
(c) Lifecycle greenhouse gas emissions and lifecycle analysis (LCA).
(1) In general.
(2) LCA verification.
(3) Standards of adequate lifecycle analysis.
(4) Third-party independent review of LCA.
(5) Submission of the LCA.
(6) LCA review.
(d) Commercial market.
(e) Applicability date.
(a) Recapture event.
(b) Ceases to be disposed of in secure geological storage or used as a tertiary injectant.
(c) Leaked amount of qualified carbon oxide.
(d) Qualified carbon oxide subject to recapture.
(e) Recapture amount.
(f) Recapture period.
(g) Application of recapture.
(1) In general.
(2) Calculation.
(3) Multiple units.
(4) Multiple taxpayers.
(i) In general.
(ii) Partnerships.
(A) General rule.
(B) Terminated partnerships.
(5) Reporting.
(6) Examples.
(i) Example 1.
(ii) Example 2.
(iii) Example 3.
(iv) Example 4.
(v) Example 5.
(vi) Example 6.
(h) Recapture in the event of deliberate removal from storage.
(1) In general.
(2) Recycled qualified carbon oxide.
(i) Limited exceptions.
(j) Applicability date.
§ 1.45Q-1 Credit for Carbon Oxide Sequestration.
(a) In general. For purposes of section 38 of the Internal Revenue Code (Code), the carbon oxide sequestration credit is determined under section 45Q of the Code and this section (section 45Q credit). Generally, the amount of the section 45Q credit and the party that is eligible to claim the credit depend on whether the taxpayer captures qualified carbon oxide using carbon capture equipment originally placed in service at a qualified facility before February 9, 2018, or on or after February 9, 2018, and whether the taxpayer disposes of the qualified carbon oxide in secure geological storage without using it as a tertiary injectant in a qualified enhanced oil or natural gas recovery project (disposal), uses it as a tertiary injectant in a qualified enhanced oil or natural gas recovery project and disposes of it in secure geological storage (injection), or utilizes it in a manner described in section 45Q(f)(5) and § 1.45Q-4 (utilization). The section 45Q credit applies only with respect to qualified carbon oxide the capture and disposal, injection, or utilization of which is within the United States (within the meaning of section 638(1) of the Code) or a possession of the United States (within the meaning of section 638(2)).
(b) Credit amount for carbon capture equipment originally placed in service before February 9, 2018—(1) In general. For carbon capture equipment originally placed in service at a qualified facility before February 9, 2018, the amount of credit determined under section 45Q(a) and this section is the sum of—
(i) $20 per metric ton of qualified carbon oxide that is—
(A) Captured by the taxpayer at the qualified facility and disposed of by the taxpayer in secure geological storage, and
(B) Not used by the taxpayer as a tertiary injectant in a qualified enhanced oil or natural gas recovery project or utilized by the taxpayer in a manner described in section 45Q(f)(5) and § 1.45Q-4, and
(ii) $10 per metric ton of qualified carbon oxide that is—
(A) Captured by the taxpayer at the qualified facility and used by the taxpayer as a tertiary injectant in a qualified enhanced oil or natural gas recovery project, and disposed of by the taxpayer in secure geological storage, or
(B) Captured by the taxpayer at the qualified facility and utilized by the taxpayer in a manner described in section 45Q(f)(5) and § 1.45Q-4.
(2) Inflation adjustment. In the case of any taxable year beginning in a calendar year after 2009, there is substituted for each dollar amount contained in paragraphs (b)(1)(i) and (ii) of this section an amount equal to the product of—
(i) Such dollar amount, multiplied by
(ii) The inflation adjustment factor for such calendar year determined under section 43(b)(3)(B) for such calendar year, determined by substituting “2008” for “1990.”
(c) Credit amount for carbon capture equipment originally placed in service on or after February 9, 2018. For carbon capture equipment originally placed in service at a qualified facility on or after February 9, 2018, the amount of credit determined under section 45Q(a)(3) and (4) and this section is the sum of—
(1) The applicable dollar amount (as determined under paragraph (d)(1) and (2) of this section) per metric ton of qualified carbon oxide that is captured during the 12-year period beginning on the date the equipment was originally placed in service, and is—
(i) Disposed of by the taxpayer in secure geological storage, and
(ii) Not used by the taxpayer as a tertiary injectant in a qualified enhanced oil or natural gas recovery project or utilized by the taxpayer in a manner described in section 45Q(f)(5) and § 1.45Q-4; and
(2) The applicable dollar amount (as determined under paragraph (d)(3) and (4) of this section) per metric ton of qualified carbon oxide that is captured during the 12-year period beginning on the date the equipment was originally placed in service and is—
(i) Used by the taxpayer as a tertiary injectant in a qualified enhanced oil or natural gas recovery project and disposed of by the taxpayer in secure geological storage, or
(ii) Utilized by the taxpayer in a manner described in section 45Q(f)(5) and § 1.45Q-4.
(d) Applicable dollar amount. In general, the applicable dollar amount depends on whether section 45Q(a)(3) and paragraph (c)(1) of this section applies or section 45Q(a)(4) and paragraph (c)(2) of this section applies, and the calendar year in which the taxable year begins.
(1) Applicable dollar amount for any taxable year beginning in a calendar year after 2016 and before 2027 for qualified carbon oxide not used as a tertiary injectant or utilized. For purposes of section 45Q(a)(3) and paragraph (c)(1) of this section, the applicable dollar amount for each taxable year beginning in a calendar year after 2016 and before 2027 is:
Table 1 to Paragraph
Year | Applicable
dollar amount |
---|---|
2017 | $22.66 |
2018 | 25.70 |
2019 | 28.74 |
2020 | 31.77 |
2021 | 34.81 |
2022 | 37.85 |
2023 | 40.89 |
2024 | 43.92 |
2025 | 46.96 |
2026 | 50.00 |
(2) Applicable dollar amount for any taxable year beginning in a calendar year after 2026 for qualified carbon oxide not used as a tertiary injectant or utilized. For purposes of section 45Q(a)(3) and paragraph (c)(1) of this section, the applicable dollar amount for any taxable year beginning in any calendar year after 2026 is an amount equal to the product of $50 and the inflation adjustment factor for the calendar year determined under section 43(b)(3)(B) for the calendar year, determined by substituting “2025” for “1990.”
(3) Applicable dollar amount for any taxable year beginning in a calendar year after 2016 and before 2027 for qualified carbon oxide used as a tertiary injectant or utilized. For purposes of section 45Q(a)(4) and paragraph (c)(2) of this section, the applicable dollar amount for each taxable year beginning in a calendar year after 2016 and before 2027 is:
Table 2 to Paragraph
Year | Applicable
dollar amount |
---|---|
2017 | $12.83 |
2018 | 15.29 |
2019 | 17.76 |
2020 | 20.22 |
2021 | 22.68 |
2022 | 25.15 |
2023 | 27.61 |
2024 | 30.07 |
2025 | 32.54 |
2026 | 35.00 |
(4) Applicable dollar amount for any taxable year beginning in a calendar year after 2026 for qualified carbon oxide used as a tertiary injectant or utilized. For purposes of section 45Q(a)(4) and paragraph (c)(2) of this section, the applicable dollar amount for any taxable year beginning in any calendar year after 2026, is an amount equal to the product of $35 and the inflation adjustment factor for such calendar year determined under section 43(b)(3)(B) for such calendar year, determined by substituting “2025” for “1990.”
(e) Election to apply the $10 and $20 credit amounts in lieu of the applicable dollar amounts. For purposes of determining the carbon oxide sequestration credit under this section, a taxpayer may elect to have the dollar amounts applicable under section 45Q(a)(1) or (2) and paragraph (b) of this section apply in lieu of the dollar amounts applicable under section 45Q(a)(3) or (4) and paragraph (d) of this section for each metric ton of qualified carbon oxide which is captured by the taxpayer using carbon capture equipment which is originally placed in service at a qualified facility on or after February 9, 2018. The election must be made on a Form 8933 (as defined in § 1.45Q-2(j)), and applies to all metric tons of qualified carbon oxide captured by the taxpayer using carbon capture equipment which is originally placed in service at the qualified facility throughout the full 12-year credit period.
(f) Application of section 45Q for certain carbon capture equipment placed in service before February 9, 2018. In the case of any carbon capture equipment placed in service before February 9, 2018, the credits under section 45Q(a)(1) and (2) and paragraph (b)(1)(i) and (ii) of this section apply with respect to qualified carbon oxide captured using such equipment before the end of the calendar year in which the Secretary of the Treasury or his delegate, in consultation with the Administrator of the Environmental Protection Agency (EPA), certifies that, during the period beginning after October 3, 2008, a total of 75,000,000 metric tons of qualified carbon oxide have been taken into account in accordance with section 45Q(a), as in effect on February 8, 2018, and section 45Q(a)(1) and (2). In general, a taxpayer may not claim credits under section 45Q(a)(1) and (2) in taxable years after the year in which the 75,000,000 metric ton limit is certified with respect to carbon capture equipment placed in service before February 9, 2018. However, see § 1.45Q-2(g)(4) regarding the election for applicable facilities to treat certain carbon capture equipment as having been placed in service on February 9, 2018 (section 45Q(f)(6) election).
(g) Installation of additional carbon capture equipment. In general, the credit amounts for property placed in service before February 9, 2018, apply to a qualified facility at which carbon capture equipment was placed in service before February 9, 2018, subject to the limitations under paragraph (f) of this section. The same qualified facility may place additional carbon capture equipment in service on or after February 9, 2018. The additional carbon capture equipment is eligible to qualify for the section 45Q credit amounts for equipment placed in service on or after February 9, 2018.
(1) Allocation of section 45Q credits for facilities installing additional carbon capture equipment. In the case of a qualified facility placed in service before February 9, 2018, for which additional carbon capture equipment is placed in service on or after February 9, 2018, the amount of qualified carbon oxide which is captured by the taxpayer is equal to—
(i) For purposes of section 45Q(a)(1)(A) and (2)(A), and paragraphs (b)(1)(i) and (ii) of this section, the lesser of the total amount of qualified carbon oxide captured at such facility for the taxable year, or the total amount of the carbon dioxide capture capacity of the carbon capture equipment in service at such facility on February 8, 2018, and
(ii) For purposes of section 45Q(a)(3)(A) and (4)(A), and paragraphs (c)(1) and (2) of this section, an amount (not less than zero) equal to the excess of the total amount of qualified carbon oxide captured at such facility for the taxable year, over the total amount of the carbon dioxide capture capacity of the carbon capture equipment in service at such facility on February 8, 2018.
(2) Additional carbon capture equipment. A physical modification or equipment addition that results in an increase in the carbon dioxide capture capacity of existing carbon capture equipment constitutes the installation of additional carbon capture equipment. Increasing the amount of carbon dioxide captured without physically modifying existing carbon capture equipment or adding new equipment, for example, by merely operating the existing carbon capture equipment above the carbon dioxide capture capacity, does not constitute the installation of additional carbon capture equipment. For purposes of this section, the term carbon dioxide capture capacity means capture design capacity. Section 45Q credits attributable to qualified carbon oxide captured by additional carbon capture equipment that is placed in service on or after February 9, 2018, are not subject to the 75,000,000 metric ton limitation described in section 45Q(g) and paragraph (f) of this section.
(3) New carbon capture equipment. A physical modification or equipment addition with a cost that satisfies the 80/20 Rule provided in § 1.45Q-2(g)(5) constitutes the installation of new carbon capture equipment rather than the installation of additional carbon capture equipment.
(4) Examples. The following examples illustrate the rules of this paragraph (g):
(i) Example 1. Taxpayer X owns qualified facility QF. In 2017, X placed in service three units of carbon capture equipment—CC1, CC2, and CC3—to capture carbon dioxide emitted by QF. Each of CC1, CC2, and CC3 are capable of capturing 50,000 metric tons of carbon dioxide. In 2017, X entered into a binding written contract with Y to provide 80,000 metric tons of carbon dioxide annually for Y to dispose of in secure geological storage. X operates CC1 and CC2 to capture carbon dioxide pursuant to the binding written contract with Y, leaving CC3 idle. In 2020, X enters into a binding written contract with Z to provide 40,000 metric tons of carbon dioxide annually for Z to dispose of in secure geological storage. X operates CC3 to capture carbon dioxide pursuant to the binding written contract with Z. CC3 is not additional carbon capture equipment under paragraph (g)(2) of this section simply because it began operating CC3 in 2020. X merely increased the amount of carbon dioxide captured by existing carbon capture equipment. As a result, any section 45Q credits attributable to the carbon dioxide captured by CC3 and disposed of by Z are calculated under section 45Q(a)(1) and paragraph (b)(1)(i) of this section, and are subject to the 75,000,000 metric ton limitation described in section 45Q(g) and paragraph (f) of this section.
(ii) Example 2. Assume the same facts as in Example 1, except that in 2019, X physically modified CC3 to enable CC3 to capture 100,000 metric tons of carbon dioxide. The physical modification to upgrade CC3 does not satisfy the 80/20 Rule in § 1.45Q-2(g)(5). In 2020 X enters into a binding written contract with Z to provide 80,000 metric tons of carbon dioxide annually for Z to dispose of in secure geological storage. X operates CC3 to capture carbon dioxide pursuant to the binding written contract with Z. Because the physical modification to upgrade CC3 does not satisfy the 80/20 Rule, the physical modification to upgrade CC3 is considered the installation of additional carbon capture equipment under paragraph (g)(2) of this section, rather than new carbon capture equipment under paragraph (g)(3) of this section. As a result, any section 45Q credits attributable to the first 50,000 metric tons of carbon dioxide captured by CC3 and disposed of by Z are calculated under section 45Q(a)(1) and paragraph (b)(1)(i) of this section, and are subject to the 75,000,000 metric ton limitation described in section 45Q(g) and paragraph (f) of this section. Any section 45Q credits attributable to additional carbon dioxide captured by CC3 and disposed of by Z in excess of those first 50,000 metric tons are calculated under section 45Q(a)(4) and paragraph (c)(2) of this section, and are not subject to the 75,000,000 metric ton limitation described in section 45Q(g) and paragraph (f) of this section.
(iii) Example 3. Assume the same facts as in Example 2, except that the physical modification to CC3 satisfies the 80/20 Rule in § 1.45Q-2(g)(5). The physical modification to CC3 is considered the installation of new carbon capture equipment under paragraph (g)(3) of this section. As a result, any section 45Q credits attributable to carbon dioxide captured by CC3 and disposed of by Z are calculated under section 45Q(a)(4) and paragraph (c)(2) of this section, and are not subject to the 75,000,000 metric ton limitation described in section 45Q(g) and paragraph (f) of this section.
(h) Eligibility for the section 45Q credit. The following rules determine who may claim the section 45Q credit.
(1) Person to whom the section 45Q credit is attributable. In general, the person to whom the credit is attributable is the person who may claim the credit. Except as provided in paragraph (h)(3) of this section, the section 45Q credit is attributable to the following persons—
(i) Equipment placed in service before February 9, 2018. In the case of qualified carbon oxide captured using carbon capture equipment that is originally placed in service at a qualified facility before February 9, 2018, the section 45Q credit is attributable to the person that captures and physically or contractually ensures the disposal, injection, or utilization of such qualified carbon oxide.
(ii) Equipment placed in service on or after February 9, 2018. In the case of qualified carbon oxide captured using carbon capture equipment that is originally placed in service at a qualified facility on or after February 9, 2018, the section 45Q credit is attributable to the person that owns the carbon capture equipment and physically or contractually ensures the capture and disposal, injection, or utilization of such qualified carbon oxide. For each single process train of carbon capture equipment (as described in § 1.45Q-2(c)(3)), only one taxpayer will be considered the person to whom the credit is attributable under this paragraph (h)(1)(ii). That person will be the taxpayer who either physically ensures the capture and disposal, injection, or utilization of such qualified carbon oxide or contracts with others to capture and dispose, inject, or utilize such qualified carbon oxide.
(iii) Reporting. The taxpayer described in this paragraph (h)(1) as eligible to claim the section 45Q credit must claim the credit on a Form 8933, “Carbon Dioxide Sequestration Credit,” with the taxpayer’s Federal income tax return or Form 1065, “U.S. Return of Partnership Income,” for each taxable year for which the taxpayer is eligible. The taxpayer must provide the name and location of the qualified facilities at which the qualified carbon oxide was captured. If the taxpayer is claiming the section 45Q credit on an amended Federal income tax return, an amended Form 1065, or an administrative adjustment request under section 6227 (AAR), as applicable, the taxpayer must state AMENDED RETURN FOR SECTION 45Q CREDIT at the top of the amended Federal income tax return, the amended Form 1065, or the AAR, as applicable. The amended Federal income tax return or the amended Form 1065 must be filed, in any event, not later than the applicable period of limitations on filing an amended Federal income tax return or Form 1065 is being filed. A BBA partnership may make a late election by filing an AAR on or before October 15, 2021, but in any event, not later than the period of limitations on filing an AAR under section 6227(c).
(2) Contractually ensuring capture and disposal, injection, or utilization of qualified carbon oxide. In the case of qualified carbon oxide captured using carbon capture equipment which is originally placed in service at a qualified facility on or after February 9, 2018, a taxpayer is not required to physically carry out the capture and disposal, injection, or utilization of qualified carbon oxide to claim the section 45Q credit if the taxpayer contractually ensures in a binding written contract that the party that physically carries out the capture, disposal, injection, or utilization of the qualified carbon oxide does so in the manner required under section 45Q, this section and §§ 1.45Q-2, 1.45Q-3, 1.45Q-4, and 1.45Q-5. A taxpayer may enter into a binding written contract with a general contractor that hires subcontractors to physically carry out the capture, disposal, injection, or utilization of the qualified carbon oxide, but the contract must bind the subcontractors to the requirements of this paragraph (h)(2). In the case of qualified carbon oxide captured using carbon capture equipment which is originally placed in service at a qualified facility before February 9, 2018, a taxpayer that contractually ensures the capture of the qualified carbon oxide is not eligible for the section 45Q credit. However, the taxpayer is not required to physically carry out the disposal, injection, or utilization of qualified carbon oxide to claim the section 45Q credit if the taxpayer contractually ensures in a binding written contract that the party that physically carries out the disposal, injection, or utilization of the qualified carbon oxide does so in the manner required under section 45Q, this section, and §§ 1.45Q-2, 1.45Q-3, 1.45Q-4, and 1.45Q-5.
(i) Binding written contract. A written contract is binding only if it is enforceable under State law against both the taxpayer and the party that physically carries out the capture, disposal, injection, or utilization of the qualified carbon oxide, or a predecessor or successor of either, and does not limit damages to a specified amount (for example, by use of a liquidated damages provision). For this purpose, a contractual provision that limits damages to an amount equal to at least five percent of the total contract price will not be treated as limiting damages to a specified amount. For additional guidance regarding the definition of a binding written contract, see § 1.168(k)-1(b)(4)(ii)(A)-(D).
(ii) Multiple binding written contracts permitted. A taxpayer may enter into multiple binding written contracts with multiple parties for the capture, disposal, injection, or utilization of qualified carbon oxide. A party that physically carries out the capture, disposal, injection, or utilization of qualified carbon oxide may enter into multiple binding written contracts with multiple parties that own carbon capture equipment or capture or contractually ensure the capture of qualified carbon oxide.
(iii) Contract provisions. Contracts ensuring the capture, disposal, injection, or utilization of qualified carbon oxide—
(A) Must include commercially reasonable terms and provide for enforcement of the party’s obligation to perform the capture, disposal, injection, or utilization of the qualified carbon oxide;
(B) May, but are not required to, include long-term liability provisions, indemnity provisions, penalties for breach of contract, or liquidated damages provisions;
(C) May, but are not required to, include information including how many metric tons of qualified carbon oxide the parties agree to dispose of, inject, or utilize;
(D) May, but are not required to, include minimum quantities that the parties agree to dispose of, inject, or utilize;
(E) Must, in the case of qualified carbon oxide that is intended to be disposed of in secure geological storage and not used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project, obligate the disposing party to comply with §§ 1.45Q-3(b)(1) and (c), and, in the case of a recapture event, promptly inform the capturing party of all information that is pertinent to the recapture (e.g., location of leak, leaked amount of qualified carbon oxide, dollar value of section 45Q credit attributable to leaked qualified carbon oxide);
(F) Must, for qualified carbon oxide that is intended to be used as a tertiary injectant in a qualified enhanced oil or natural gas recovery, obligate the disposing party to comply with § 1.45Q-3(b)(2) and (c), and in the case of a recapture event, promptly inform the capturing party of all information that is pertinent to recapture of the section 45Q credit as listed in § 1.45Q-5; and
(G) Must, for qualified carbon oxide that is intended to be utilized in a manner specified in § 1.45Q-4, obligate the utilizing party to comply with § 1.45Q-4.
(iv) Pre-existing contracts. If a taxpayer entered into a contract for the capture, disposal, injection, or utilization of qualified carbon oxide prior to January 13, 2021, and that contract does not satisfy all of the requirements of this paragraph (h)(2), the taxpayer must amend its existing contract or execute a new contract that satisfies all of the requirements of this paragraph (h)(2) by July 12, 2021.
(v) Reporting of contract information. The existence of each contract and the parties involved must be reported to the IRS annually. Each party to a contract must complete a signed Form 8933 (as defined in § 1.45-2(j)) and provide information required by the instructions to Form 8933. The party that contracts with the taxpayer claiming the credit must also provide that taxpayer with a signed Form 8933 in accordance with the instructions to Form 8933. The taxpayer claiming the credit must attach and file all other signed Forms 8933 received by each other party to the contract to its own signed Form 8933. Failure of the taxpayer claiming the credit to satisfy this reporting requirement in a taxable year will result in the inability of that taxpayer to claim the credit with respect to any qualified carbon oxide that is disposed of, injected, or utilized in that taxable year pursuant to that particular contract. In addition to any information stated as required on Form 8933, the report must include the following information—
(A) The name and taxpayer identification number of the taxpayer to whom the credit is attributable;
(B) The name and taxpayer identification number of each party with whom the taxpayer has entered into a contract to ensure the disposal, injection, or utilization of qualified carbon oxide;
(C) The date each contract to ensure the disposal, injection, or utilization of qualified carbon oxide was entered into;
(D) The number of metric tons of qualified carbon oxide each contracting party disposes of, injects, or utilizes on behalf of the contracting taxpayer each taxable year for reporting to the IRS; and
(E) For contracts for the disposal of qualified carbon oxide in secure geological storage or the use of qualified carbon oxide as a tertiary injectant in enhanced oil or natural gas recovery, the name of the operator, the field, unit, and reservoir, location by county and state, and identification number assigned to the facility by the EPA’s electronic Greenhouse Gas Reporting Tool (e-GGRT ID number) for submission of the facility’s 40 CFR part 98 annual reports.
(vi) Relationship with election to allow section 45Q credit. A taxpayer does not elect to allow all or a portion of the credit to any of the contracting parties merely by contracting with that party to ensure the disposal, injection, or utilization of qualified carbon oxide. Any election to allow all or a portion of the credit to be claimed by another party must be made separately pursuant to paragraph (h)(3) of this section.
(3) Election to allow the section 45Q credit to another taxpayer. The taxpayer described in paragraph (h)(1) of this section as the person to whom the section 45Q credit is attributable (electing taxpayer) may elect to allow the person that enters into a contract with the electing taxpayer to dispose of the qualified carbon oxide (disposer), utilize the qualified carbon oxide (utilizer), or use the qualified carbon oxide as a tertiary injectant (injector) to claim the credit (credit claimant) (section 45Q(f)(3)(B) election). However, the electing taxpayer may not elect or otherwise allow the section 45Q credit to a contractor or subcontractor that physically captures carbon oxide on behalf of the taxpayer. For purposes of this paragraph (h)(3), the disposer or injector that is eligible to be a credit claimant is the party that obtains the permit to dispose of the qualified carbon oxide in secure geological storage. In the case of an injector that is itself a joint venture (not a federal tax partnership), only those taxpayers that hold a working interest in the joint venture may be credit claimants. A credit claimant may not allow the section 45Q credit to a subcontractor that performs the disposal, utilization, or injection for the credit claimant. The electing taxpayer may not claim any section 45Q credits that are allowable to a credit claimant. An electing taxpayer may elect to allow a credit claimant to claim the full amount or a partial amount of section 45Q credits arising during the taxable year. An electing taxpayer may elect to allow a single credit claimant or multiple credit claimants to claim section 45Q credits in the same taxable year. If an electing taxpayer elects to allow multiple credit claimants to claim section 45Q credits, the maximum amount of section 45Q credits allowable to each credit claimant is proportional to the amount of qualified carbon oxide disposed of, utilized, or used as a tertiary injectant by the credit claimant. A credit claimant may receive allowances of section 45Q credits from multiple electing taxpayers in the same taxable year. In the case of an electing taxpayer with multiple qualified facilities, the electing taxpayer must make a separate election for each qualified facility.
(i) Example. Electing Taxpayer, E, captures 1,000,000 metric tons of qualified carbon oxide with carbon capture equipment that was placed in service in 2020. In 2021, E contracts with two companies, A and B, for the disposal of the qualified carbon oxide. E is eligible for a section 45Q credit at a rate of $22.68 per metric ton, for a total section 45Q credit of $22,680,000. E contractually ensures that A will dispose of 300,000 metric tons of qualified carbon oxide and that B will dispose of 700,000 metric tons of qualified carbon oxide. E may make a section 45Q(f)(3)(B) election to allow up to $6,804,000 of section 45Q credit to A and up to $15,876,000 of section 45Q credit to B, equal to the value of the number of metric tons each party has contracted to ensure disposal, multiplied by the credit value of the metric tons disposed of.
(ii) Time and manner of making election. The electing taxpayer makes a section 45Q(f)(3)(B) election by filing a statement of election containing the information described in paragraph (h)(3)(iv) of this section with the taxpayer’s Federal income tax return or Form 1065 for each taxable year in which the credit arises. The section 45Q(f)(3)(B) election must be made in accordance with Form 8933 no later than the time prescribed by law (including extensions) for filing the Federal income tax return or Form 1065 for the year in which the credit arises. The election may not be filed with an amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, after the prescribed date (including extensions) for filing the original Federal income tax return or Form 1065 for the year, with the exception of amended Federal income tax returns, amended Forms 1065, or AARs, as applicable, for any taxable year ending after February 9, 2018, and beginning on or before January 13, 2021. The amended Federal income tax return or the amended Form 1065 must be filed, in any event, not later than the applicable period of limitations on assessment for the taxable year for which the amended Federal income tax return or Form 1065 is being filed. A BBA partnership may make a late election by filing an AAR on or before October 15, 2021, but in any event, not later than the period of limitations on filing an AAR under section 6227(c).
(iii) Annual election. A section 45(Q)(f)(3)(B) election is only effective for the taxable year for which it is made. A new section 45Q(f)(3)(B) election must be made for each taxable year for which an electing taxpayer wishes to allow section 45Q credits to a credit claimant.
(iv) Required information. For the section 45Q(f)(3)(B) election to be valid under paragraph (h)(3)(ii) of this section, the election statement of the electing taxpayer must be made on Form 8933 and must indicate that an election is being made under section 45Q(f)(3)(B). The electing taxpayer must provide each credit claimant with a copy of the electing taxpayer’s Form 8933. The electing taxpayer must, in addition to any information required on Form 8933 set forth the following information—
(A) The electing taxpayer’s name, address, taxpayer identification number, location, and e-GGRT ID number(s) (if available) of each qualified facility where qualified carbon oxide was captured;
(B) The full amount of credit attributable to the taxpayer prior to the election and the corresponding metric tons of qualified carbon oxide;
(C) The name, address, and taxpayer identification number of each credit claimant, and the name and location and e-GGRT ID number(s) (if available) of:
(i) Each secure geological storage site where the qualified carbon oxide is disposed of or injected, or
(ii) Each site where the qualified carbon oxide is utilized;
(D) The dollar amount of section 45Q credits the taxpayer is allowing each credit claimant to claim and the corresponding metric tons of qualified carbon oxide; and
(E) The dollar amount of section 45Q credits retained by the electing taxpayer and the corresponding metric tons of qualified carbon oxide.
(v) Requirements for section 45Q credit claimant. For a section 45Q(f)(3)(B) election to be valid, the section 45Q credit claimant must include the following information on Form 8933—
(A) The name, address, taxpayer identification number of the credit claimant;
(B) The name, address, and taxpayer identification number of each taxpayer making an election under section 45Q(f)(3)(B) to allow the credit to the credit claimant;
(C) The name and location and e-GGRT ID number(s) (if available) of each qualified facility where qualified carbon oxide was captured;
(D) The name and location and e-GGRT ID number(s) (if available) of:
(i) Each secure geological storage site where the qualified carbon oxide is disposed of or injected, or
(ii) Each site where the qualified carbon oxide is utilized.
(E) The full dollar amount of section 45Q credits attributable to each electing taxpayer prior to the election and the corresponding metric tons of qualified carbon oxide;
(F) The dollar amount of section 45Q credits that each electing taxpayer is allowing the credit claimant to claim and the corresponding metric tons of qualified carbon oxide; and
(G) A copy of the electing taxpayer’s Form 8933. The credit claimant must include this Form 8933 with its timely filed Federal income tax return or Form 1065 (including extensions). The election may not be filed with an amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, after the prescribed date (including extensions) for filing the original Federal income tax return or Form 1065 for the year, with the exception of amended Federal income tax returns, amended Forms 1065, or AARs, as applicable, for any taxable year ending after February 9, 2018, and beginning on or before January 13, 2021. The amended Federal income tax return or the amended Form 1065 must be filed, in any event, not later than the applicable period of limitations on filing an amended Federal income tax return or Form 1065. In the case of a BBA partnership, the BBA partnership may make a late election by filing an AAR on or before October 15, 2021, but in any event, not later than the period of limitations on filing an AAR under section 6227(c).
(vi) Failure to satisfy reporting requirements. With respect to any section 45Q(f)(3)(B) election, the failure of an electing taxpayer or a credit claimant to satisfy the requirements in paragraph (h)(3)(iv) or (v) in a taxable year will result in the inability to claim the credit with respect to any qualified carbon oxide that is disposed of, injected, or utilized in that taxable year pursuant to that particular election.
(i) Applicability date. This section applies to taxable years beginning on or after January 13, 2021. Taxpayers may choose to apply this section for taxable years beginning on or after January 1, 2018, provided the taxpayer applies this section and §§ 1.45Q-2, 1.45Q-3, 1.45Q-4, and 1.45Q-5 in their entirety and in a consistent manner.
§ 1.45Q-2 Definitions for Purposes of §§ 1.45Q-1 through 1.45Q-5.
(a) Qualified carbon oxide. The term qualified carbon oxide means—
(1) Any carbon dioxide which—
(i) Is captured from an industrial source by carbon capture equipment which is originally placed in service before February 9, 2018,
(ii) Would otherwise be released into the atmosphere as industrial emission of greenhouse gas or lead to such release, and
(iii) Is measured at the source of capture and verified at the point of disposal, injection, or utilization; or
(2) Any carbon dioxide or other carbon oxide which—
(i) Is captured from an industrial source by carbon capture equipment which is originally placed in service on or after February 9, 2018,
(ii) Would otherwise be released into the atmosphere as industrial emission of greenhouse gas or lead to such release, and
(iii) Is measured at the source of capture and verified at the point of disposal, injection, or utilization; or
(3) In the case of a direct air capture facility, any carbon dioxide that is captured directly from the ambient air and is measured at the source of capture and verified at the point of disposal, injection, or utilization.
(b) Recycled carbon oxide. The term qualified carbon oxide includes the initial deposit of captured carbon oxide used as a tertiary injectant. Qualified carbon oxide does not include carbon oxide that is recaptured, recycled, and re-injected as part of the enhanced oil or natural gas recovery process.
(c) Carbon capture equipment. In general, carbon capture equipment includes all components of property that are used to capture or process carbon oxide until the carbon oxide is transported for disposal, injection, or utilization. Except as described in paragraph (c)(2) of this section, carbon capture equipment generally does not include components of property used for transporting qualified carbon oxide for disposal, injection, or utilization. Carbon capture equipment that is originally placed in service at a qualified facility on or after February 9, 2018, may be owned by a taxpayer other than the taxpayer that owns the industrial facility at which the carbon capture equipment is placed in service.
(1) Use of carbon capture equipment. Carbon capture equipment is equipment used for the purpose of—
(i) Separating, purifying, drying, and/or capturing carbon oxide that would otherwise be released into the atmosphere from an industrial facility;
(ii) Removing carbon oxide from the atmosphere via direct air capture; or
(iii) Compressing or otherwise increasing the pressure of carbon oxide.
(2) Carbon capture equipment components. Carbon capture equipment generally includes components of property necessary to compress, treat, process, liquefy, pump or perform some other physical action to capture qualified carbon oxide. For purposes of this paragraph (c), carbon capture equipment includes a system of gathering and distribution lines that collect carbon oxide captured from a qualified facility or multiple qualified facilities that constitute a single project (as described in section 8.01 of Notice 2020-12, 2020-11 I.R.B. 495 (see § 601.601(d)(1) and (2)(ii) of this chapter)) for the purpose of transporting that carbon oxide away from the qualified facility or single project to a pipeline used to transport carbon oxide to or from one or more taxpayers and projects.
(3) Single process train. All components that make up an independently functioning process train capable of capturing, processing, and preparing carbon oxide for transport will be treated as a single unit of carbon capture equipment.
(d) Industrial facility. An industrial facility is a facility, including an electricity generating facility, that produces a carbon oxide stream from a fuel combustion source or fuel cell, a manufacturing process, or a fugitive carbon oxide emission source that, absent capture and disposal, injection, or utilization, would otherwise be released into the atmosphere as industrial emission of greenhouse gas or lead to such release.
(1) Exclusion. An industrial facility does not include a facility that produces carbon dioxide from carbon dioxide production wells at natural carbon dioxide-bearing formations or a naturally occurring subsurface spring. For purposes of section 45Q, a carbon dioxide production well at natural carbon dioxide-bearing formations or a naturally occurring subsurface spring means a well that contains 90 percent or greater carbon dioxide by volume (90 percent test).
(2) Exception for wells at natural carbon dioxide-bearing formations or a naturally occurring subsurface spring that contain a product other than carbon dioxide. A well meeting the 90 percent test will not be treated as a carbon dioxide production well at natural carbon dioxide-bearing formations or a naturally occurring subsurface spring if:
(i) The deposit contains a product, other than carbon oxide, that is commercially viable to extract and sell without taking into account the availability of a commercial market for the carbon oxide that is extracted or any section 45Q tax credit that might be available;
(ii) The taxpayer provides an attestation to paragraph (d)(2)(i) of this section from an independent registered engineer with experience in feasibility studies for extraction of gases from the subsurface;
(iii) A direct air capture facility (defined in section 45Q(e)(1)(A)) is not used to capture carbon oxide from the gas stream; and
(iv) Any carbon oxide extracted from the deposit is used as tertiary injectant in an enhanced oil or natural gas recovery project or as feedstock of a utilization project.
(2) Industrial source. An industrial source is an emission of carbon oxide from an industrial facility.
(3) Manufacturing process. A manufacturing process is a process involving the manufacture of one or more products, other than carbon oxide, that are intended to be sold at a profit, or are used for a commercial purpose (other than producing carbon oxide). All facts and circumstances with respect to the process and products are to be taken into account.
(4) Examples. The following examples illustrate the rules of paragraph (d) of this section:
(i) Example 1. A natural underground reservoir contains a gas that is comprised of 50 percent carbon dioxide and 50 percent methane by volume. The raw gas is not usable without the application of a separation process to create two gases that are primarily carbon dioxide and methane. Taxpayer B constructs processing equipment that separates the raw gas into carbon oxide and methane. The carbon dioxide is sold to a third party for use in a qualified enhanced oil recovery project. Some of the methane is used as fuel to power the processing equipment. The remainder of the methane is injected into the reservoir. The injection will increase the ultimate recovery of carbon dioxide. The injected methane can be produced later from the reservoir. At the end of the taxable year Taxpayer B has not secured a contract to sell methane and does not have any plans to use the methane for a commercial purpose other than producing carbon oxide. Because carbon dioxide is the only product manufactured that is intended to be sold at a profit or used for a commercial purpose, the separation process applied to the gases is not a manufacturing process within the meaning of paragraph (d)(3) of this section. The carbon dioxide captured by the process is not qualified carbon oxide.
(ii) Example 2. (A) A natural underground reservoir contains a gas that is comprised of 95 percent carbon dioxide and 5 percent helium by volume. The raw gas is not usable without the application of a separation process to create two gases that are primarily carbon dioxide and helium. Taxpayer C determines that the extraction of helium is economically viable even if there were no commercial market for carbon dioxide or any section 45Q credit. An independent registered engineer attests to Taxpayer C’s determination. Taxpayer C constructs processing equipment that separates the raw gas into carbon dioxide and helium. The helium is sold to various customers for use in commercial and industrial applications. The carbon dioxide is sold to a third party for use in a qualified enhanced oil recovery project. Any carbon dioxide which the third party cannot accept is returned to the reservoir or vented in accordance with applicable permits.
(B) Because the extraction of helium is economically viable even if there were no commercial market for carbon dioxide or any section 45Q credit, the reservoir will not be considered a natural carbon dioxide-bearing formation or a naturally occurring subsurface spring within the meaning of paragraph (d)(1) and the separation process applied to the gases is a manufacturing process within the meaning of paragraph (d)(3). Taxpayer C may claim the section 45Q credit with respect to the carbon dioxide sold to the third party and which the third party uses in ad oil recovery project during the taxable year. Taxpayer C may not claim the section 45Q credit with respect to the carbon dioxide that is returned to the reservoir or vented.
(e) Electricity generating facility. An electricity generating facility is a facility described in section 45Q(d)(2)(A) or (B) of the Internal Revenue Code (Code) that is subject to depreciation under MACRS Asset Class 49.11 (Electric Utility Hydraulic Production Plant), 49.12 (Electric Utility Nuclear Production Plant), 49.13 (Electric Utility Steam Production Plant), or 49.15 (Electric Utility Combustion Turbine Production Plant).
(f) Direct air capture facility. A direct air capture facility means any facility that uses carbon capture equipment to capture carbon oxide directly from the ambient air. It does not include any facility that captures carbon dioxide (1) that is deliberately released from naturally occurring subsurface springs or (2) using natural photosynthesis.
(g) Qualified facility. A qualified facility means any industrial facility or direct air capture facility, the construction of which begins before January 1, 2026, and either at which construction of carbon capture equipment begins before that date, or the original planning and design for which includes installation of carbon capture equipment, and at which carbon capture equipment is placed in service that captures the requisite annual thresholds of carbon oxide described in paragraph (g)(1) of this section. See Notice 2020-12 (see § 601.601(d)(1) and (2)(ii) of this chapter), for guidance on the determination of when construction has begun on a qualified facility or on carbon capture equipment. For purposes of whether a facility satisfies the requisite annual carbon oxide capture thresholds described in paragraph (g)(1) of this section, a taxpayer may apply the rules of section 8.01 of Notice 2020-12 (see § 601.601(d)(1) and (2)(ii) of this chapter) to treat multiple facilities as a single facility.
(1) Emissions and capture requirements. The carbon capture equipment placed in service at the qualified facility must capture—
(i) In the case of a facility, other than a direct air capture facility, which emits not more than 500,000 metric tons of carbon oxide i the atmosphere during the taxable year, at least 25,000 metric tons of qualified carbon oxide during the taxable year which is utilized in a manner consistent with section 45Q(f)(5) and § 1.45Q-4 (section 45Q(d)(2)(A) facility);
(ii) In the case of an electricity generating facility which is not a section 45Q(d)(2)(A) facility (section 45Q(d)(2)(B) facility), not less than 500,000 metric tons of qualified carbon oxide during the taxable year; and
(iii) In the case of a direct air capture facility or other facility that is not a section 45Q(d)(2)(A) facility or a section 45Q(d)(2)(B) facility, at least 100,000 metric tons of qualified carbon oxide during the taxable year.
(2) Examples. The following examples illustrate the rules of paragraph (g) of this section:
(i) Example 1. During the taxable year, an ethanol plant emits 200,000 metric tons of carbon dioxide. Carbon capture equipment located at the facility captures 35,000 metric tons of carbon dioxide, all of which are utilized in a manner consistent with section 45Q(f)(5) and § 1.45Q-4. The ethanol plant is a qualified facility under section 45Q(d)(2)(C) and § 1.45Q-2(g)(1)(i) during the taxable year because it met the requirement to capture at least 25,000 metric tons of qualified carbon oxide during the taxable year which were utilized in a manner consistent with section 45Q(f)(5) and § 1.45Q-4.
(ii) Example 2. During the taxable year, an electricity generating facility emits 600,000 metric tons of carbon dioxide. Carbon capture equipment located at the facility captures a total of 450,000 metric tons of carbon dioxide. 50,000 metric tons of the captured carbon dioxide are utilized in a manner consistent with section 45Q(f)(5) and § 1.45Q-4, and 400,000 metric tons of the carbon dioxide are disposed of in secure geological storage. The electricity generating facility is not a qualified facility under section 45Q(d)(2)(B) during the taxable year because it did not capture at least 500,000 metric tons of qualified carbon oxide during the taxable year. Further, because the electricity generating facility emitted greater than 500,000 metric tons of carbon dioxide during the taxable year, but only captured 450,000 metric tons, it is not a qualified facility under section 45Q(d)(2)(A) and § 1.45Q-2(g)(1)(ii).
(iii) Example 3. During the taxable year, a cement manufacturing plant emits 110,000 metric tons of carbon dioxide. Carbon capture equipment located at the plant captures 100,000 metric tons of carbon dioxide. 10,000 metric tons of the amount captured are utilized in a manner consistent with section 45Q(f)(5) and § 1.45Q-4, and 90,000 metric tons of carbon dioxide, are disposed of in secure geological storage. The cement manufacturing plant is a qualified facility during the taxable year because the carbon capture equipment located at the plant met the requirement under section 45Q(d)(2)(C) and § 1.45Q-2(g)(1)(i) to capture at least 100,000 metric tons of qualified carbon oxide during the taxable year.
(iv) Example 4. Taxpayer X owns and operates three natural gas processing facilities (A, B, and C) that separate carbon dioxide from natural gas. A, B, and C are all located within several miles of each other. X installed carbon capture equipment by A, B, and C. Carbon dioxide captured by A, B, and C is collected via a single system of gathering and distribution lines for delivery to a transportation pipeline. X contracts with third-party Z for the use of carbon dioxide captured by A, B, and C as a tertiary injectant pursuant to a single contract. During the taxable year, equipment at A captures 30,000 metric tons of carbon dioxide, equipment at B captures 40,000 metric tons of carbon dioxide, and equipment at C captures 50,000 tons of carbon dioxide. All other factors listed in the single project rule in section 8.01 of Notice 2020-12 support the conclusion that A, B and C are a single facility. X may treat A, B, and C as a single facility under the rules of section 8.01 of Notice 2020-12 for purposes of determining whether the requirement under section 45Q(d)(2)(C) and § 1.45Q-2(g)(1)(i), to capture at least 100,000 metric tons of qualified carbon oxide during the taxable year is satisfied. If X treats A, B, and C as a single facility, the minimum capture requirement will be satisfied for the taxable year.
(3) Annualization of first-year and last-year qualified carbon oxide emission and/or capture amounts—(i) In general. For both the taxable year in which carbon capture equipment is placed in service at a qualified facility and the taxable year in which the 12-year period described in sections 45Q(a)(3)(A) and (4)(A) and § 1.45Q-1(c)(1) and (2) ends, annualization of the amount of qualified carbon oxide emitted and captured (or captured directly from the ambient air in the case of a direct air capture facility) is permitted to determine if the threshold requirements under paragraph (g)(1) of this section are satisfied. Such annualization may result in a facility being deemed to satisfy the threshold requirements under paragraph (g)(1) of this section for the year and may permit a taxpayer to claim section 45Q credits even though the amount of qualified carbon oxide emitted or captured in the first year or last year of the 12-year period is less than the threshold requirements under paragraph (g)(1) of this section.
(ii) Calculation. Annualization is only available for the taxable year in which the carbon capture equipment is placed in service at the qualified facility and the taxable year in which the 12-year period described in sections 45Q(a)(3)(A) and (4)(A) and § 1.45Q-1(c)(1) and (2) ends. Annualized amounts must be calculated by—
(A) Determining the amount of qualified carbon oxide emitted and captured (or captured directly from the ambient air in the case of a direct air capture facility) during the taxable year in which the carbon capture equipment was placed in service at the qualified facility or the taxable year in which the 12-year period described in sections 45Q(a)(3)(A) and (4)(A) and § 1.45Q-1(c)(1) and (2) ends,
(B) Dividing the amount of qualified carbon determined under paragraph (g)(3)(ii)(A) of this section by the number of days in the period either (I) beginning with the date on which the carbon capture equipment was placed in service at the qualified facility and ending with the last day of the taxable year containing that date, or (II) beginning with the first day of the taxable year in which the 12-year period described in sections 45Q(a)(3)(A) and (4)(A) and § 1.45Q-1(c)(1) and (2) ends and ending with the last day of that 12-year period; and
(C) Multiplying by 365.
(iii) Consequences. If the annualized amounts of qualified carbon oxide emitted and captured (or captured directly from the ambient air in the case of a direct air capture facility) as calculated under this formula meet the threshold requirements under paragraph (g)(1) of this section, the threshold requirements under paragraph (g)(1) of this section are deemed satisfied for the taxable year in which the carbon capture equipment was placed in service at the qualified facility or the taxable year in which the 12-year period described in sections 45Q(a)(3)(A) and (4)(A) and § 1.45Q-1(c)(1) and (2) ends. The taxpayer may be eligible for a section 45Q credit for that taxable year but must calculate the credit based on actual amounts of qualified carbon oxide captured and disposed of, injected, or utilized during the taxable year.
(4) Election for applicable facilities. In the case of an applicable facility, for any taxable year during which such facility captures not less than 500,000 metric tons of qualified carbon oxide, the taxpayer described in section 45Q(f)(3)(A)(ii) and § 1.45Q-1(h)(1)(ii) (that is, the person that owns the carbon capture equipment and physically or contractually ensures the capture and disposal, injection or utilization of such qualified carbon oxide), may elect to have such facility, and any carbon capture equipment placed in service at such facility, deemed as having been placed in service on February 9, 2018 (section 45Q(f)(6) election). For purposes of whether a facility satisfies the 500,000 metric ton qualified carbon oxide capture threshold, a taxpayer may apply the rules of section 8.01 of Notice 2020-12 to treat multiple facilities as a single facility.
(i) Applicable facility. An applicable facility means a qualified facility described in section 45Q(f)(6)(B) and § 1.45Q-2(g) that was placed in service before February 9, 2018, for which no taxpayer claimed a section 45Q credit for qualified carbon oxide captured at the facility for any taxable year ending before February 9, 2018.
(ii) Time and manner of making election. The taxpayer described § 1.45Q-1(h)(1) makes a section 45Q(f)(6) election by filing a statement of election with the taxpayer’s income tax return for each taxable year in which the credit arises. The section 45Q(f)(6) election must be made in accordance with Form 8933 filed with the taxpayer’s Federal income tax return for each taxable year in which the taxpayer makes the section 45Q(f)(6) election. The statement of election must, in addition to any information required on Form 8933, set forth the electing taxpayer’s name, address, taxpayer identification number, location, and e-GGRT ID number(s) (if available) of the applicable facility.
(iii) Retroactive credit revocations. A taxpayer may not file an amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, for any taxable year ending before February 9, 2018, to revoke a prior claim of section 45Q credits.
(5) Retrofitted qualified facility or carbon capture equipment (80/20 Rule). A qualified facility or carbon capture equipment may qualify as originally placed in service even if it contains some used components of property, provided the fair market value of the used components of property is not more than 20 percent of the qualified facility or carbon capture equipment’s total value (that is, the cost of the new components of property plus the value of the used components of property) (80/20 Rule). In determining the value of the used components of property as compared to the new components, the general principles of Revenue Ruling 94-31 (see § 601.601(d)(2)(i)(a) and (ii) of this chapter), will apply. The relevant unit of retrofitted carbon capture equipment for purposes of the 80/20 Rule is an independently functioning process train. For purposes of the 80/20 Rule, the cost of a new qualified facility or carbon capture equipment includes all properly capitalized costs of the new qualified facility or carbon capture equipment. Solely for purposes of the 80/20 Rule, properly capitalized costs of a new qualified facility or carbon capture equipment may, at the option of the taxpayer, include the cost of new equipment for a pipeline (the cost of equipment for a new pipeline, not equipment used to repair an existing pipeline) owned and used exclusively by that taxpayer to transport carbon oxides captured by that taxpayer’s qualified facility or carbon capture equipment that would otherwise be emitted into the atmosphere.
(h) Qualified enhanced oil or natural gas recovery project. The term qualified enhanced oil or natural gas recovery project has the same meaning as a qualified enhanced oil recovery project under section 43(c)(2) of the Code and § 1.43-2, by substituting crude oil or natural gas for crude oil in section 43(c)(2)(A)(i) and §§ 1.43-2 and 1.43-3.
(1) Application of §§ 1.43-2 and 1.43-3. For purposes of applying §§ 1.43-2 and 1.43-3 with respect to a qualified enhanced oil or natural gas recovery project, the term enhanced oil or natural gas recovery is substituted for enhanced oil recovery, and the term oil or natural gas is substituted for oil.
(2) Required certification. The qualified enhanced oil or natural gas recovery project must be certified under § 1.43-3, even if no credit related to enhanced oil or natural gas recovery is claimed for the taxable year. For purposes of a natural gas project—
(i) The petroleum engineer’s certification under § 1.43-3(a)(3) and the operator’s continued certification of a project under § 1.43-3(b)(3) must include an additional statement that the certification is for purposes of the section 45Q carbon oxide sequestration tax credit;
(ii) The petroleum engineer’s certification must be attached to a Form 8933 and filed not later than the last date prescribed by law (including extensions) for filing the operator’s or designated owner’s Federal income tax return or Form 1065 for the first taxable year in which qualified carbon oxide is injected into the reservoir; and
(iii) The operator’s continued certification of a project must be attached to a Form 8933 and filed not later than the last date prescribed by law (including extensions) for filing the operator’s or designated owner’s Federal income tax return or Form 1065 for taxable years after the taxable year for which the petroleum engineer’s certification is filed but not after the taxable year in which injection activity ceases and all injection wells are plugged and abandoned.
(3) Natural gas. Natural gas has the same meaning as under section 613A(e)(2) of the Code.
(4) Timely filing of petroleum engineer’s certification. For purposes of this paragraph (h), if a section 45Q credit is claimed on an amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, the petroleum engineer’s certification for a natural gas project will be treated as filed timely if it is attached to a Form 8933 that is submitted with such amended Federal income tax return, amended Form 1065, or AAR. With respect to a section 45Q credit that is claimed on a timely filed Federal income tax return or Form 1065 for a taxable year ending after December 31, 2017, and beginning on or before January 13, 2021, for which the petroleum engineer’s certification for a natural gas project was not submitted, the petroleum engineer’s certification for a natural gas project will be treated as filed timely if it is attached to an amended Form 8933 for such taxable year.
(5) Carbon oxide injected in oil reservoir. Carbon oxide that is injected into an oil reservoir that is not a qualified enhanced oil recovery project under section 43(c)(2) due to circumstances such as the first injection of a tertiary injectant occurring before 1991, or because a petroleum engineer’s certification was not timely filed, cannot be treated as qualified carbon oxide, disposed of in secure geological storage, or utilized in a manner described in section 45Q(f)(5). This rule will not apply to an oil reservoir if—
(i) The reservoir has permanently ceased oil production;
(ii) The operator has obtained an Underground Injection Control Class VI permit; and
(iii) The operator complies with 40 CFR part 98 subpart RR.
(6) Tertiary Injectant. For purposes of section 45Q, a tertiary injectant is qualified carbon oxide that is injected into and stored in a qualified enhanced oil or natural gas recovery project and contributes to the extraction of crude oil or natural gas. The term tertiary injectant has the same meaning as used in section 193(b)(1) of the Code.
(i) Section 45Q credit. The term section 45Q credit means the carbon oxide sequestration credit determined under section 45Q of the Internal Revenue Code and § 1.45Q-1.
(j) Form 8933. The term Form 8933 means Form 8933, Carbon Oxide Sequestration Credit, any successor form(s), pursuant to instructions to any of the foregoing (see § 601.602 of this chapter), or other guidance. This definition of Form 8933 applies to this section and to §§ 1.45Q-1, 1.45Q-3, 1.45Q-4, and 1.45Q-5.
(k) Applicability date. This section applies to taxable years beginning on or after January 13, 2021. Taxpayers may choose to apply this section for taxable years beginning on or after January 1, 2018, provided the taxpayer applies this section and §§ 1.45Q-1, 1.45Q-3, 1.45Q-4, and 1.45Q-5 in their entirety and in a consistent manner.
§ 1.45Q-3 Secure Geological Storage.
(a) In general. To qualify for the section 45Q credit, a taxpayer must either physically or contractually dispose of captured qualified carbon oxide in secure geological storage in the manner provided in paragraph (b) of this section, or utilize qualified carbon oxide in a manner conforming with section 45Q(f)(5) of the Internal Revenue Code and § 1.45Q-4. Secure geological storage includes, but is not limited to, storage at deep saline formations, oil and gas reservoirs, and unminable coal seams.
(b) Requirements for secure geological storage. For purposes of the section 45Q credit, qualified carbon oxide is considered disposed of by the taxpayer in secure geological storage such that the qualified carbon oxide does not escape into the atmosphere if the qualified carbon oxide is—
(1) Injected into a well that
(i) Complies with applicable Underground Injection Control or other regulations, located onshore or offshore under submerged lands within the territorial jurisdiction of States or federal waters, and
(ii) Is not used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project, in compliance with applicable requirements under 40 CFR part 98 subpart RR; or
(2) Injected into a well that
(i) Complies with applicable Underground Injection Control or other regulations, is located onshore or offshore under submerged lands within the territorial jurisdiction of States or federal waters, and
(ii) Is used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project and stored in compliance with applicable requirements under 40 CFR part 98 subpart RR, or the International Organization for Standardization (ISO) standards endorsed by the American National Standards Institute (ANSI) under CSA/ANSI ISO 27916:2019, Carbon dioxide capture, transportation and geological storage—Carbon dioxide storage using enhanced oil recovery (CO
(c) Documentation. Documentation must be filed in accordance with Form 8933.
(d) Certification. For qualified enhanced oil or natural gas recovery projects in which the taxpayer reported volumes of carbon oxide to the Environmental Protection Agency pursuant to 40 CFR part 98 subpart RR, the taxpayer may self-certify the volume of qualified carbon oxide claimed for purposes of section 45Q. For qualified enhanced oil or natural gas recovery projects in which the taxpayer determined volumes pursuant to CSA/ANSI ISO 27916:2019, a taxpayer may prepare documentation as outlined in CSA/ANSI ISO 27916:2019 internally, but all such documentation must be provided to a qualified independent engineer or geologist, who then must certify that the documentation provided, including the mass balance calculations as well as information regarding monitoring and containment assurance, is accurate and complete. The qualified independent engineer or geologist certifying a project must be duly registered or certified in any State. The certification must contain an affidavit from the certifying engineer or geologist stating that he or she is independent from the taxpayer (and if a section 45Q(f)(3)(B) election has been made, the affidavit must state that he or she is independent from both the electing taxpayer and the credit claimant). Certifications must be made annually and under penalties of perjury. For any leaked amount of qualified carbon oxide (as defined in § 1.45Q-5(c)) that is determined pursuant to CSA/ANSI ISO 27916:2019, the certification must also include a statement that the quantity was determined in accordance with sound engineering principles. Taxpayers that capture qualified carbon oxide giving rise to the section 45Q credit must file Form 8933 with a timely filed Federal income tax return or Form 1065, including extensions or for the purpose of this rule, amendments to Federal income tax returns, Forms 1065, or on AARs, as applicable. Taxpayers that dispose of, inject, or utilize qualified carbon oxide must also file Form 8933 with a timely filed Federal income tax return or Form 1065, including extensions or for the purpose of this rule, amendments to Federal income tax returns, Forms 1065, or on AARs, as applicable. If the volume of carbon oxide certified and reported is a negative amount, see § 1.45Q-5 for rules regarding recapture.
(e) Failure to submit complete documentation or certification. No section 45Q credit is allowed for any taxable year for which the taxpayer (including credit claimants) has failed to timely submit complete documentation and certification that is required by this regulation or Form 8933. The credit will be allowed only for a taxable year for which complete documentation and certification has been timely submitted. Certifications for each taxable year must be submitted by the due date of the federal income tax return or Form 1065 on which the section 45Q credit is claimed, including extensions. However, if a section 45Q credit is claimed on an amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, certifications may also be submitted with such amended Federal income tax return, amended Form 1065, or AAR. Further, if a section 45Q credit was claimed on a timely filed Federal income tax return or Form 1065 for a taxable year ending on or after January 1, 2018, and beginning on or before January 13, 2021, for which certifications were not submitted, such certifications may be submitted with a timely filed amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, for such taxable year.
(f) Applicability date. This section applies to taxable years beginning on or after January 13, 2021. Taxpayers may choose to apply this section for taxable years beginning on or after January 1, 2018, provided the taxpayer applies this section and §§ 1.45Q-1, 1.45Q-2, 1.45Q-4, and 1.45Q-5 in their entirety and in a consistent manner.
§ 1.45Q-4 Utilization of Qualified Carbon Oxide.
(a) In general. For purposes of this section, utilization of qualified carbon oxide means—
(1) The fixation of such qualified carbon oxide through photosynthesis or chemosynthesis, such as through the growing of algae or bacteria,
(2) The chemical conversion of such qualified carbon oxide to a material or chemical compound in which such qualified carbon oxide is securely stored, or
(3) The use of such qualified carbon oxide for any other purpose for which a commercial market exists (with the exception of use as a tertiary injectant in a qualified enhanced oil or natural gas recovery project), as described in paragraph (d) of this section.
(b) Amount utilized—(1) In general. For purposes of § 1.45Q-1(b) (ii) and (c)(2)(ii), the amount of qualified carbon oxide utilized by the taxpayer is equal to the metric tons of qualified carbon oxide which the taxpayer demonstrates, based upon an analysis of lifecycle greenhouse gas emissions (LCA), were—
(i) Captured and permanently isolated from the atmosphere through use of a process described in paragraph (a) of this section, or
(ii) Displaced from being emitted into the atmosphere through use of a process described in paragraph (a) of this section.
(2) Limitation. The amount determined under paragraph (b)(1) of this section cannot exceed the amount of qualified carbon oxide measured at the source of capture.
(c) Lifecycle greenhouse gas emissions and lifecycle analysis (LCA)—(1) In general. For purposes of paragraph (b) of this section, the term lifecycle greenhouse gas emissions means the aggregate quantity of greenhouse gas emissions (including direct emissions and significant indirect emissions such as significant emissions from land use changes) related to the full product lifecycle, including all stages of product and feedstock production and distribution, from feedstock generation or extraction through the distribution and delivery and use of the finished product to the ultimate consumer, where the mass values for all greenhouse gases are adjusted to account for their relative global warming potential according to Table A-1 of 40 CFR part 98 subpart A. Such emissions are expressed in carbon dioxide equivalent (CO
(2) LCA verification. The taxpayer verifies the amount of qualified carbon oxide utilized through an LCA. The LCA must demonstrate that the proposed process results in a net reduction of carbon dioxide equivalents when compared to a comparison system. The results of the LCA must be documented in a written LCA report.
(3) Standards of adequate lifecycle analysis. The LCA report must be prepared in conformity with and contain documentation that conforms with International Organization for Standardization (ISO) 14040:2006, Environmental management—Life cycle assessment—Principles and framework and ISO 14044:2006, Environmental management—Life cycle assessment—Requirements and guidelines. The LCA may consist of direct and indirect data in conformity with ISO 14040:2006 and 14044:2006.
(4) Third-party independent review of LCA. The LCA report must be performed or verified by an independent third party. The LCA report must provide a statement documenting the qualifications of the independent third party, including proof of appropriate U.S. or foreign professional license, an affidavit from the third party stating that it is independent from the taxpayer (if a section 45Q(f)(3)(B) election has been made, the affidavit must state that the third party is independent from both the electing taxpayer and the credit claimant), and the statement must be made under penalties of perjury. If an independent third-party review is conducted, then it must include an assessment of the model and supporting data.
(5) Submission of the LCA. The taxpayer must submit the LCA report and third-party independent statement required by paragraph (c) of this section to the IRS and the Department of Energy. The taxpayer must also submit the model if the LCA is not verified by an independent third-party review.
(6) LCA review. The LCA report will be subject to a technical review by the DOE. The IRS will determine whether to approve the LCA and will notify the taxpayer. The taxpayer must receive approval of its LCA prior to claiming the section 45Q credits for such taxable year on any federal income tax return. In addition to receiving approval of its LCA, the taxpayer must satisfy all other requirements of section 45Q and §§ 1.45Q-1, 1.45Q-2, and this section in order to be eligible to claim section 45Q credits.
(d) Commercial market. A commercial market means a market in which a product, process, or service that utilizes carbon oxide is sold or transacted on commercial terms. A taxpayer must submit a statement attached to its Form 8933 substantiating that a commercial market exists for its particular product, process, or service.
(e) Applicability date. This section applies to taxable years beginning on or after January 13, 2021. Taxpayers may choose to apply this section for taxable years beginning on or after January 1, 2018, provided the taxpayer applies this section and §§ 1.45Q-1, 1.45Q-2, 1.45Q-3, and 1.45Q-5 in their entirety and in a consistent manner.
§ 1.45Q-5 Recapture of Credit.
(a) Recapture event. A recapture event occurs when qualified carbon oxide for which a section 45Q credit has been previously claimed ceases to be disposed of in secure geological storage (as described in § 1.45Q-3(b)), or used as a tertiary injectant during the recapture period. Recapture events are determined separately for each project involving the disposal or use of qualified carbon oxide as a tertiary injectant. A recapture event does not occur if some portion of qualified carbon oxide disposed of in the current year does not remain in secure storage at the end of the year. The amount of such carbon oxide that is securely stored in the current year is determined according to the applicable requirements of 40 CFR part 98 subpart RR or CSA/ANSI ISO 27916:2019.
(b) Ceases to be disposed of in secure geological storage or used as a tertiary injectant. Qualified carbon oxide for which a section 45Q credit has been previously claimed ceases to be disposed of in secure geological storage (as described in § 1.45Q-3(b)), or used as a tertiary injectant, if the leaked amount of qualified carbon oxide in the taxable year exceeds the amount of qualified carbon oxide securely stored in that same taxable year.
(c) Leaked amount of qualified carbon oxide. When a taxpayer that claimed a section 45Q credit with respect to qualified carbon oxide stored at a secure storage site, operator of the secure storage site, or regulatory agency with jurisdiction over the site determines that the qualified carbon oxide that was disposed of in secure geological storage has leaked to the atmosphere, the taxpayer or the party with whom the taxpayer contracted to ensure the secure geological storage of the qualified carbon oxide must quantify the metric tons of qualified carbon oxide that has leaked to the atmosphere pursuant to the requirements of 40 CFR part 98 subpart RR or CSA/ANSI ISO 27916:2019. The quantity determined pursuant to CSA/ANSI ISO 27916:2019 must be certified by a qualified independent engineer or geologist, including a statement that the quantity was determined in accordance with sound engineering principles in the same manner as required in § 1.45Q-3. The IRS will consider all available facts and circumstances, and may consult with the relevant regulatory agency with jurisdiction over such site, in verifying the amount of qualified carbon oxide that has leaked to the atmosphere. The verified amount is the leaked amount of qualified carbon oxide.
(d) Qualified carbon oxide subject to recapture. The quantity of recaptured qualified carbon oxide (in metric tons) subject to recapture is the amount by which the leaked amount of qualified carbon oxide exceeds the amount of qualified carbon oxide securely stored in the taxable year. The leaked amount of qualified carbon oxide shall be subtracted from the amount of qualified carbon oxide that is securely stored in the taxable year. If the leaked amount does not exceed the amount of qualified carbon oxide that is securely stored in the taxable year, then the taxpayer is entitled to a credit equal to the amount of qualified carbon oxide securely stored less the leaked amount in the taxable year, multiplied by the appropriate statutory credit rate.
(e) Recapture amount. The recapture amount is equal to the product of the quantity of recaptured qualified carbon oxide (in metric tons) subject to recapture and the appropriate statutory credit rate.
(f) Recapture period. The recapture period begins on the date of first injection of qualified carbon oxide for disposal in secure geological storage or use as a tertiary injectant for which a section 45Q credit was claimed. The recapture period ends on the earlier of three years after the last taxable year in which the taxpayer claimed a section 45Q credit or was eligible to claim a credit that it elected to carry forward or the date monitoring ends under the requirements of the standards described in § 1.45Q-3(b)(1) or (2).
(g) Application of recapture—(1) In general. Any recapture amount must be taken into account in the taxable year in which it is identified and reported. If the leaked amount of qualified carbon oxide does not exceed the amount of qualified carbon oxide securely stored in the taxable year reported, there is no recapture amount and no further adjustments to prior taxable years are needed. If the leaked amount of qualified carbon oxide does exceed the amount of qualified carbon oxide securely stored in the taxable year reported, then the taxpayer must add the recapture amount to the amount of tax due in the taxable year in which the recapture event occurs.
(2) Calculation. Recapture amounts are calculated on a last-in-first-out basis (LIFO), such that the leaked amount of qualified carbon oxide that exceeds the amount of qualified carbon oxide securely stored in the current taxable year will be deemed attributable first to the prior taxable year, then to taxable year before that, and then up to a maximum of the third preceding year.
(3) Multiple units. In the event of a recapture event in which the leaked amount of qualified carbon oxide had been captured from multiple units of carbon capture equipment that were not under common ownership, the recapture amount must be allocated on a pro rata basis among the multiple units of carbon capture equipment. All taxpayers that claimed a section 45Q credit with respect to one or more of such units of carbon capture equipment are responsible for adding the recapture amount to their amount of tax due in the taxable year in which the recapture event occurs.
(4) Multiple taxpayers—(i) In general. In the event of a recapture event involving a leaked amount of qualified carbon oxide that is deemed attributable to qualified carbon oxide for which multiple taxpayers claimed section 45Q credits (for example, if ownership of the carbon capture equipment was transferred, or if a taxpayer made an election under section 45Q(f)(3)(B) to allow one or more credit claimants to claim a portion of the section 45Q credit), the recapture amount must be allocated on a pro rata basis among the taxpayers that claimed the section 45Q credits.
(ii) Partnerships—(A) General rule. For purposes of paragraph (g)(4)(i) of this section, if a partnership is one of the multiple taxpayers that claimed section 45Q credit amounts, the partnership and not its partners will be the taxpayer to which the pro rata recapture amount must be allocated. The partnership must allocate its pro rata recapture amount among its partners under § 1.704-1(b)(4)(ii).
(B) Terminated partnerships. If a partnership described in paragraph (g)(4)(ii)(A) of this section terminates under section 708(b)(1) prior to a recapture event, the partners of that terminated partnership at the time the section 45Q credit was claimed will be the taxpayers to which the pro rata recapture amount must be allocated.
(5) Reporting. If a recapture event occurs during a project’s recapture period, any taxpayer that claimed a section 45Q credit for that project must report the following information on a Form 8933 filed with that taxpayer’s Federal income tax return or Form 1065 for the taxable year for which the recapture event occurred—
(A) The recapture amount (as defined in § 1.45Q-5(e));
(B) The leaked amount of qualified carbon oxide (in metric tons) (as defined in § 1.45Q-5(c));
(C) The statutory credit rate(s) at which the section 45Q credits were previously calculated; and
(D) A statement that describes how the taxpayer became aware of the recapture event, how the leaked amount was determined, and the identity and involvement of any regulatory agencies.
(6) Examples. The following examples illustrate the principles of this paragraph (g):
(i) Example 1. (A) A owns direct air capture Facility X. No other taxpayer has owned Facility X, and A has never allowed another taxpayer to claim any section 45Q credits with respect to qualified carbon oxide captured by Facility X. Facility X captured 100,000 metric tons of carbon dioxide in each of 2021, 2022, and 2023. All captured carbon dioxide was sold to B for use a tertiary injectant in a qualified enhanced oil recovery project. B provided contractual assurance that the carbon dioxide would be disposed of in secure geological storage. A claimed section 45Q credit amounts of $2,268,000 in 2021, $2,515,000 in 2022, and $2,761,000 in 2023 using the statutory rates in § 1.45Q-1(d)(3). In 2024, A captured and sold another 100,000 metric tons of carbon dioxide to B, which B used as a tertiary injectant in a qualified enhanced oil recovery project. In late 2024, B determined that 10,000 metric tons of qualified carbon dioxide injected during 2021 had leaked from the containment area of the reservoir and were released into the atmosphere.
(B) Because the leakage determined in 2024 (10,000 metric tons) did not exceed the presumed amount stored in 2024 (100,000 metric tons), a recapture event did not occur in 2024. B’s actual storage in 2024 is 90,000 metric tons of qualified carbon oxide. A’s section 45Q credit for 2024 is $2,706,300 (net 90,000 metric tons of qualified carbon oxide captured, disposed of in secure geological storage, and used as a tertiary injectant multiplied by the statutory credit rate for 2024 of $30.07).
(ii) Example 2. (A) Assume same facts as in Example 1. Additionally, in 2025, B determines that 190,000 metric tons of qualified carbon dioxide injected in 2021 and 2022 had leaked and were released into the atmosphere. No injection of carbon dioxide takes place in 2025.
(B) Because the leakage determined in 2025 (190,000 metric tons) exceeds the amount stored in 2025 (0 metric tons), a recapture event occurred in 2025. A’s credit for 2025 is $0 because the net amount of carbon dioxide captured, disposed of in secure geological storage, and used as a tertiary injectant in 2025 was 0 metric tons. The 2025 recapture amount is calculated by multiplying the 190,000 metric tons of recaptured qualified carbon oxide by the appropriate statutory credit rate using the LIFO method. The first 90,000 metric tons of recaptured qualified carbon oxide is deemed attributable to 2024, and is recaptured at the 2024 statutory rate of $30.07 per metric ton. The remaining 100,000 metric tons of recaptured qualified carbon oxide are deemed attributable to 2023. The credits attributable to 2023 are recaptured at the 2023 statutory rate of $27.61 per metric ton. Thus, the total recapture amount is $5,467,300, and is added to A’s tax due for 2025.
(iii) Example 3. (A) Assume the same facts as in Example 2, except that A sells Facility X to C on January 1, 2024. C sells 100,000 metric tons of carbon dioxide captured by Facility X to B for use as a tertiary injectant in a qualified enhanced oil recovery project. C claims a section 45Q credit in 2024 of $2,706,300 (net 90,000 metric tons of qualified carbon oxide captured, disposed of in secure geological storage, and used as a tertiary injectant multiplied by the statutory credit rate for 2024 of $30.07).
(B) The total recapture amount in 2025 is the same $5,467,300 as in Example 2, but is allocated between A and C. The first 90,000 metric tons of recaptured qualified carbon oxide are deemed attributable to 2024. The credits that are attributable to 2024 are recaptured at the 2024 statutory rate of $30.07 per ton (for a recapture amount of $2,706,300). Because C claimed that amount of section 45Q credit in 2024, a recapture amount of $2,706,300 is added to C’s tax due for 2025. The remaining 100,000 metric tons of recaptured qualified carbon oxide are deemed attributable to 2023. The credits that are attributable to 2023 are recaptured at the 2023 statutory rate of $27.61 per ton (for a recapture amount of $2,761,000). Because A claimed that amount of section 45Q credit in 2023, a recapture amount of $2,761,000 is added to A’s tax due for 2025.
(iv) Example 4. (A) Assume the same facts as in Example 2, except that in 2023, A made a section 45Q(f)(3)(B) election to allow B to claim one-half of the section 45Q credit for 2023. A and B each claimed $1,380,500 of section 45Q credit in 2023 (50,000 metric tons each multiplied by the 2023 statutory rate of $27.61).
(B) The total recapture amount in 2025 is the same $5,467,300 as in Example 2, but is allocated among A and B. The first 90,000 metric tons of recaptured qualified carbon oxide is deemed attributable to 2024. The section 45Q credit amounts attributable to 2024 are recaptured at the 2024 statutory rate of $30.07 per ton (for a recapture amount of $2,706,300). Because A claimed that amount of section 45Q credit in 2024, $2,706,300 is added to A’s tax due for 2025. The remaining 100,000 metric tons of recaptured qualified carbon oxide is deemed attributable to 2023. The section 45Q credit amounts attributable to 2023 are recaptured at the 2023 statutory rate of $27.61 per ton (for a recapture amount of $2,761,000). Because A and B each claimed half of that amount ($1,380,500) of section 45Q credit in 2023, $1,380,500 is added to both A’s and B’s tax due for 2025. Thus, a recapture amount of $4,086,800 is added to A’s tax due for 2025, and a recapture amount of $1,380,500 is added to B’s tax due for 2025.
(v) Example 5. (A) Assume the same facts as in Example 2, except that the 100,000 metric tons of carbon dioxide sold to B in 2021, 2022, 2023, and 2024 for use as a tertiary injectant in a qualified enhanced oil recovery project were captured equally (50,000 metric tons per year) from qualified facilities owned by J and K. Neither J nor K made a section 45Q(f)(3)(B) election to allow B to claim the credit.
(B) Because the leakage determined in 2024 (10,000 metric tons) did not exceed the presumed amount stored in 2024 (100,000 metric tons) a recapture event did not occur in 2024. The total amount of section 45Q credit for 2024 is $2,706,300 (net 90,000 metric tons of qualified carbon oxide captured, disposed of in secure geological storage, and used as a tertiary injectant multiplied by the statutory credit rate for 2024 of $30.07). J and K may each claim half of this amount of section 45Q credit ($1,353,150) in 2024.
(C) The total recapture amount in 2025 is the same $5,467,300 as in Example 2, but is allocated between J and K. The section 45Q credit amounts relating to the first 90,000 metric tons of recaptured qualified carbon oxide are deemed attributable to 2024 and are recaptured at the 2024 statutory rate of $30.07 per ton (for a recapture amount of $2,706,300). Because J and K each claimed half of that amount ($1,353,150) of section 45Q credit in 2024, $1,353,150 is added to both J’s and K’s tax due for 2025. The section 45Q credit amounts relating to the remaining 100,000 metric tons of recaptured qualified carbon oxide are deemed attributable to 2023 and are recaptured at the 2023 statutory rate of $27.61 per ton (for a recapture amount of $2,761,000). Because J and K each claimed half of that amount ($1,380,500) of section 45Q credit in 2023, an additional $1,380,500 is added to both J’s and Ks tax due for 2025. Thus, a total recapture amount of $2,733,650 is added to both J’s and K’s tax due for 2025.
(vi) Example 6. (A) M owns Industrial Facility Z. No other taxpayer has ever owned Z, and M has never allowed another taxpayer to claim any section 45Q credits with respect to qualified carbon oxide captured from Z. M captured 1,000,000 metric tons of carbon dioxide annually in each of 2017, 2018, 2019, 2020, 2021, 2022, 2023, 2024, and 2025. All captured carbon dioxide was sold to N for use a tertiary injectant in a qualified enhanced oil recovery project. N provided contractual assurance that the carbon dioxide would be sequestered in secure geological storage. M claimed section 45Q credit amounts of $12,830,000 in 2017, $15,209,000 in 2018, $17,760,000 in 2019, $20,220,000 in 2020, $22,680,000 in 2021, $25,150,000 in 2022, $27,610,000 in 2023, $30,070,000 in 2024, and $32,540,000 in 2025 using the statutory rates in § 1.45Q-1(d)(3). No injection of carbon oxides takes place in 2026. In 2026, N determined that 6,200,000 metric tons of qualified carbon dioxide previously injected had leaked from the containment area of the reservoir and were released into the atmosphere.
(B) Because the leakage determined in 2025 (6,200,000 metric tons) exceed the amount stored in 2026 (0 metric tons) a recapture event occurred in 2026. A’s credit for 2026 is $0 because the net amount of carbon dioxide captured and used as a tertiary injectant in 2026 was 0 metric tons. The 2026 recapture amount is calculated by multiplying the 6,200,000 metric tons of recaptured qualified carbon oxide by the appropriate statutory credit rate using the LIFO method. The first 1,000,000 metric tons of recaptured qualified carbon oxide is deemed attributable to 2025, and is recaptured at the 2025 statutory rate of $32.54 per metric ton. The next 1,000,000 metric tons of recaptured qualified carbon oxide is deemed attributable to 2024, and is recaptured at the 2024 statutory rate of $30.07 per metric ton. The next 1,000,000 metric tons of recaptured qualified carbon oxide is deemed attributable to 2023, and is recaptured at the 2023 statutory rate of $27.16 per metric ton. The remaining 3,200,000 metric tons are not subject to recapture because of the three-year lookback limit in § 1.45Q-1(g)(2). Thus, the total recapture amount is $89,770,000, and is added to A’s tax due for 2026.
(h) Recapture in the event of deliberate removal from storage—(1) In general. If qualified carbon oxide for which a credit has been claimed is deliberately removed from a secure geological storage site, then a recapture event would occur in the year in which the qualified carbon oxide is removed from the storage site pursuant to § 1.45Q-5(a).
(2) Recycled qualified carbon oxide. If qualified carbon oxide for which a credit has been claimed is recaptured, recycled, and reinjected as part of the enhanced oil and natural gas recovery project, that qualified carbon oxide will be considered recycled carbon oxide under section 45Q(c)(2). If recycled carbon oxide is reinjected into the same qualified enhanced oil or natural gas recovery project it was originally injected into, it will not be considered deliberately removed from a secure geological storage site for purposes of paragraph (h)(1) of this section. If recycled carbon oxide is reinjected into a different qualified enhanced oil or natural gas recovery project from the one it was initially injected into, or used for any other purpose, that qualified carbon oxide will be considered deliberately removed from a secure geological storage site for purposes of paragraph (h)(1) of this section.
(i) Limited exceptions. A recapture event is not triggered in the event of a loss of containment of qualified carbon oxide resulting from actions not related to the selection, operation, or maintenance of the storage facility, such as volcanic activity or terrorist attack.
(j) Applicability date. This section applies to taxable years beginning on or after January 13, 2021. Taxpayers may choose to apply this section for taxable years beginning on or after January 1, 2018, provided the taxpayer applies this section and §§ 1.45Q-1, 1.45Q-2, 1.45Q-3, and 1.45Q-4 in their entirety and in a consistent manner.
§ 1.45R-0 Table of contents.
This section lists the table of contents for §§ 1.45R-1 through 1.45R-5.
(a) Definitions.
(1) Average premium.
(2) Composite billing.
(3) Credit period.
(4) Eligible small employer.
(5) Employee.
(6) Employer-computed composite rate.
(7) Exchange.
(8) Family member.
(9) Full-time equivalent employee (FTE).
(10) List billing.
(11) Net premium payments.
(12) Nonelective contribution.
(13) Payroll taxes.
(14) Qualified health plan QHP.
(15) Qualifying arrangement.
(16) Seasonal worker.
(17) SHOP dependent coverage.
(18) Small Business Health Options Program (SHOP).
(19) State.
(20) Tax-exempt eligible small employer.
(21) Tier.
(22) Tobacco surcharge.
(23) United States.
(24) Wages.
(25) Wellness program.
(b) Effective/applicability date.
(a) Eligible small employer.
(b) Application of section 414 employer aggregation rules.
(c) Employees taken into account.
(d) Determining the hours of service performed by employees.
(1) In general.
(2) Permissible methods.
(3) Examples.
(e) FTE calculation.
(1) In general.
(2) Example.
(f) Determining the employer’s average annual wages.
(1) In general.
(2) Example.
(g) Effective/applicability date.
(a) In general.
(b) Average premium limitation.
(1) In general.
(2) Examples.
(c) Credit phaseout.
(1) In general.
(2) $25,000 dollar amount adjusted for inflation.
(3) Examples
(d) State credits and subsidies for health insurance.
(1) Payments to employer.
(2) Payments to issuer.
(3) Credits may not exceed net premium payment.
(4) Examples.
(e) Payroll tax limitation for tax-exempt eligible small employers.
(1) In general.
(2) Example.
(f) Two-consecutive-taxable year credit period limitation.
(g) Premium payments by the employer for a taxable year.
(1) In general.
(2) Excluded amounts.
(h) Rules applicable to trusts, estates, regulated investment companies, real estate investment trusts and cooperative organizations.
(i) Transition rule for 2014.
(1) In general.
(2) Example.
(j) Effective/applicability date.
(a) In general.
(b) Employers offering one QHP.
(1) Employers offering one QHP, self-only coverage, composite billing.
(2) Employers offering one QHP, other tiers of coverage, composite billing.
(3) Employers offering one QHP, self-only coverage, list billing.
(4) Employers offering one QHP, other tiers of coverage, list billing.
(5) Employers offering SHOP dependent coverage.
(c) Employers offering more than one QHP.
(1) QHP-by-QHP method.
(2) Reference QHP method.
(d) Tobacco surcharges and wellness program discounts.
(i) Tobacco surcharges.
(ii) Wellness programs.
(e) Special rules regarding employer compliance with applicable State and local law.
(f) Examples.
(g) Effective/applicability date.
(a) Claiming the credit.
(b) Estimated tax payments and alternative minimum tax (AMT) liability.
(c) Reduction of section 162 deduction.
(d) Effective/applicability date.
§ 1.45R-1 Definitions.
(a) Definitions. The definitions in this section apply to this section and §§ 1.45R-2, 1.45R-3, 1.45R-4, and 1.45R-5.
(1) Average premium. The term average premium means an average premium for the small group market in the rating area in which the employee enrolls for coverage. The average premium for the small group market in a rating area is determined by the Secretary of Health and Human Services.
(2) Composite billing. The term composite billing means a system of billing under which a health insurer charges a uniform premium for each of the employer’s employees or charges a single aggregate premium for the group of covered employees that the employer then divides by the number of covered employees to determine the uniform premium.
(3) Credit period—(i) In general. The term credit period means, with respect to any eligible small employer (or any predecessor employer), the two-consecutive-taxable-year period beginning with the first taxable year beginning after 2013, for which the eligible small employer files an income tax return with an attached Form 8941, “Credit for Small Employer Health Insurance Premiums” (or files a Form 990-T, “Exempt Organization Business Income Tax Return,” with an attached Form 8941 in the case of a tax-exempt eligible employer). For a transition rule for 2014, see § 1.45R-3(i).
(ii) Examples. The following examples illustrate the provisions of paragraph (a)(3)(i) of this section:
(ii) Conclusion. Employer’s taxable year 2016 is the first year of the credit period. Accordingly, Employer’s two-year credit period is 2016 and 2017.
(ii) Conclusion. Employer’s taxable year 2015 is the first year of the credit period. Accordingly, Employer’s two-year credit period is 2015 and 2016 (and does not include 2017). Employer is entitled to a credit based on a partial year of SHOP Exchange coverage for Employer’s taxable year 2015.
(4) Eligible small employer. (i) The term eligible small employer means an employer that meets the requirements set forth in § 1.45R-2.
(ii) For the definition of tax-exempt eligible small employer, see paragraph (a)(19) of this section.
(iii) A farmers’ cooperative described under section 521 that is subject to tax pursuant to section 1381, and otherwise meets the requirements of this paragraph (a)(4) and § 1.45R-2, is an eligible small employer.
(5) Employee—(i) In general. Except as otherwise specifically provided in this paragraph (a)(5), the term employee means an individual who is an employee of the eligible small employer under the common law standard. See § 31.3121(d)-1(c).
(ii) Leased employees. For purposes of this paragraph (a)(5), the term employee also includes a leased employee (as defined in section 414(n)).
(iii) Certain individuals excluded. The term employee does not include independent contractors (including sole proprietors), partners in a partnership, shareholders owning more than two percent of an S corporation, and any owners of more than five percent of other businesses. The term employee also does not include family members of these owners and partners, including the employee-spouse of a shareholder owning more than two percent of the stock of an S corporation, the employee-spouse of an owner of more than five percent of a business, the employee-spouse of a partner owning more than a five percent interest in a partnership, and the employee-spouse of a sole proprietor, or any other member of the household of these owners and partners who qualifies as a dependent under section 152(d)(2)(H).
(iv) Seasonal workers. The term employee does not include seasonal workers unless the seasonal worker provides services to the employer on more than 120 days during the taxable year.
(v) Ministers. Whether a minister is an employee is determined under the common law standard for determining worker status. If, under the common law standard, a minister is not an employee, the minister is not an employee for purposes of this paragraph (a)(5) and is not taken into account in determining an employer’s FTEs, and premiums paid for the minister’s health insurance coverage are not taken into account in computing the credit. If, under the common law standard, a minister is an employee, the minister is an employee for purposes of this paragraph (a)(5), and is taken into account in determining an employer’s FTEs, and premiums paid by the employer for the minister’s health insurance coverage can be taken into account in computing the credit. Because the performance of services by a minister in the exercise of his or her ministry is not treated as employment for purposes of the Federal Insurance Contributions Act (FICA), compensation paid to the minister is not wages as defined under section 3121(a), and is not counted as wages for purposes of computing an employer’s average annual wages.
(vi) Former employees. Premiums paid on behalf of a former employee with no hours of service may be treated as paid on behalf of an employee for purposes of calculating the credit (see § 1.45R-3) provided that, if so treated, the former employee is also treated as an employee for purposes of the uniform percentage requirement (see § 1.45R-4). For the treatment of terminated employees for purposes of determining employer eligibility for the credit, see § 1.45R-2(c).
(6) Employer-computed composite rate. The term employer-computed composite rate refers to a rate for a tier of coverage (such as employee-only, dependent or family) of a QHP that is the average rate determined by adding the premiums for that tier of coverage for all employees eligible to participate in the QHP (whether or not they actually receive coverage under the plan or under that tier of coverage) and dividing by the total number of such eligible employees. The employer-computed composite rate may be used in list billing to convert individual premiums for a tier of coverage into an employer-computed composite rate for that tier of coverage. See § 1.45R-4(b)(3).
(7) Exchange. The term Exchange means an exchange as defined in 45 CFR 155.20.
(8) Family member. The term family member is defined with respect to a taxpayer as a child (or descendant of a child); a sibling or step-sibling; a parent (or ancestor of a parent); a step-parent; a niece or nephew; an aunt or uncle; or a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law. A spouse of any of these family members is also considered a family member.
(9) Full-time equivalent employee (FTE). The number of full-time equivalent employees (FTEs) is determined by dividing the total number of hours of service for which wages were paid by the employer to employees during the taxable year by 2,080. See § 1.45R-2(d) and (e) for permissible methods of calculating hours of service and the method for calculating the number of an employer’s FTEs.
(10) List billing. The term list billing refers to a system of billing under which a health insurer lists a separate premium for each employee based on the age of the employee or other factors.
(11) Net premium payments. The term net premium payments means, in the case of an employer receiving a State tax credit or State subsidy for providing health insurance to its employees, the excess of the employer’s actual premium payments over the State tax credit or State subsidy received by the employer. In the case of a State payment directly to an insurance company (or another entity licensed under State law to engage in the business of insurance), the employer’s net premium payments are the employer’s actual premium payments. If a State-administered program (such as Medicaid or another program that makes payments directly to a health care provider or insurance company on behalf of individuals and their families who meet certain eligibility guidelines) makes payments that are not contingent on the maintenance of an employer-provided group health plan, those payments are not taken into account in determining the employer’s net premium payments.
(12) Nonelective contribution. The term nonelective contribution means an employer contribution other than a contribution pursuant to a salary reduction arrangement under section 125.
(13) Payroll taxes. For purposes of section 45R, the term payroll taxes means amounts required to be withheld as tax from the employees of a tax-exempt eligible small employer under section 3402, amounts required to be withheld from such employees under section 3101(b), and amounts of tax imposed on the tax-exempt eligible small employer under section 3111(b).
(14) Qualified health plan or QHP. The term qualified health plan or the term QHP means a qualified health plan as defined in Affordable Care Act section 1301(a) (see 42 U.S.C. 18021(a)), but does not include a catastrophic plan described in Affordable Care Act section 1302(e) (see 42 U.S.C. 18022(e)).
(15) Qualifying arrangement. The term qualifying arrangement means an arrangement that requires an eligible small employer to make a nonelective contribution on behalf of each employee who enrolls in a QHP offered to employees by the employer through a SHOP Exchange in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the QHP.
(16) Seasonal worker. The term seasonal worker means a worker who performs labor or services on a seasonal basis as defined by the Secretary of Labor, including (but not limited to) workers covered by 29 CFR 500.20(s)(1), and retail workers employed exclusively during holiday seasons. Employers may apply a reasonable, good faith interpretation of the term seasonal worker and a reasonable good faith interpretation of 29 CFR 500.20(s)(1) (including as applied by analogy to workers and employment positions not otherwise covered under 29 CFR 500.20(s)(1)).
(17) SHOP dependent coverage. The term SHOP dependent coverage refers to coverage offered through SHOP separately to any individual who is or may become eligible for coverage under the terms of a group health plan offered through SHOP because of a relationship to a participant-employee, whether or not a dependent of the participant-employee under section 152 of the Internal Revenue Code. The term SHOP dependent coverage does not include coverage such as family coverage, which includes coverage of the participant-employee.
(18) Small Business Health Options Program (SHOP). The term Small Business Health Options Program (SHOP) means an Exchange established pursuant to section 1311 of the Affordable Care Act and defined in 45 CFR 155.20.
(19) State. The term State means a State as defined in section 7701(a)(10), including the District of Columbia.
(20) Tax-exempt eligible small employer. The term tax-exempt eligible small employer means an eligible small employer that is exempt from federal income tax under section 501(a) as an organization described in section 501(c).
(21) Tier. The term tier refers to a category of coverage under a benefits package that varies only by the number of individuals covered. For example, employee-only coverage, dependent coverage, and family coverage would constitute three separate tiers of coverage.
(22) Tobacco surcharge. The term tobacco surcharge means any allowable differential that is charged for insurance in the SHOP Exchange that is attributable to tobacco use as the term tobacco use is defined in 45 CFR 147.102(a)(1)(iv).
(23) United States. The term United States means United States as defined in section 7701(a)(9).
(24) Wages. The term wages for purposes of section 45R means wages as defined under section 3121(a) for purposes of the Federal Insurance Contributions Act (FICA), determined without regard to the social security wage base limitation under section 3121(a)(1).
(25) Wellness program. The term wellness program for purposes of section 45R means a program of health promotion or disease prevention subject to the requirements of § 54.9802-1(f).
(b) Effective/applicability date. This section is applicable for periods after 2013. For rules relating to certain plan years beginning in 2014, see § 1.45R-3(i).
§ 1.45R-2 Eligibility for the credit.
(a) Eligible small employer. To be eligible for the credit under section 45R, an employer must be an eligible small employer. In order to be an eligible small employer, with respect to any taxable year, an employer must have no more than 25 full-time equivalent employees (FTEs), must have in effect a qualifying arrangement, and the average annual wages of the employer’s FTEs must not exceed an amount equal to twice the dollar amount in effect under § 1.45R-3(c)(2). For purposes of eligibility for the credit for taxable years beginning in or after 2014, a qualifying arrangement is an arrangement that requires an employer to make a nonelective contribution on behalf of each employee who enrolls in a qualified health plan (QHP) offered to employees through a small business health options program (SHOP) Exchange in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the QHP. Notwithstanding the foregoing, an employer that is an agency or instrumentality of the federal government, or of a State, local or Indian tribal government, is not an eligible small employer if it is not an organization described in section 501(c) that is exempt from tax under section 501(a). An employer does not fail to be an eligible small employer merely because its employees are not performing services in a trade or business of the employer. An employer located outside the United States (including an employer located in a U.S. territory) must have income effectively connected with the conduct of a trade or business in the United States, and otherwise meet the requirements of this section, to be an eligible small employer. For eligibility standards for SHOP related to foreign employers, see 45 CFR 155.710. Paragraphs (b) through (f) of this section provide the rules for determining whether the requirements to be an eligible small employer are met, including rules related to identifying and counting the number of the employer’s FTEs, counting the employees’ hours of service, and determining the employer’s average annual FTE wages for the taxable year. For rules on determining whether the uniform percentage requirement is met, see § 1.45R-4.
(b) Application of section 414 employer aggregation rules. All employers treated as a single employer under section 414(b), (c), (m) or (o) are treated as a single employer for purposes of this section. Thus, all employees of a controlled group under section 414(b), (c) or (o), or an affiliated service group under section 414(m), are taken into account in determining whether any member of the controlled group or affiliated service group is an eligible small employer. Similarly, all wages paid to, and premiums paid for, employees by the members of the controlled group or affiliated service group are taken into account when determining the amount of the credit for a group treated as a single employer under these rules.
(c) Employees taken into account. To be eligible for the credit, an employer must have employees as defined in § 1.45R-1(a)(5) during the taxable year. All such employees of the eligible small employer are taken into account for purposes of determining the employer’s FTEs and average annual FTE wages. Employees include employees who terminate employment during the year for which the credit is being claimed, employees covered under a collective bargaining agreement, and employees who do not enroll in a QHP offered by the employer through a SHOP Exchange.
(d) Determining the hours of service performed by employees—(1) In general. An employee’s hours of service for a year include each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s taxable year. It also includes each hour for which an employee is paid, or entitled to payment, by the employer on account of a period of time during which no duties are performed due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence (except that no more than 160 hours of service are required to be counted for an employee on account of any single continuous period during which the employee performs no duties).
(2) Permissible methods. In calculating the total number of hours of service that must be taken into account for an employee during the taxable year, eligible small employers need not use the same method for all employees, and may apply different methods for different classifications of employees if the classifications are reasonable and consistently applied. Eligible small employers may change the method for calculating employees’ hours of service for each taxable year. An eligible small employer may use any of the following three methods.
(i) Actual hours worked. An employer may use the actual hours of service provided by employees including hours worked and any other hours for which payment is made or due (as described in paragraph (d)(1) of this section).
(ii) Days-worked equivalency. An employer may use a days-worked equivalency whereby the employee is credited with 8 hours of service for each day for which the employee would be required to be credited with at least one hour of service under paragraph (d)(1) of this section.
(iii) Weeks-worked equivalency. An employer may use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which the employee would be required to be credited with at least one hour of service under paragraph (d)(1) of this section.
(3) Examples. The following examples illustrate the rules of paragraph (d) of this section:
(ii) Conclusion. Under this method of counting hours, Employee A must be credited with 2,080 hours of service (2,000 hours worked and 80 hours for which payment was made or due).
(ii) Conclusion. Under this method of counting hours, Employee B must be credited with 1,600 hours of service (8 hours for each day Employee B would otherwise be credited with at least 1 hour of service × 200 days).
(ii) Conclusion. Under this method of counting hours, Employee C must be credited with 2,040 hours of service (40 hours for each week during which Employee C would otherwise be credited with at least 1 hour of service × 51 weeks).
(ii) Conclusion. Employee D is a seasonal employee who worked for 120 days or less for Employer during the year. Employee D’s hours are not counted when determining the hours of service of Employer’s employees. Employee E works throughout most of the year and is not a seasonal employee. Employer counts Employee E’s 350 hours of service during the year.
(e) FTE Calculation—(1) In general. The number of an employer’s FTEs is determined by dividing the total hours of service, determined in accordance with paragraph (d) of this section, credited during the year to employees taken into account under paragraph (c) of this section (but not more than 2,080 hours for any employee) by 2,080. The result, if not a whole number, is then rounded to the next lowest whole number. If, however, after dividing the total hours of service by 2,080, the resulting number is less than one, the employer rounds up to one FTE.
(2) Example. The following example illustrates the provisions of paragraph (e) of this section:
(ii) Conclusion. The sole proprietor’s FTEs equal 6 (13,520 divided by 2,080 = 6.5, rounded to the next lowest whole number).
(f) Determining the employer’s average annual FTE wages—(1) In general. All wages paid to employees (including overtime pay) are taken into account in computing an eligible small employer’s average annual FTE wages. The average annual wages paid by an employer for a taxable year is determined by dividing the total wages paid by the eligible small employer during the employer’s taxable year to employees taken into account under paragraph (c) of this section by the number of the employer’s FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000). For purposes of determining the employer’s average annual wages for the taxable year, only wages that are paid for hours of service determined under paragraph (d) of this section are taken into account.
(2) Example. The following example illustrates the provision of paragraphs (e) and (f) of this section:
(ii) Conclusion. The hours of service and wages of all employees are taken into consideration in determining whether the employer is an eligible small employer for purposes of the credit. Because the employer does not have fewer than 25 FTEs for the taxable year, the employer is not an eligible small employer for purposes of this section, even if fewer than 25 employees (or FTEs) enroll for coverage through the SHOP Exchange.
(g) Effective/applicability date. This section is applicable for periods after 2013. For transition rules relating to certain plan years beginning in 2014, see § 1.45R-3(i).
§ 1.45R-3 Calculating the credit.
(a) In general. The tax credit available to an eligible small employer equals 50 percent of the eligible small employer’s premium payments made on behalf of its employees under a qualifying arrangement, or in the case of a tax-exempt eligible small employer, 35 percent of the employer’s premium payments made on behalf of its employees under a qualifying arrangement. The employer’s tax credit is subject to the following adjustments and limitations:
(1) The average premium limitation for the small group market in the rating area in which the employee enrolls for coverage, described in paragraph (b) of this section;
(2) The credit phaseout described in paragraph (c) of this section;
(3) The net premium payment limitation in the case of State credits or subsidies described in paragraph (d) of this section;
(4) The payroll tax limitation for a tax-exempt eligible small employer described in paragraph (e) of this section;
(5) The two-consecutive-taxable year-credit period limitation, described in paragraph (f) of this section;
(6) The rules with respect to the premium payments taken into account, described in paragraph (g) of this section;
(7) The rules with respect to credits applicable to trusts, estates, regulated investment companies, real estate investment trusts and cooperatives described in paragraph (h) of this section; and
(8) The transition relief for 2014 described in paragraph (i) of this section.
(b) Average premium limitation—(1) In general. The amount of an eligible small employer’s premium payments that is taken into account in calculating the credit is limited to the premium payments the employer would have made under the same arrangement if the average premium for the small group market in the rating area in which the employee enrolls for coverage were substituted for the actual premium.
(2) Examples. The following examples illustrate the provisions of paragraph (b)(1) of this section:
(ii) Conclusion. The amount of premiums paid by Employer for purposes of computing the credit equals $19,500 ((6 × $2,000) plus (5 × $1,500)).
(ii) Conclusion. The amount of premiums paid by Employer for purposes of computing the credit equals $25,000 ((6 × $2,500) plus (5 × $2,000)).
(c) Credit phaseout—(1) In general. The tax credit is subject to a reduction (but not reduced below zero) if the employer’s FTEs exceed 10 or average annual FTE wages exceed $25,000. If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10 and the denominator of which is 15. If average annual FTE wages exceed $25,000, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual FTE wages exceed $25,000 and the denominator of which is $25,000. In both cases, the result of the calculation is subtracted from the otherwise applicable credit to determine the credit to which the employer is entitled. For an employer with both more than 10 FTEs and average annual FTE wages exceeding $25,000, the total reduction is the sum of the two reductions.
(2) $25,000 dollar amount adjusted for inflation. For taxable years beginning in a calendar year after 2013, each reference to “$25,000” in paragraph (c)(1) of this section is replaced with a dollar amount equal to $25,000 multiplied by the cost-of-living adjustment under section 1(f)(3) for the calendar year, determined by substituting “calendar year 2012” for “calendar year 1992” in section 1(f)(3)(B).
(3) Examples. The following examples illustrate the provisions of paragraph (c) this section. For purposes of these examples, no employer is a tax-exempt organization and no other adjustments or limitations on the credit apply other than those adjustments and limitations explicitly set forth in the example.
(ii) Conclusion. Employer’s credit equals $36,000 (50% × $72,000).
(ii) Conclusion. The initial amount of the credit is determined before any reduction (50% × $96,000) = $48,000. The credit reduction for FTEs in excess of 10 is $6,400 ($48,000 × 2/15). The credit reduction for average annual FTE wages in excess of $25,000 is $9,600 ($48,000 × $5,000/$25,000), resulting in a total credit reduction of $16,000 ($6,400 + $9,600). Employer’s total tax credit equals $32,000 ($48,000−$16,000).
(d) State credits and subsidies for health insurance—(1) Payments to employer. If the employer is entitled to a State tax credit or a premium subsidy that is paid directly to the employer, the premium payment made by the employer is not reduced by the credit or subsidy for purposes of determining whether the employer has satisfied the requirement to pay an amount equal to a uniform percentage (not less than 50 percent) of the premium cost. Also, except as described in paragraph (d)(3) of this section, the maximum amount of the credit is not reduced by reason of a State tax credit or subsidy or by reason of payments by a State directly to an employer.
(2) Payments to issuer. If a State makes payments directly to an insurance company (or another entity licensed under State law to engage in the business of insurance) to pay a portion of the premium for coverage of an employee enrolled for coverage through a SHOP Exchange, the State is treated as making these payments on behalf of the employer for purposes of determining whether the employer has satisfied the requirement to pay an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of coverage. Also, except as described below in paragraph (d)(3) of this section, these premium payments by the State are treated as an employer contribution under this section for purposes of calculating the credit.
(3) Credits may not exceed net premium payment. Regardless of the application of paragraphs (d)(1) and (2) of this section, in no event may the amount of the credit exceed the amount of the employer’s net premium payments as defined in § 1.45R-1(a)(11).
(4) Examples. The following examples illustrate the provisions of paragraphs (d)(1) through (3) of this section. For purposes of these examples, each employer is an eligible small employer that is not a tax-exempt organization and the eligible small employer’s taxable year and plan year begin during or after 2014. No other adjustments or limitations on the credit apply other than those adjustments and limitations explicitly set forth in the example.
(ii) Conclusion. For purposes of calculating the credit, the amount of premiums paid by the employer is $80 per month (the premium payment by the Employer without regard to the subsidy from the State). The maximum credit is $40 ($80 × 50%).
(ii) Conclusion. For purposes of calculating the amount of the credit, the amount of premiums paid by Employer is $80 per month (the sum of Employer’s payment and the State’s payment). The maximum credit is $40 ($80 × 50%).
(ii) Conclusion. The maximum credit without adjustments or limitations is $35 ($70 × 50%). Employer’s net premium payment is $20 (the amount actually paid by Employer excluding the State subsidy). Because the credit may not exceed Employer’s net premium payment, the credit is $20 (the lesser of $35 or $20).
(e) Payroll tax limitation for tax-exempt eligible small employers—(1) In general. For a tax-exempt eligible employer, the amount of the credit claimed cannot exceed the total amount of payroll taxes (as defined in § 1.45R-1(a)(13)) of the employer during the calendar year in which the taxable year begins.
(2) Example. The following example illustrates the provisions of paragraph (e)(1) of this section. For purposes of this example, the eligible small employer’s taxable year and plan year begin during or after 2014. No other adjustments or limitations on the credit apply other than those adjustments and limitations explicitly set forth in the example.
(ii) Conclusion. The initial amount of the credit is determined before any reduction: (35% × $80,000) = $28,000, and Employer’s payroll taxes are $30,000. The total tax credit equals $28,000 (the lesser of $28,000 and $30,000).
(f) Two-consecutive-taxable-year credit period limitation. The credit is available to an eligible small employer, including a tax-exempt eligible small employer, only during that employer’s credit period. For a transition rule for 2014, see paragraph (i) of this section. To prevent the avoidance of the two-year limit on the credit period through the use of successor entities, a successor entity and a predecessor entity are treated as the same employer. For this purpose, the rules for identifying successor entities under § 31.3121(a)(1)-1(b) apply. Accordingly, for example, if an eligible small employer claims the credit for the 2014 and 2015 taxable years, that eligible small employer’s credit period will have expired so that any successor employer to that eligible small employer will not be able to claim the credit for any subsequent taxable years.
(g) Premium payments by the employer for a taxable year—(1) In general. Only premiums paid by an eligible small employer or tax-exempt eligible small employer on behalf of each employee enrolled in a QHP or payments paid to the issuer in accordance with paragraph (d)(2) of this section are counted in calculating the credit. If an eligible small employer pays only a portion of the premiums for the coverage provided to employees (with employees paying the rest), only the portion paid by the employer is taken into account. Premiums paid on behalf of seasonal workers may be counted in determining the amount of the credit (even though seasonal worker wages and hours of service are not included in the FTE calculation and average annual FTE wage calculation unless the seasonal worker works for the employer on more than 120 days during the taxable year). Subject to the average premium limitation, premiums paid on behalf of an employee with respect to any individuals who are or may become eligible for coverage under the terms of the plan because of a relationship to the employee (including through family coverage or SHOP dependent coverage) may also be taken into account in determining the amount of the credit. (However, premiums paid for SHOP dependent coverage are not taken into account in determining whether the uniform percentage requirement is met, see § 1.45R-4(b)(5).)
(2) Excluded amounts—(i) Salary reduction amounts. Any premium paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer for purposes of section 45R and these regulations. For this purpose, premiums paid with employer-provided flex credits that employees may elect to receive as cash or other taxable benefits are treated as paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan.
(ii) HSAs, HRAs, and FSAs. Employer contributions to, or amounts made available under, health savings accounts, reimbursement arrangements, and health flexible spending arrangements are not taken into account in determining the premium payments by the employer for a taxable year.
(h) Rules applicable to trusts, estates, regulated investment companies, real estate investment trusts and cooperative organizations. Rules similar to the rules of section 52(d) and (e) and the regulations thereunder apply in calculating and apportioning the credit with respect to a trust, estate, a regulated investment company or real estate investment trusts or cooperative organization.
(i) Transition rule for 2014—(1) In general. This paragraph (i) applies if as of August 26, 2013, an eligible small employer offers coverage for a health plan year that begins on a date other than the first day of its taxable year. In such a case, if the eligible small employer has a health plan year beginning after January 1, 2014 but before January 1, 2015 (2014 health plan year) that begins after the start of its first taxable year beginning on or after January 1, 2014 (2014 taxable year), and the employer offers one or more QHPs to its employees through a SHOP Exchange as of the first day of its 2014 health plan year, then the eligible small employer is treated as offering coverage through a SHOP Exchange for its entire 2014 taxable year for purposes of section 45R if the health care coverage provided from the first day of the 2014 taxable year through the day immediately preceding the first day of the 2014 health plan year would have qualified for a credit under section 45R using the rules applicable to taxable years beginning before January 1, 2014. If the eligible small employer claims the section 45R credit in the 2014 taxable year, the 2014 taxable year begins the first year of the credit period.
(2) Example. The following example illustrates the rule of this paragraph (i) of this section. For purposes of this example, it is assumed that the eligible small employer is not a tax-exempt organization and that no other adjustments or limitations on the credit apply other than those adjustments and limitations explicitly set forth in the example.
(ii) Conclusion. Employer may claim the credit at the 50% rate under section 45R for the entire 2014 taxable year using the rules under this paragraph (i) of this section. Accordingly, in calculating the credit, Employer may count premiums paid for the coverage from January 1, 2014 through June 30, 2014, as well as premiums paid for the coverage from July 1, 2014 through December 31, 2014. If Employer claims the credit for the 2014 taxable year, that taxable year is the first year of the credit period.
(j) Effective/applicability date. This section is applicable for periods after 2013. For transition rules relating to certain plan years beginning in 2014, see paragraph (i) of this section.
(a) In general. An eligible small employer must pay a uniform percentage (not less than 50 percent) of the premium for each employee enrolled in a qualified health plan (QHP) offered to employees by the employer through a small business health options program (SHOP) Exchange.
(b) Employers offering one QHP. An employer that offers a single QHP through a SHOP Exchange must satisfy the requirements of this paragraph (b).
(1) Employers offering one QHP, employee-only coverage, composite billing. For an eligible small employer offering employee-only coverage and using composite billing, the employer satisfies the requirements of this paragraph if it pays the same amount toward the premium for each employee receiving employee-only coverage under the QHP, and that amount is equal to at least 50 percent of the premium for employee-only coverage.
(2) Employers offering one QHP, other tiers of coverage, composite billing. For an eligible small employer offering one QHP providing at least one tier of coverage with a higher premium than employee-only coverage and using composite billing, the employer satisfies the requirements of this paragraph (b)(2) if it either—
(i) Pays an amount for each employee enrolled in that more expensive tier of coverage that is the same for all employees and that is no less than the amount that the employer would have contributed toward employee-only coverage for that employee, or
(ii) Meets the requirements of paragraph (b)(1) of this section for each tier of coverage that if offers.
(3) Employers offering one QHP, employee-only coverage, list billing. For an eligible small employer offering one QHP providing only employee-only coverage and using list billing, the employer satisfies the requirements of this paragraph (b)(3) if either—
(i) The employer pays toward the premium an amount equal to a uniform percentage (not less than 50 percent) of the premium charged for each employee, or
(ii) The employer converts the individual premiums for employee-only coverage into an employer-computed composite rate for self-only coverage, and, if an employee contribution is required, each employee who receives coverage under the QHP pays a uniform amount toward the employee-only premium that is no more than 50 percent of the employer-computed composite rate for employee-only coverage.
(4) Employers offering one QHP, other tiers of coverage, list billing. For an eligible small employer offering one QHP providing at least one tier of coverage with a higher premium than employee-only coverage and using list billing, the employer satisfies the requirements of this paragraph (b)(4) if it either—
(i) Pays toward the premium for each employee covered under each tier of coverage an amount equal to or exceeding the amount that the employer would have contributed with respect to that employee for employee-only coverage, calculated either based upon the actual premium that would have been charged by the insurer for that employee for employee-only coverage or based upon the employer-computed composite rate for employee-only coverage, or
(ii) Meets the requirements of paragraph (b)(3) of this section for each tier of coverage that it offers substituting the employer-computed composite rate for each tier of coverage for the employer-computed composite rate for employee-only coverage.
(5) Employers offering SHOP dependent coverage. If SHOP dependent coverage is offered through the SHOP Exchange, the employer does not fail to satisfy the uniform percentage requirement by contributing a different amount toward that SHOP dependent coverage, even if that contribution is zero. For treatment of premiums paid on behalf of an employee’s dependents, see § 1.45R-3(g)(1).
(c) Employers offering more than one QHP. If an eligible small employer offers more than one QHP, the employer must satisfy the requirements of this paragraph (c). The employer may satisfy the requirements of this paragraph (c) in either of the following two ways:
(1) QHP-by-QHP method. The employer makes payments toward the premium with respect to each QHP for which the employer is claiming the credit that satisfy the uniform percentage requirement under paragraph (b) of this section on a QHP-by-QHP basis (so that the amounts or percentages of premium paid by the employer for each QHP need not be identical, but the payments with respect to each QHP must satisfy paragraph (b) of this section); or
(2) Reference QHP method. The employer designates a reference QHP and makes employer contributions in accordance with the following requirements—
(i) The employer determines a level of employer contributions for each employee such that, if all eligible employees enrolled in the reference QHP, the contributions would satisfy the uniform percentage requirement under paragraph (b) of this section, and
(ii) The employer allows each employee to apply an amount of employer contribution determined necessary to meet the uniform percentage requirement under paragraph (b) of this section either toward the reference QHP or toward the cost of coverage under any of the other available QHPs.
(d) Tobacco surcharges and wellness program discounts or rebates—(i) Tobacco surcharges. The tobacco surcharge and amounts paid by the employer to cover the surcharge are not included in premiums for purposes of calculating the uniform percentage requirement, nor are payments of the surcharge treated as premium payments for purposes of calculating the credit. The uniform percentage requirement is also applied without regard to employee payment of the tobacco surcharges in cases in which all or part of the employee tobacco surcharges are not paid by the employer.
(ii) Wellness programs. If a plan of an employer provides a wellness program, for purposes of meeting the uniform percentage requirement any additional amount of the employer contribution attributable to an employee’s participation in the wellness program over the employer contribution with respect to an employee that does not participate in the wellness program is not taken into account in calculating the uniform percentage requirement, whether the difference is due to a discount for participation or a surcharge for nonparticipation. The employer contribution for employees that do not participate in the wellness program must be at least 50 percent of the premium (including any premium surcharge for nonparticipation). However, for purposes of computing the credit, the employer contributions are taken into account, including those contributions attributable to an employee’s participation in a wellness program.
(e) Special rules regarding employer compliance with applicable State or local law. An employer will be treated as satisfying the uniform percentage requirement if the failure to otherwise satisfy the uniform percentage requirement is attributable solely to additional employer contributions made to certain employees to comply with an applicable State or local law.
(f) Examples. The following examples illustrate the provisions of paragraphs (a) through (e) of this section:
(ii) Conclusion. Employer’s contributions of 60% of the premium for each tier of coverage satisfy the uniform percentage requirement.
(ii) Conclusion. Employer’s contributions of 60% of the premium toward employee-only coverage and the same dollar amount toward the premium for family coverage satisfy the uniform percentage requirement, even though the percentage is not the same.
(ii) Conclusion. Employer’s contributions of 60% (or $3,000) of the premiums for employee-only coverage and the same dollar amounts toward the premium for family coverage under Plan A, and of 50% (or $3,500) of the premium for employee-only of coverage and the same dollar amount toward the premium for family coverage under Plan B, satisfy the uniform percentage requirement on a QHP-by-QHP basis; therefore the employer’s contributions to both plans satisfy the uniform percentage requirement.
(ii) Conclusion. Employer’s contribution of 50% (or $2,500) toward the premium of each employee enrolled under Plan A or Plan B satisfies the uniform percentage requirement.
(ii) Conclusion. Employer satisfies the uniform percentage requirement because it offers and makes contributions based on an employer-calculated composite employee-only rate such that, to receive employee-only coverage, each employee must pay a uniform amount which is not more than 50% of the composite rate, and it allows employees to use the same employer contributions toward family coverage.
(ii) Conclusion. Employer satisfies the uniform percentage requirement because it offers and makes contributions based on a calculated employee-only and family rate such that, to receive either employee-only or family coverage, each employee must pay a uniform amount which is not more than 50% of the composite rate for coverage of that tier.
(ii) Conclusion. Employer satisfies the uniform percentage requirement because it offers and makes contributions based on the employer-calculated composite employee-only premium for the Plan X reference QHP such that, in order to receive employee-only coverage, each employee must pay a uniform amount which is not more than 50% of the employee-only composite premium of the reference QHP; it allows employees to use the same employer contributions toward family coverage in the reference QHP or coverage through another QHPs.
(ii) Conclusion. Employer’s contribution of 100% toward the premium costs of employee-only coverage satisfies the uniform percentage requirement, even though Employer is only contributing 25% toward SHOP dependent coverage.
(ii) Conclusion. Employer satisfies the uniform percentage requirement because its failure to otherwise satisfy the uniform percentage requirement is attributable solely to compliance with the applicable State or local law.
(ii) Conclusion. Employer’s contribution of 50% toward the premium costs of employee-only coverage satisfies the uniform percentage requirement. Tobacco surcharges are not factored into premiums when calculating the uniform percentage requirement.
(ii) Conclusion. Employer’s contribution of 50% toward the premium costs of employee-only coverage for the two employees who do not participate in the wellness program and 55% toward the premium costs of employee-only coverage for three employees who participate in the wellness program satisfies the uniform percentage requirement because the additional 5% contribution due to the employees’ participation in the wellness program is not taken into account. However, the additional 5% contributions are taken into account for purposes of calculating the credit.
(g) Effective/applicability date. This section is applicable for periods after 2013. For transition rules relating to certain plan years starting in 2014, see § 1.45R-3(i).
§ 1.45R-5 Claiming the credit.
(a) Claiming the credit. The credit is a general business credit. It is claimed on an eligible small employer’s annual income tax return and offsets an employer’s actual tax liability for the year. The credit is claimed by attaching Form 8941, “Credit for Small Employer Health Insurance Premiums,” to the eligible small employer’s income tax return or, in the case of a tax-exempt eligible small employer, by attaching Form 8941 to the employer’s Form 990-T, “Exempt Organization Business Income Tax Return.” To claim the credit, a tax-exempt eligible small employer must file a form 990-T with an attached Form 8941, even if a Form 990-T would not otherwise be required to be filed.
(b) Estimated tax payments and alternative minimum tax (AMT) liability. An eligible small employer may reflect the credit in determining estimated tax payments for the year in which the credit applies in accordance with the estimated tax rules as set forth in sections 6654 and 6655 and the applicable regulations. An eligible small employer may also use the credit to offset the employer’s alternative minimum tax (AMT) liability for the year, if any, subject to certain limitations based on the amount of the employer’s regular tax liability, AMT liability and other allowable credits. See section 38(c)(1), as modified by section 38(c)(4)(B)(vi). However, an eligible small employer, including a tax-exempt eligible small employer, may not reduce its deposits and payments of employment tax (that is, income tax required to be withheld under section 3402, social security and Medicare tax under sections 3101 and 3111, and federal unemployment tax under section 3301) during the year in anticipation of the credit.
(c) Reduction of section 162 deduction. No deduction under section 162 is allowed for the eligible small employer for that portion of the health insurance premiums that is equal to the amount of the credit under § 1.45R-2.
(d) Effective/applicability date. This section is applicable for periods after 2013. For rules relating to certain plan years beginning in 2014, see § 1.45R-3(i).
§ 1.46-1 Determination of amount.
(a) Effective dates—(1) In general. This section is effective for taxable years beginning after December 31, 1975. However, transitional rules under paragraph (g) of this section are effective for certain earlier taxable years.
(2) Acts covered. This section reflects changes made by the following Acts of Congress:
(3) Prior regulations. For taxable years beginning before January 1, 1976, see 26 CFR 1.46-1 (Rev. as of April 1, 1979). Those regulations do not reflect changes made by Pub. L. 89-384, Pub. L. 89-389, and Pub. L. 91-172.
(b) General rule. The amount of investment credit (credit) allowed by section 38 for the taxable year is the portion of credit available under section 46(a)(1) that does not exceed the limitation based on tax under section 46(a)(3).
(c) Credit available. The credit available for the taxable year is the sum of—
(1) Unused credit carried over from prior taxable years under section 46(b) (carryovers).
(2) Amount of credit determined under section 46(a)(2) for the taxable year (credit earned), and
(3) Unused credit carried back from succeeding taxable years under section 46(b) (carrybacks).
(d) Credit earned. The credit earned for the taxable year is the sum of the following percentages of qualified investment (as determined under section 46 (c) and (d))—
(1) The regular percentage (as determined under section 46),
(2) For energy property, the energy percentage (as determined under section 46), and
(3) For the portion of the basis of a qualified rehabilitated building (as defined in § 1.48-12(b)) that is attributable to qualified rehabilitation expenditures (as defined in § 1.48-12(c)), the rehabilitation percentage (as determined under section 46(b)(4)).
(e) Designation of credits. The credit available for the taxable year is designated as follows:
(1) The credit attributable to the regular percentage is the “regular credit”.
(2) The credit attributable to the ESOP percentage is the “ESOP credit”.
(3) The credit attributable to the energy percentage for energy property other than solar or wind is the “nonrefundable energy credit”.
(4) The credit attributable to the energy percentage for solar or wind energy property is the “refundable energy credit”.
(5) The credit attributable to the rehabilitation percentage for qualified rehabilitation expenditures is the rehabilitation investment credit.
(f) Special rules for certain energy property. Energy property is defined in section 48(l). Under section 46(a)(2)(D), energy property that is section 38 property solely by reason of section 48(l)(1) qualifies only for the energy credit. Other energy property qualifies for both the regular credit (and, if applicable, the ESOP credit) and the energy credit. For limitation on the energy percentage for property financed by industrial development bonds, see section 48(l)(11).
(g) Transitional rule for regular and ESOP credit—(1) In general. Although section 46(a)(2) was amended by section 301(a)(1) of the Energy Tax Act of 1977 to eliminate the transitional rules under section 46(a)(2)(D), those rules still apply in certain instances. Section 46(a)(2)(D) was added by section 301(a) of the Tax Reduction Act of 1975 and amended by section 802(a) of the Tax Reform Act of 1976.
(2) Regular credit. Under section 46(a)(2)(D), the regular credit is 10 percent and applies for the following property:
(i) Property to which section 46 (d) does not apply, the construction, reconstruction, or erection of which is completed by the taxpayer after January 21, 1975, but only to the extent of basis attributable to construction, reconstruction, or erection after that date.
(ii) Property to which section 46(d) does not apply, acquired by the taxpayer after January 21, 1975.
(iii) Qualified progress expenditures (as defined in section 46(d)) made after January 21, 1975.
(3) ESOP credit. See section 48(m) for transitional rules limiting the period for which the ESOP percentage under section 46(a)(2)(E) applies. For prior statutes, see section 46(a)(2) (B) and (D), as added by section 301 of the Tax Reduction Act of 1975 and amended by section 802 of the Tax Reform Act of 1976.
(4) Cross reference. (i) The principles of § 1.48-2 (b) and (c) apply in determining the portion of basis attributable to construction, reconstruction, or erection after January 21, 1975, and in determining the time when property is acquired.
(ii) Section 311 of the Revenue Act of 1978 made the 10 percent regular credit permanent.
(5) Seven percent credit. To the extent that, under paragraph (g)(1) of this section, the 10 percent does not apply, the regular credit, in general, is 7 percent. For a special limitation on qualified investment for public utility property (other than energy property), see section 46(c)(3)(A).
(6) Qualified progress expenditures. For progress expenditure property that is constructed, reconstructed, or erected by the taxpayer within the meaning of § 1.48-2(b), the ten-percent credit applies in the year the property is placed in service to the portion of the qualified investment that remains after reduction for qualified progress expenditures under section 46(c)(4), but only to the extent that the remaining qualified investment is attributable to construction, reconstruction, or erection after January 21, 1975. For progress expenditure property that is acquired by the taxpayer (within the meaning of § 1.48-2(b)) after January 21, 1975, and placed in service after that date, the ten-percent credit applies in the year the property is placed in service to the entire portion of qualified investment that remains after reduction for qualified progress expenditures.
(h) Tax liability limitation—(1) In general. Section 46(a)(3) provides a tax liability limitation on the amount of credit allowed by section 38 (other than the refundable energy credit) for any taxable year. See section 46(a)(10)(C)(i). Tax liability is defined in paragraph (j) of this section. The excess of available credit over the applicable tax liability limitation for the year is an unused credit which may be carried forward or carried back under section 46(b).
(2) Regular and ESOP tax liability limitation. In general, the tax liability limitation for the regular and ESOP credits is the portion of tax liability that does not exceed $25,000 plus a percentage of the excess, as determined under section 46(a)(3)(B).
(3) Nonrefundable energy credit tax liability limitation. (i) For nonrefundable energy credit carrybacks to a taxable year ending before October 1, 1978, the tax liability limitation is the portion of tax liability that does not exceed $25,000 plus a percentage of the excess, as determined under section 46(a)(3)(B).
(ii) For a taxable year ending after September 30, 1978, the tax liability limitation for available nonrefundable energy credit is 100 percent of the year’s tax liability.
(4) Alternative limitations. Alternative limitations apply for certain utilities, railroads, and airlines in determining the regular tax liability limitation and, for nonrefundable energy credit carrybacks to taxable years ending before October 1, 1978, the nonrefundable energy credit tax liability limitation. These alternative limitations do not apply in determining the energy tax liability limitation for a taxable year ending after October 1, 1978. The provisions listed below set forth the alternative limitations:
Code section | Type | Years applicable |
---|---|---|
46(a)(6) 1 | Utilities | Taxable years ending in 1975-1978 |
46(a)(7) 2 | Utilities | Taxable year ending in 1979 |
46(a)(8) | Railroads and Airlines | Taxable year ending in 1979 or 1980 |
46(a)(8) 3 | Railroads | Taxable years ending in 1977 or 1978 |
46(a)(9) 3 | Airlines | Taxable years ending in 1977 or 1978 |
1 Section 46(a)(6) was added by section 301(b)(2) of the Tax Reduction Act of 1975 and redesignated as section 46(a)(7) by section 302(a)(1) of the Tax Reform Act of 1976.
2 Section 46(a)(7) was amended by section 312(b)(1) of the Revenue Act of 1978.
3 These provisions were repealed by section 312(b)(2) of the Revenue Act of 1978.
(i) [Reserved]
(j) Tax liability—(1) In general. “Tax liability” for purposes of the regular and ESOP credit and carrybacks of nonrefundable energy credit to a taxable year ending before October 1, 1978, means the liability for tax as defined in section 46(a)(4). For ordering of regular, ESOP, and nonrefundable energy credits, see paragraph (m) of this section. In addition to taxes excluded under section 46(a)(4), tax liability does not include tax resulting from recapture of credit under section 47 and the alternative minimum tax imposed by section 55. See sections 47(c) and 55(c)(1).
(2) Certain nonrefundable energy credit. For a taxable year ending after September 30, 1978, “tax liability” for purposes of the nonrefundable energy credit is liability for tax, as defined in section 46(a)(4) and paragraph (j)(1) of this section, reduced by the regular and ESOP credit allowed for the taxable year. Thus, carrybacks of regular or ESOP credit to a taxable year may displace nonrefundable energy carryovers or credit earned taken into account in that year. However, carrybacks of regular, ESOP, or nonrefundable energy credit do not affect refundable energy credit which is treated as an overpayment of tax under section 6401(b). See paragraph (k) of this section.
(k) Special rule for refundable energy credit. The amount of the refundable energy credit is determined under the rules of section 46 (other than section 46(a)(3)). However, to permit the refund, the refundable energy credit for purposes of the Internal Revenue Code (other than section 38, part IVB, and chapter 63 of the Code) is treated as allowed by section 39 and not by section 38. The refundable credit is not applied against tax liability for purposes of determining the tax liability limitation for other investment credits. Rather, it is treated as an overpayment of tax under section 6401(b).
(l) FIFO rule. If the credit available for a taxable year is not allowed in full because of the tax liability limitation, special rules determine the order in which credits are applied. Under the first-in-first-out rule of section 46(a)(1) (FIFO), carryovers are applied against the tax liability limitation first. To the extent the tax liability limitation exceeds carryovers, credit earned, and carrybacks are then applied.
(m) Special ordering rule—(1) In general. Under section 46(a)(10)(A), the FIFO rule applies separately—
(i) First, with respect to regular and ESOP credits, and
(ii) Second, with respect to nonrefundable energy credit.
(2) Regular and ESOP credit. Under § 1.46-8(c)(9)(ii), regular and ESOP credits available are applied in the following order:
(i) Regular carryovers;
(ii) ESOP carryovers;
(iii) Regular credit earned;
(iv) ESOP credit earned;
(v) Regular carrybacks; and
(vi) ESOP carrybacks.
(3) Example. For an example of the order of application of regular and ESOP credits, see § 1.46-8(c)(9)(iii).
(n) Examples. The following examples illustrate paragraphs (a) through (m) of this section.
Regular carryovers | $5,000 |
Regular credit earned | 10,000 |
Regular carrybacks | 15,000 |
Credit available | 30,000 |
(c) The regular carryovers and credit earned are allowed in full. However, only $13,000 of the regular carryback is allowed for 1979. The remaining $2,000 must be carried to the next year to which it may be carried under section 46(b).
(b) N’s “tax liability” for 1980 for the regular credit is $35,000. N’s tax liability limitation for 1980 for the regular credit is $32,000, consisting of $25,000 plus 70 percent of the $10,000 of “tax liability” in excess of $25,000.
(c) The entire regular credit is allowed in 1980.
(d) N’s “tax liability” for 1980 for the nonrefundable energy credit is $5,000, consisting of $35,000 less $30,000 regular credit allowed for 1980. N’s tax liability limitation for 1980 for the nonrefundable energy credit is 100 percent of $5,000.
(e) $5,000 of the nonrefundable energy credit is allowed for 1980. The remaining $4,000 energy credit is an unused nonrefundable energy credit which must be carried to the next year to which it may be carried under section 46(b).
(b) The $30,000 regular credit earned and $2,000 of the regular carryback is allowed for 1980. N’s “tax liability” for 1980 for the nonrefundable energy credit is reduced to $3,000, consisting of $35,000 less $32,000 regular credit allowed for 1980. The nonrefundable energy credit allowed for 1980 is reduced to $3,000. The remaining $6,000 is an unused nonrefundable energy credit which must be carried to the next year to which it may be carried under section 46(b).
(b) P’s “tax liability” for 1980 for the regular credit is $25,000 which is also the tax liability limitation for the regular credit.
(c) The entire $20,000 regular credit is allowed for 1980. The entire $9,000 refundable energy credit is treated as an overpayment of tax under section 6401(b), even though “tax liability” remains.
(ii) For 1976, 1977, 1978, and 1979, qualified progress expenditures total $200,000. The ten-percent credit applies to those expenditures.
(iii) For 1980, qualified investment for the ship is $450,000. Under section 46(c)(4), X must reduce this amount by $200,000, the amount of qualified progress expenditures taken into account. The ten-percent credit applies to the portion of the remaining qualified investment attributable to construction after January 21, 1975 ($150,000). The seven-percent credit applies to the portion of qualified investment attributable to construction before January 22, 1975 ($100,000).
(ii) For 1975, 1976, 1977, 1978, and 1979, qualified progress expenditures total $250,000. The ten-percent credit applies to those expenditures.
(iii) For 1980, qualified investment for the ship is $400,000, which is the contract price. X must reduce qualified investment by $250,000, the amount of qualified progress expenditures. The ten-percent credit applies to the $150,000 of qualified investment that remains after reduction for qualified progress expenditures.
(o) Married individuals. If a separate return is filed by a husband or wife, the tax liability limitation is computed by substituting a $12,500 amount for the $25,000 amount that applies under section 46(a)(3). However, this reduction of the $25,000 amount to $12,500 applies only if the taxpayer’s spouse is entitled to a credit under section 38 for the taxable year of such spouse which ends with, or within, the taxpayer’s taxable year. The taxpayer’s spouse is entitled to a credit under section 38 either because of investment made in qualified property for such taxable year of the spouse (whether directly made by such spouse or whether apportioned to such spouse, for example, from an electing small business corporation, as defined in section 1371(b)), or because of an investment credit carryback or carryover to such taxable year. The determination of whether an individual is married shall be made under the principles of section 143 and the regulations thereunder.
(p) Apportionment of $25,000 amount among component members of a controlled group—(1) In general. In determining the tax liability limitation under section 46(a)(3) for corporations that are component members of a controlled group on December 31, only one $25,000 amount is available to those component members for their taxable years that include that December 31. See subparagraph (2) of this paragraph for apportionment of such amount among such component members. See subparagraph (3) of this paragraph for definition of “component member”.
(2) Manner of apportionment. (i) In the case of corporations which are component members of a controlled group on a particular December 31, the $25,000 amount may be apportioned among such members for their taxable years that include such December 31 in any manner the component members may select, provided that each such member less than 100 percent of whose stock is owned, in the aggregate, by the other component members of the group on such December 31 consents to an apportionment plan. The consent of a component member to an apportionment plan with respect to a particular December 31 shall be made by means of a statement, signed by a person duly authorized to act on behalf of the consenting member, stating that such member consents to the apportionment plan with respect to such December 31. The statement shall set forth the name, address, employer identification number, and taxable year of each component member of the group on such December 31, the amount apportioned to each such member under the plan, and the location of the Service Center where the statement is to be filed. The consent of more than one component member may be incorporated in a single statement. The statement shall be timely filed with the Service Center where the component member having the taxable year first ending on or after such December 31 files its return for such taxable year and shall be irrevocable after such filing. If two or more component members have the same such taxable year, a statement of consent may be filed by any one of such members. However, if the due date (including any extensions of time) of the return of such member is on or before December 15, 1971, the required statement shall be considered as timely filed if filed on or before March 15, 1972. Each component member of the group on such December 31 shall keep as a part of its records a copy of the statement containing all the required consents.
(ii) An apportionment plan adopted by a controlled group with respect to a particular December 31 shall be valid only for the taxable year of each member of the group which includes such December 31. Thus, a controlled group must file a separate consent to an apportionment plan with respect to each taxable year which includes a December 31 as to which an apportionment plan is desired.
(iii) If the apportionment plan is not timely filed, the $25,000 amount specified in section 46(a)(3) shall be reduced for each component member of the controlled group, for its taxable year which includes a December 31, to an amount equal to $25,000 divided by the number of component members of such group on such December 31.
(iv) If a component member of the controlled group makes its income tax return on the basis of a 52-53-week taxable year, the principles of section 441(f)(2)(A)(ii) and § 1.441-2 apply in determining the last day of such taxable year.
(3) Definitions of controlled group of corporations and component member of controlled group. For the purpose of this paragraph, the terms “controlled group of corporations” and “component member” of a controlled group of corporations shall have the same meaning assigned to those terms in section 1563 (a) and (b). For purposes of applying § 1.1563-1(b)(2)(ii)(c), an electing small business corporation shall be treated as an excluded member whether or not it is subject to the tax imposed by section 1378.
(4) Members of a controlled group filing a consolidated return. If some component members of a controlled group join in filing a consolidated return pursuant to § 1.1502-3(a)(3), and other component members do not join, then, unless a consent is timely filed apportioning the $25,000 amount among the group filing the consolidated return and the other component members of the controlled group, each component member of the controlled group (including each component member which joins in filing the consolidated return) shall be treated as a separate corporation for purposes of equally apportioning the $25,000 amount under subparagraph (2)(iii) of this paragraph. In that case, the tax liability limitation for the group filing the consolidated return is computed by substituting for the $25,000 amount under section 46(a)(3) the total amount apportioned to each component member that joins in filing the consolidated return. If the affiliated group filing the consolidated return and the other component members of the controlled group adopt an apportionment plan, the affiliated group shall be treated as a single member for the purpose of applying subparagraph (2)(i) of this paragraph. Thus, for example, only one consent executed by the common parent to the apportionment plan is required for the group filing the consolidated return. If any component member of the controlled group which joins in the filing of the consolidated return is an organization to which section 593 applies or a cooperative organization described in section 1381(a), see paragraph (a)(3)(ii) of § 1.1502-3.
(5) Examples. The provisions of this paragraph may be illustrated by the following examples:
(q) Rehabilitation percentage—(1) General rule—(i) In general. Due to amendments made by the Tax Reform Act of 1986, different rules apply depending on when the property attributable to the qualified rehabilitated expenditures (as defined in § 1.48-12(c)) is placed in service. Paragraph (q)(1)(ii) of this section contains the general rule relating to property placed in service after December 31, 1986. Paragraph (q)(1)(iii) of this section contains rules relating to property placed in service before January 1, 1987. Paragraph (q)(1)(iv) of this section contains rules relating to property placed in service after December 31, 1986, that qualifies for a transition rule.
(ii) Property placed in service after December 31, 1986. Except as otherwise provided in paragraph (q)(1)(iv) of this section, in the case of section 38 property described in section 48(a)(1)(E) placed in service after December 31, 1986, the term “rehabilitation percentage” means—
(A) 10 percent in the case of qualified rehabilitation expenditures with respect to a qualified rehabilitated building other than a certified historic structure, and
(B) 20 percent in the case of qualified rehabilitation expenditures with respect to a certified historic structure.
(iii) Property placed in service before January 1, 1987. For qualified rehabilitation expenditures (as defined in § 1.48-12(c)) with respect to property placed in service before January 1, 1987, section 46(b)(4)(A) as in effect prior to the enactment of the Tax Reform Act of 1986 provided for a three-tier rehabilitation percentage. The applicable rehabilitation percentage for such expenditures depends on whether the qualified rehabilitated building is a “30-year building,” a “40-year building,” or a certified historic structure (as defined in section 48(g)(3) and § 1.48-12(d)(1)). The rehabilitation percentage for such qualified rehabilitation expenditures incurred with respect to a qualified rehabilitated building is 15 percent to the extent that the building is a 30-year building (i.e., at least 30 years, but less than 40 years, has elapsed between the date the physical work on the rehabilitation began and the date the building was first placed in service), 20 percent to the extent that the building is a 40-year building (i.e., at least 40 years has so elapsed), and 25 percent for certified historic structures, regardless of age. See paragraph (q)(2)(ii) of this section for rules concerning buildings to which additions have been added.
(iv) Property placed in service after December 31, 1986, that qualifies under the transition rules. In the case of section 38 property described in section 48(a)(1)(E) placed in service after December 31, 1986, and to which the amendments made by section 251 of the Tax Reform Act of 1986 do not apply because the transition rules in section 251(d) of that Act and § 1.48-12(a)(2)(iv)(B) or (C) apply, the rehabilitation percentage for a “30-year building” (within the meaning of paragraph (q)(1)(iii) of this section) shall be 10 percent, the rehabilitation percentage for a “40-year building” (within the meaning of paragraph (q)(1)(iii) of this section) shall be 13 percent, and the rehabilitation percentage for a certified historic structure shall be 25 percent.
(2) Special rules—(i) Moved buildings. With respect to paragraph (q)(1)(ii) of this section, § 1.48-12(b)(5) provides that a building (other than a certified historic structure) is not a qualified rehabilitated building unless it has been at the location where it is being rehabilitated since January 1, 1936. In addition, for purposes of paragraph (q)(1) (iii) and (iv) of this section, a building is not a “30-year building” unless it has been at the location where it is being rehabilitated for the thirty-year period immediately preceding the beginning of the rehabilitation process, and is not a “40-year building” unless it has been at the location where it is being rehabilitated for the forty-year period immediately preceding the beginning of the rehabilitation process.
(ii) Building to which additions have been added—(A) Property placed in service after December 31, 1986. For purposes of paragraph (q)(1)(ii) of this section, if part of a building meets the definition of a qualified rehabilitated building, and part of the building does not meet the definition of a qualified rehabilitated building because such part is an addition that was placed in service after December 31, 1935, the qualified rehabilitation expenditures made to the building must be allocated to the pre-1936 portion of the building and the post-1935 portion of the building using the principles in § 1.48-12(c)(10)(ii). Qualified rehabilitation expenditures attributable to the post-1935 addition shall not qualify for the 10 percent rehabilitation percentage.
(B) Property placed in service before January 1, 1987, and property qualifying for a transitional rule. For purposes of paragraphs (q)(1) (iii) and (iv) of this section, if part of a building meets the definition of a “40-year building” and part of the building is an addition that was placed in service less than forty years before physical work on the rehabilitation began but more than thirty years before such date, then the qualified rehabilitation expenditures made to the building shall be allocated between the forty year old portion of the building and the thirty year old portion of the building, and a 20 percent rehabilitation percentage shall be applied to the forty year old portion of the building and a 15 percent rehabilitation percentage shall be applied to the thirty year old portion. This allocation shall be made using the principles in § 1.48-12(c)(10)(ii). If an allocation cannot be made between the expenditures to the forty year old portion of the building and the thirty year old portion of the building, then the building will be considered to be a 30-year building. Furthermore, for purposes of this paragraph (q), a building (other than a certified historic structure) is not a qualified rehabilitated building to the extent of that portion of the building that is less than 30 years old. If rehabilitation expenditures are incurred with respect to an addition to a qualified rehabilitated building, but the addition is not considered to be part of the qualified rehabilitated building because the addition does not meet the age requirement in section 48(g)(1)(B) (as in effect prior to its amendment by the Tax Reform Act of 1986) and § 1.48-12(b)(4)(i)(B), then no rehabilitation percentage will be applied to the expenditures attributable to the rehabilitation of the addition. Thus, for purposes of paragraphs (q)(1) (iii) and (iv) of this section, it may be necessary to allocate rehabilitation expenditures incurred with respect to a building between the original portion of the building and the addition.
(iii) Mixed-use buildings. If qualified rehabilitation expenditures are incurred for property that is excluded from section 38 property described in section 48(a)(1)(E) (because, for example, they are made with respect to a portion of the building used for lodging within the meaning of section 48(a)(3) and § 1.48-1(h)), an allocation of the expenditures must be made between the expenditures that result in an addition to basis that is section 38 property and the expenditures that result in an addition to basis that is excluded from the definition of section 38 property since the rehabilitation percentage is applicable only to section 38 property. These allocations should be made using the principles contained in § 1.48-12(c)(10)(ii).
(3) Regular and energy percentages not to apply. The regular percentage and the energy percentage shall not apply to that portion of the basis of any building that is attributable to qualified rehabilitation expenditures (as defined in § 1.48-12(c)).
(4) Effective date. The rehabilitation percentage is applicable only to qualified rehabilitation expenditures (as defined in § 1.48-12(c)). For rules relating to applicability of the regular percentage to qualified rehabilitation expenditures (as defined in § 1.48-11(c)), see § 1.48-11.
§ 1.46-2 Carryback and carryover of unused credit.
(a) Effective date. This section is effective for taxable years beginning after December 31, 1975. For taxable years beginning before January 1, 1976, see 26 CFR 1.46-2 (Rev. as of April 1, 1979).
(b) In general. Under section 46(b)(1), unused credit may be carried back and carried over. Carrybacks and carryovers of unused credit are taken into account in determining the amount of credit available and the credit allowed for the taxable years to which they may be carried. In general, the application of the rules of this section to regular and ESOP credits are separate from their application to nonrefundable energy credits. For example, the limitations on carrybacks and carryovers of unused nonrefundable energy credit under section 46(b) (2) and (3), respectively, differ in amount from the limitations on the regular and ESOP credits because the tax liability limitations for those credits differ. See § 1.46-1(h). For a further example, see the special ordering rule in § 1.46-1(m). Section 46(b) does not apply to the refundable energy credit.
(c) Unused credit. If carryovers and credit earned (as defined in § 1.46-1(c)(1)) exceed the applicable tax liability limitation, the excess attributable to credit earned is an unused credit. The taxable year in which an unused credit arises is referred to as the “unused credit year”.
(d) Taxable years to which unused credit may be carried. An unused credit is a carryback to each of the 3 taxable years preceding the unused credit year and a carryover to each of the 7 taxable years succeeding the unused credit year. An unused credit must be carried first to the earliest of those 10 taxable years. An unused credit then must be carried to each of the other 9 taxable years (in order of time) to the extent that the unused credit was not absorbed during a prior taxable year because of the limitations under section 46(b) (2) and (3).
(e) Special rule for pre-1971 years—(1) In general. For unused credit years ending before January 1, 1971, unused credit is allowed a 10-year carryover rather than the 7-year carryover. The principles of paragraph (d) of this section apply to this 10-year carryover.
(2) Cross reference. For limitations on the taxable years to which unused credit from pre-1971 credit years may be carried, see paragraph (g) of this section.
(f) Limitations on carrybacks. Under the FIFO rule to section 46(a)(1), carryovers and credit earned are applied against the tax liability limitation before carrybacks. Thus, carrybacks to a taxable year may not exceed the amount by which the applicable tax liability limitation for that year exceeds the sum of carryovers to and credit earned for that year. Carrybacks from an unused credit year are applied against tax liability before carrybacks from a later unused credit year. To the extent an unused credit cannot be carried back to a particular preceding taxable year, the unused credit must be carried to the next succeeding taxable year to which it may be carried.
(g) Limitations on carryovers—(1) General rule. Carryovers to a taxable year may not exceed the applicable tax liability limitation for that year. Carryovers from an unused credit year are applied before carryovers from a later unused credit year.
(2) Exception. A 10-year carryover from a pre-1971 unused credit year may, under certain circumstances, be postponed to prevent a later-earned 7-year carryover from expiring. This exception does not extend the 10-year carryover period for pre-1971 unused credit. See section 46(b)(1)(D).
(h) Examples. The following examples illustrate paragraphs (a) through (g) of this section.
(1) | (2) | (3) | (4) | (5) | (6) | (7) | |
---|---|---|---|---|---|---|---|
Credit available | Tax liability | Percent | Tax liability limitation (remaining from col. (6) on preceding line) | Credit allowed (lower of (1) or (4)) | Remaining tax liability limitation ((4)-(5)) | Unused credit ((1)-(5)) or (amount absorbed) | |
1977: | |||||||
A. Credit earned | $20,000 | $45,000 | 50 | $35,000 | $20,000 | $15,000 | 0 |
B. Carryback from 1978 | *15,000 | [15,000] | 15,000 | ||||
1978: | |||||||
A. Credit earned | 80,000 | 55,000 | 50 | 40,000 | 40,000 | 0 | $20,000 |
Carryback to 1977 | (*15,000) | ||||||
Carryover to 1979 | (*5,000) | ||||||
1979: | |||||||
A. Carryover from 1978 | *5,000 | 50,000 | 60 | 40,000 | 6,000 | 35,000 | |
B. Credit earned | 50,000 | [35,000] | 35,000 | 0 | 15,000 | ||
Carryover to 1980 | (*15,000) | ||||||
1980: | |||||||
A. Carryover from 1979 | *15,000 | 55,000 | 70 | 46,000 | 15,000 | 31,000 | |
B. Credit earned | 25,000 | [31,000] | 25,000 | 6,000 | 0 |
*For line “A” each year: Lesser of (1) tax liability or (2) $25,000 + (percentage in col. (3) × [col. (2) − $25,000]). See, § 1.46-1(h). For other lines: Amount in col. (6) on preceding line.
(1) | (2) | (3) | (4) | (5) | (6) | (7) | ||
---|---|---|---|---|---|---|---|---|
Credit available | Tax liability | Percent | Tax liability limitation* (remaining from col. (6) on preceding line) | Credit allowed (lower of (1) or (4)) | Remaining tax liability limitation ((4)-(5)) | Unused credit ((1)-(5)) or (amount absorbed) | ||
(a) Regular | (b) Energy ((2)(a)-(5)(R)) | |||||||
1977: | ||||||||
Regular: | ||||||||
A. Credit earned | $20,000 | $45,000 | 50 | $35,000 | $20,000R | $15,000 | 0 | |
B. Carryback from 1978 | *15,000 | [15,000] | 15,000R | 0 | ||||
1978: | ||||||||
Regular: | ||||||||
A. Credit earned | 60,000 | 55,000 | 50 | 40,000 | 40,000R | 0 | $20,000 | |
Carryback to 1977 | (*15,000) | |||||||
Carryover to 1979 | (*5,000) | |||||||
Energy: | ||||||||
A. Carryback from 1979 | *15,000 | $15,000 | 100 | 15,000 | 15,000E | 0 | ||
1979: | ||||||||
Regular: | ||||||||
A. Carryover from 1978 | *5,000 | 50,000 | 60 | 40,000 | 5,000R | 35,000 | ||
B. Credit earned | 50,000 | [35,000] | 35,000R | 0 | 15,000 | |||
Carryover to 1980 | (*15,000) | |||||||
Energy: | ||||||||
A. Credit earned | 35,000 | 10,000 | 100 | 10,000 | 10,000E | 0 | 25,000 | |
Carryback to 1978 | (*15,000) | |||||||
Carryover to 1980 | (*10,000) | |||||||
1980: | ||||||||
Regular: | ||||||||
A. Carryover from 1979 | *15,000 | 55,000 | 70 | 46,000 | 15,000R | 31,000 | ||
B. Credit earned | 25,000 | [31,000] | 25,000R | 6,000 | 0 | |||
Energy: | ||||||||
A. Carryover from 1979 | *10,000 | 15,000 | 100 | 15,000 | 10,000E | 5,000 |
*See footnote to the chart in
(1) | (2) | (3) | (4) | (5) | (6) | (7) | ||
---|---|---|---|---|---|---|---|---|
Credit available | Tax liability | Percent | Tax liability limitation* (remaining from col. (6) on preceding line) | Credit allowed (lower of (1) or (4)) | Remaining tax liability limitation ((4)-(5)) | Unused credit ((1)-(5)) or (amount absorbed) | ||
(a) Regular | (b) Energy ((2)-(5)(R)) | |||||||
1979 (restated): | ||||||||
Energy: | ||||||||
To be carried over | $10,000 | |||||||
Carryover to 1980 | (*9,000) | |||||||
Carryover to 1981 | (*1,000) | |||||||
1980 (restated): | ||||||||
Regular: | ||||||||
A. Carryover from 1979 | $15,000 | $55,000 | 70 | $46,000 | $15,000R | $31,000 | ||
B. Credit earned | *25,000 | [31,000] | 25,000R | 6,000 | 0 | |||
C. Carryback from 1981 | *6,000 | [6,000] | 6,000R | 0 | ||||
Energy: | ||||||||
A. Carryover from 1979 | *9,000 | $9,000 | 100 | 9,000 | 9,000E | |||
1981: Regular: | ||||||||
A. Credit earned | 37,000 | 32,500 | 80 | 31,000 | 31,000R | 0 | 6,000 | |
Carryback to 1980 | (*6,000) | |||||||
Energy: | ||||||||
A. Carryover from 1979 | *1,000 | 1,500 | 100 | 1,500 | 1,000E | 500 | 0 |
*See footnote to chart under
(i) [Reserved]
(j) Electing small business corporation. A shareholder of an electing small business corporation (as defined in section 1371(b)) may not take into account unused credit of the corporation attributable to unused credit years for which the corporation was not an electing small business corporation. However, a taxable year for which the corporation is an electing small business corporation is counted as a taxable year for determining the taxable years to which that unused credit may be carried.
(k) Periods of less than 12 months. A fractional part of a year that is considered a taxable year under sections 441(b) and 7701(a)(23) is treated as a preceding or succeeding taxable year for determining under section 46(b) the taxable years to which an unused credit may be carried.
(l) Corporate acquisitions. For carryover of unused credits in the case of certain corporate acquisitions, see section 381(c)(23).
§ 1.46-3 Qualified investment.
(a) In general. (1) With respect to any taxable year, the qualified investment of the taxpayer is the aggregate (expressed in dollars) of (i) the applicable percentage of the basis of each new section 38 property placed in service by the taxpayer during such taxable year, plus (ii) the applicable percentage of the cost of each used section 38 property placed in service by the taxpayer during such taxable year. With respect to any section 38 property, qualified investment means the applicable percentage of the basis (or cost) of such property. Section 38 property placed in service by the taxpayer during the taxable year includes the taxpayer’s share of the basis (or cost) of section 38 property placed in service by a partnership in the taxable year of such partnership ending with or within the taxpayer’s taxable year. In the case of a shareholder of an electing small business corporation (as defined in section 1371(b)), or a beneficiary of an estate or trust, see §§ 1.48-5 and 1.48-6, respectively, for apportionment of the basis (or cost) of section 38 property placed in service by such corporation, estate, or trust. For the definitions of new section 38 property and used section 38 property, see §§ 1.48-2 and 1.48-3, respectively. See § 1.46-5 for special rules for progress expenditure property.
(2) The basis (or cost) of section 38 property placed in service during a taxable year shall not be taken into account in determining qualified investment for such year if such property is disposed of or otherwise ceases to be section 38 property during such year, except where § 1.47-3 applies. Thus, if individual A places in service during a taxable year section 38 property and later in the same year sells such property, the basis (or cost) of such property shall not be taken into account in determining A’s qualified investment. On the other hand, if A places in service section 38 property during a taxable year and dies later in the same year, the basis (or cost) of such property would be taken into account in computing qualified investment. Similarly, if section 38 property is destroyed by fire in the same year in which it is placed in service and paragraph (h) of this section applies to reduce the basis (or cost) of replacement property, the basis (or cost) of the destroyed property would be taken into account in computing qualified investment. In order to determine whether section 38 property is disposed of or otherwise ceases to be section 38 property see § 1.47-2.
(3) Qualified investment is reduced in the case of property which is “public utility property” (see paragraph (h) of this section), and in the case of property of organizations to which section 593 applies, regulated investment companies or real estate investment trusts subject to taxation under subchapter M, chapter 1 of the Code, and cooperative organizations described in section 1381(a) (see § 1.46-4).
(b) Applicable percentage. The applicable percentage to be applied to the basis (or cost) of property is 33
Property | Estimated useful life (years) | Basis (or cost) |
---|---|---|
A (new) | 4 | $60,000 |
B (new) | 10 | 90,000 |
C (new) | 6 | 150,000 |
D (used) | 3 | 30,000 |
Property | Basis (or cost) | Applicable percentage | Qualified investment |
---|---|---|---|
A | $60,000 | 33 | $20,000 |
B | 90,000 | 100 | 90,000 |
C | 150,000 | 66 | 100,000 |
D | 30,000 | 33 | 10,000 |
Total | 220,000 |
(c) Basis or cost. (1) The basis of any new section 38 property shall be determined in accordance with the general rules for determining the basis of property. Thus, the basis of property would generally be its cost (see section 1012), unreduced by the adjustment to basis provided by section 48(g)(1) with respect to property placed in service before January 1, 1964, and any other adjustment to basis, such as that for depreciation, and would include all items properly included by the taxpayer in the depreciable basis of the property, such as installation and freight costs. However, for purposes of determining qualified investment, the basis of new section 38 property constructed, reconstructed, or erected by the taxpayer shall not include any depreciation sustained with respect to any other property used in the construction, reconstruction, or erection of such new section 38 property. (See paragraph (b)(4) of § 1.48-1.) If new section 38 property is acquired in exchange for cash and other property in a transaction described in section 1031 in which no gain or loss is recognized, the basis of the newly acquired property for purposes of determining qualified investment would be equal to the adjusted basis of the other property plus the cash paid. See § 1.48-4 for the basis of property to a lessee where the lessor has elected to treat such lessee as a purchaser.
(2) The cost of any used section 38 property shall be determined in accordance with paragraph (b) of § 1.48-3. However, the aggregate cost of used section 38 property which may be taken into account in any taxable year in computing qualified investment cannot exceed $50,000 (see paragraph (c) of § 1.48-3).
(3) For reduction in the basis (or cost) of certain property which replaces other property which was destroyed or damaged by fire, storm, shipwreck, or other casualty, or which was stolen, see paragraph (h) of this section.
(d) Placed in service. (1) For purposes of the credit allowed by section 38, property shall be considered placed in service in the earlier of the following taxable years:
(i) The taxable year in which, under the taxpayer’s depreciation practice, the period for depreciation with respect to such property begins; or
(ii) The taxable year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity.
(2) In the case of property acquired by a taxpayer for use in his trade or business (or in the production of income), the following are examples of cases where property shall be considered in a condition or state of readiness and availability for a specifically assigned function:
(i) Parts are acquired and set aside during the taxable year for use as replacements for a particular machine (or machines) in order to avoid operational time loss.
(ii) Operational farm equipment is acquired during the taxable year and it is not practicable to use such equipment for its specifically assigned function in the taxpayer’s business of farming until the following year.
(iii) Equipment is acquired for a specifically assigned function and is operational but is undergoing testing to eliminate any defects.
(iv) Reforestation expenditures (as defined in § 1.194-3(c)) are incurred during the taxable year in connection with qualified timber property (as defined in § 1.194-3(a)).
(3) Notwithstanding subparagraph (1) of this paragraph, property with respect to which an election is made under § 1.48-4 to treat the lessee as having purchased such property shall be considered placed in service by the lessor in the taxable year in which possession is transferred to such lessee.
(4)(i) The credit allowed by section 38 with respect to any property shall be allowed only for the first taxable year in which such property is placed in service by the taxpayer. The determination of whether property is section 38 property in the hands of the taxpayer shall be made with respect to such first taxable year. Thus, if a taxpayer places property in service in a taxable year and such property does not qualify as section 38 property (or only a portion of such property qualifies as section 38 property) in such year, no credit (or a credit only as to the portion which qualifies in such year) shall be allowed to the taxpayer with respect to such property notwithstanding that such property (or a greater portion of such property) qualifies as section 38 property in a subsequent taxable year. For example, if a taxpayer places property in service in 1963 and uses the property entirely for personal purposes in such year, but in 1964 begins using the property in a trade or business, no credit is allowable to the taxpayer under section 38 with respect to such property. See § 1.48-1 for the definition of section 38 property.
(ii) Notwithstanding subdivision (i) of this subparagraph, if, for the first taxable year in which property is placed in service by the taxpayer, the property qualifies as section 38 property but the basis of the property does not reflect its full cost for the reason that the total amount to be paid or incurred by the taxpayer for the property is indeterminate, a credit shall be allowed to the taxpayer for such first taxable year with respect to so much of the cost as is reflected in the basis of the property as of the close of such year, and an additional credit shall be allowed to the taxpayer for any subsequent taxable year with respect to the additional cost paid or incurred during such year and reflected in the basis of the property as of the close of such year. The estimated useful life used in computing each additional credit with respect to the property shall be the same as the estimated useful life used in computing the credit for the first taxable year in which the property was placed in service by the taxpayer. Assume, for example, that in 1964 X Corporation, a utility company which makes its return on the basis of a calendar year, enters into an agreement with Y Corporation, a builder, to construct certain utility facilities for a housing development built by Y. Assume further that part of the funds for the construction of the utility facilities is advanced by Y under a contract providing that X will repay the advances over a 10-year period in accordance with an agreed formula, after which no further amounts will be repayable by X even though the full amount advanced by Y has not been repaid. Assuming that the utility facilities are placed in service in 1964 and qualify as section 38 property, X is allowed a credit for 1964 with respect to its basis in the utility facilities at the close of 1964. For each succeeding taxable year X is allowed an additional credit with respect to the increase in the basis of the utility facilities resulting from the repayments to Y during such year.
(e) Estimated useful life—(1)(i) In general. With respect to assets placed in service by the taxpayer during any taxable year, for the purpose of computing qualified investment the estimated useful lives assigned to all assets which fall within a particular guideline class (within the meaning of Revenue Procedure 62-21) may be determined, at the taxpayer’s option, under either subparagraph (2) or (3) of this paragraph. Thus, the taxpayer may assign estimated useful lives to all the assets falling in one guideline class in accordance with subparagraph (2) of this paragraph, and may assign estimated useful lives to all the assets falling within another guideline class in accordance with subparagraph (3) of this paragraph. See subparagraphs (4) and (5) of this paragraph for determination of estimated useful lives of assets not subject to subparagraph (2) or (3) of this paragraph.
(ii) Except as provided in subparagraph (7), this paragraph shall not apply to property described in section 50.
(2) Class life system. The taxpayer may assign to each asset falling within a guideline class, which is placed in service during the taxable year, the class life of the taxpayer for the guideline class for such year as determined under section 4, part II of Revenue Procedure 62-21. The preceding sentence may be applied to the assets falling within a guideline class irrespective of whether the taxpayer uses single asset accounts or multiple asset accounts in computing depreciation with respect to such assets and irrespective of whether the taxpayer chooses to have his depreciation allowance with respect to such assets examined under the rules provided in Revenue Procedure 62-21.
(3) Individual useful life system. (i) The taxpayer may assign an individual estimated useful life to each asset falling within a guideline class which is placed in service during the taxable year. With respect to the assets falling within the guideline class which are placed in single asset accounts for purposes of computing depreciation, the estimated useful life used for each asset for that purpose shall be used in determining qualified investment. With respect to the assets falling within the guideline class which are placed in multiple asset accounts (including a guideline class account described in Revenue Procedure 62-21) for which a group, classified, or composite rate is used in computing depreciation (or in single asset accounts for which an average life rate is used), the determination of estimated useful life for each asset in the account shall be made individually on the best estimate obtainable on the basis of all the facts and circumstances. The individual estimated useful lives used for all the assets placed in a multiple asset account, when viewed together, must be consistent with the group, classified, or composite life used for the account for purposes of computing depreciation.
(ii) In determining the individual estimated useful lives of assets similar in kind contained in a multiple asset account (or in single asset accounts for which an average life rate is used), the taxpayer may (a) assign to each of such assets the average useful life of such assets used for purposes of computing depreciation, or (b) assign separate lives to such assets based on the estimated range of years taken into consideration in establishing the average useful life. Thus, for example, if a taxpayer places nine similar trucks with an average estimated useful life of 7 years, based on an estimated range of 6 to 8 years (two trucks with a useful life of 6 years, five trucks with a useful life of 7 years, and two trucks with a useful life of 8 years), in a multiple asset account for which a group rate is used in computing depreciation, he may either assign a useful life of 6 years to two of the trucks, 7 years to five of the trucks, and 8 years to two of the trucks, or he may assign the average useful life of the trucks (7 years) to each of the nine trucks. Likewise, if a taxpayer places 100 similar telephone poles with an average useful life of 28 years, based on an estimated range of 3 to 40 years (two with a useful life of less than 4 years, three with a useful life of 4 to 6 years, four with a useful life of 6 to 8 years, and 91 with a useful life of more than 8 years), in a multiple asset account for which a group rate is used in computing depreciation, he may either assign useful lives corresponding to the estimated range of years of the poles (i.e., a useful life of less than 4 years to two of the poles, etc.), or he may assign the average useful life of the poles (28 years) to each of the poles.
(iii) [Reserved]
(iv) For purposes of subdivision (ii) of this subparagraph, assets (other than “mass assets”) shall not be considered as “similar in kind” in respect of other assets unless all such assets are substantially of the same value, nor shall used section 38 property be considered as “similar in kind” to new section 38 property.
(4) Useful life of property subject to amortization—(i) In general. In the case of property with respect to which amortization in lieu of depreciation is allowable, the term over which amortization deductions are taken shall be considered as the estimated useful life of such property.
(ii) Qualified timber property. In the case of qualified timber property (within the meaning of section 194(c)(1)), the normal growing period of such property shall be considered its estimated useful life.
(5) Useful life of property subject to certain methods of depreciation. If a taxpayer is using a method of depreciation, such as the unit of production or retirement method, which does not measure the useful life of the property in terms of years, he must estimate such useful life in years in order to compute his qualified investment.
(6) Record requirements. The taxpayer shall maintain sufficient records to determine whether section 47 (relating to certain dispositions, etc., of section 38 property) applies with respect to any asset.
(7) Section 50 property. (i) The provisions of this subparagraph and subparagraphs (4) and (6) of this paragraph shall apply to property which is described in section 50.
(ii) The estimated useful life of property for purposes of computing qualified investment shall be the useful life used or to be used by the taxpayer in computing the allowance for depreciation with respect to such property under section 167 for the taxable year in which the property is placed in service. Thus, if property is placed in service by a taxpayer in a taxable year but the period for depreciation with respect to such property does not begin until a succeeding taxable year (see paragraph (d)(1) of this section), the estimated useful life for purposes of computing qualified investment must be the estimated useful life that the taxpayer uses in computing the allowance for depreciation. See subdivision (iv) of this subparagraph for rules for determining the estimated useful life of property with respect to which the allowance for depreciation under section 167 is computed under the unit of production method, the income-forecast method, or any other method which does not measure the useful life of the property in terms of years.
(iii)(a) The estimated useful life of any section 38 property to which an election under section 167(m) applies shall be the asset depreciation period selected for such property under § 1.167(a)-11(b)(4), whether or not such property constitutes mass assets (as defined in § 1.47-1(e)(4)).
(b) The estimated useful life of any section 38 property to which an election under section 167(m) does not apply and which is placed in a multiple asset account for which a group, classified, or composite rate is used in computing depreciation (or in single asset accounts for which an average life rate is used) shall be determined individually for each asset on the best estimate obtainable on the basis of all the facts and circumstances. The individual estimated useful life for each asset placed in a multiple asset account (including a mass asset account) must be the same as the useful life of such asset used in determining the group, classified, or composite life for the account for purposes of computing depreciation. The individual estimated useful lives of assets similar in kind may be determined in accordance with subdivisions (ii) and (iv) of subparagraph (3) of this paragraph. In the case of mass assets, subdivision (iii) of subparagraph (3) of this paragraph shall apply.
(f) Partnerships—(1) In general. In the case of a partnership, each partner shall take into account separately, for his taxable year with or within which the partnership taxable year ends, his share of the basis of partnership new section 38 property and his share of the cost of partnership used section 38 property placed in service by the partnership during such partnership taxable year. Each partner shall be treated as the taxpayer with respect to his share of the basis of partnership new section 38 property and his share of the cost of partnership used section 38 property. The estimated useful life to each partner of such property shall be deemed to be the estimated useful life of the property in the hands of the partnership. Partnership section 38 property shall not, by reason of each partner taking his share of the basis or cost into account, lose its character as either new section 38 property or used section 38 property, as the case may be. For computation of each partner’s qualified investment for the energy credit for a qualified intercity bus, see § 1.48-9(q)(9)(iv).
(2) Determination of partner’s share. (i) Each partner’s share of the basis (or cost) of any section 38 property shall be determined in accordance with the ratio in which the partners divide the general profits of the partnership (that is, the taxable income of the partnership as described in section 702(a)(9)) regardless of whether the partnership has a profit or a loss for its taxable year during which the section 38 property is placed in service. However, if the ratio in which the partners divide the general profits of the partnership changes during the taxable year of the partnership, the ratio effective for the date on which the property is placed in service shall apply.
(ii) Notwithstanding subdivision (i) of this subparagraph, if all related items of income, gain, loss, and deduction with respect to any item of partnership section 38 property are specially allocated in the same manner and if such special allocation is recognized under section 704 (a) and (b) and paragraph (b) of § 1.704-1, then each partner’s share of the basis of such item of new section 38 property or the cost of such item of used section 38 property shall be determined by reference to such special allocation effective for the date on which the property is placed in service.
(iii) Notwithstanding subdivisions (i) and (ii) of this subparagraph, if with respect to a partnership’s taxable year the conditions set forth in (a) through (c) of this subdivision are satisfied with respect to a partner, then such partner shall not take into account the basis (or cost) of any section 38 property placed in service by the partnership during such taxable year. The conditions referred to in the preceding sentence are:
(a) Such partner’s interest in the general profits of the partnership during the taxable year is 5 percent or less;
(b) Under the partnership agreement, such partner will retire from the partnership during the taxable year or within 7 years after the end of such year; and
(c) The partnership agreement provides that the basis (or cost) of section 38 property placed in service by the partnership during the taxable year shall not be taken into account by a partner described in (a) and (b) of this subdivision.
(3) Examples. This paragraph may be illustrated by the following examples:
Property | Estimated useful life | Basis | M’s share of basis | Applicable percentage | Qualified investment |
---|---|---|---|---|---|
Partnership MR | |||||
Icemaker | 8 | $1,000 | $700 | 100 | $700 |
Soda fountain | 6 | 600 | 300 | 66 | 200 |
Sole proprietorship | |||||
Machine | 4 | 300 | 33 | 100 | |
Total | 1,000 |
(g) Public utility property—(1) In general—(i) Scope of paragraph. This paragraph only applies to property described in section 50. For rules relating to public utility property not described in section 50, see 26 CFR part 1, § 1.46-3(g) (as revised April 1, 1977). This paragraph does not reflect amendments to section 46(c) made after enactment of the Revenue Act of 1971.
(ii) Amount of qualified investment. A taxpayer’s qualified investment in section 38 property that is public utility property is
(2) Meaning and uses of certain terms. For purposes of this paragraph—
(i) Public utility property. “Public utility property” is property used by a taxpayer predominantly in a trade or business that is a public utility activity and property that is nonregulated communication property.
(ii) Public utility activity. A “public utility activity” is any activity in which the goods or services described in section 46(c)(3)(B) (i), (ii), or (iii) are furnished or sold at regulated rates. If property is used by a taxpayer both in a public utility activity and in another activity, the characterization of such property is based on the predominant use of such property during the taxable year in which it is placed in service.
(iii) Regulated rates. A taxpayer’s rates are “regulated” if they are established or approved on a rate-of-return basis. Rates regulated on a rate-of-return basis are an authorization to collect revenues that cover the taxpayer’s cost of providing goods or services, including a fair return on the taxpayer’s investment in providing such goods or services, where the taxpayer’s costs and investment are determined by use of a uniform system of accounts prescribed by the regulatory body. A taxpayer’s rates are not “regulated” if they are established or approved on the basis of maintaining competition within an industry, insuring adequate service to customers of an industry, or charging “reasonable” rates within an industry since the taxpayer is not authorized to collect revenues based on the taxpayer’s cost of providing goods or services. Rates are considered to have been “established or approved” if a schedule of rates is filed with a regulatory body that has the power to approve such rates, even though the regulatory body takes no action on the filed schedule or generally leaves undisturbed rates filed by the taxpayer.
(iv) Nonregulated communication property. “Nonregulated communication property” is property that is clearly the same type of property (and is used by the taxpayer predominantly for the same type of communication purposes) as communication property, but it is used by the taxpayer predominantly in a trade or business that is not a public utility activity. For purposes of this paragraph (g)(2)(iv), of this section, communication property is property ordinarily used for communication purposes by persons who provide regulated telephone or microwave communication services described in section 46(c)(3)(B)(iii). The determination of whether property is clearly of this same type and is used predominantly for these same communication purposes as communication property is made on the basis of the facts and circumstances of each particular case, including the current state of technology in the communications industry and the range and type of services permitted or required to be provided by the regulated telephone and microwave communication industry. As of 1978, wires or cables used predominantly to distribute to subscribers the signals of one or more television broadcast stations or cablecast stations (such as in a CATV system) are not used for the same type of communication purposes as communication property. Communication property includes microwave transmission equipment, private communication equipment (other than land mobile radio equipment for which the operator must obtain a license from the Federal Communications Commission), private switchboard (PBX) equipment, communications terminal equipment connected to telephone networks, data transmission equipment, and communications satellites. Communication property does not include (as of 1978) computer terminals or facsimile reproduction equipment that is connected to telephone lines to transmit data. It also does not include office furniture stands for communication property, tools, repair vehicles, and similar property, even if such property is exclusively used in providing regulated telephone or microwave communication services.
(3) Leased property. Public utility property includes property which is leased to others by a taxpayer where the leasing of such property is part of the lessor’s public utility activity. Thus, such leased property is public utility property even though the lessee uses such property in an activity which is not a public utility activity, and whether or not the lessor of such property makes a valid election under § 1.48-4 to treat the lessee as having purchased such property for purposes of the credit allowed by section 38. Property leased by a lessor, where the leasing is not part of a public utility activity, to a lessee who uses such property predominantly in a public utility activity is public utility property for purposes of computing the lessor’s or lessee’s qualified investment with respect to such property.
(4) Property used in both the production or transmission of gas and the local distribution of gas. (i) With respect to properties of a taxpayer engaged in both the production or transmission of gas and the local distribution of gas, section 38 property shall be considered as used predominantly in the trade or business of the furnishing or sale of gas through a local distribution system if expenditures for such property are chargeable to any of the following accounts under either the uniform system of accounts prescribed for natural gas companies (class A and class B) by the Federal Power Commission, effective January 1, 1961, or the uniform system of accounts for class A and B gas utilities adopted in 1958 by the National Association of Railroad and Utility Commissioners (or would be chargeable to any of the following accounts if the taxpayer used either of such systems):
(a) Accounts 360 through 363, inclusive (Local Storage Plant), or
(b) Accounts 374 through 387, inclusive (Distribution Plant).
(ii) If expenditures for section 38 property are chargeable (or would be chargeable) to any of the following accounts under either of the systems named in subdivision (i) of this subparagraph, the determination of whether or not such property is used predominantly in the trade or business of the furnishing or sale of gas through a local distribution system shall be made under all the facts and circumstances relating to the actual use of such property in the year such property is placed in service:
(a) Accounts 304 through 320, inclusive (Manufactured Gas Production Plant), or
(b) Accounts 389 through 399, inclusive (General Plant).
(5) Certain submarine cable property. In the case of any interest in a submarine cable circuit which is property described in section 50 used to furnish telegraph service between the United States and a point outside the United States of a taxpayer engaged in furnishing international telegraph service (if the rates for such furnishing have been established or approved by a governmental unit, agency, instrumentality, commission, or similar body described in subparagraph (2) of this paragraph), the qualified investment shall not exceed the qualified investment attributable to so much of the interest of the taxpayer in the circuit as does not exceed 50 percent of all interests in the circuit.
(h) Certain replacement property. (1)(i) If section 38 property is placed in service by the taxpayer to replace property (whether or not section 38 property) similar or related in service or use, which was destroyed or damaged before August 16, 1971, by fire, storm, shipwreck, or other casualty, or was stolen before such date, then for purposes of paragraph (a) of this section the basis (or cost) of the replacement section 38 property otherwise determined under paragraph (c) of this section shall be reduced by an amount equal to the lesser of—
(a) The amount of money, or the fair market value of other property, received as compensation, by insurance or otherwise, for the property which was destroyed, damaged, or stolen, or
(b) The adjusted basis of such destroyed, damaged, or stolen property (immediately before such destruction, damage, or theft).
(ii) For purposes of subdivision (i) of this subparagraph—
(a) Section 38 property placed in service after the due date (including extensions of time thereof) for filing the taxpayer’s income tax return for the taxable year in which the other property was destroyed, damaged, or stolen shall not be considered as replacement section 38 property, and
(b) If the property which is destroyed, damaged, or stolen, is leased property, no other leased property shall be considered as replacement property with respect to the property destroyed, damaged, or stolen, in any case in which the lessor makes or made an election under section 48(d) (relating to election with respect to certain leased property) with respect to either the property destroyed, damaged, or stolen, the other leased property, or both.
(2) Subparagraph (1) of this paragraph shall not apply to replacement property if the reduction, under such subparagraph (1), in the basis (or cost) of such replacement property is less than the excess of—
(i) The qualified investment with respect to the destroyed, damaged, or stolen property, over
(ii) The recomputed qualified investment with respect to such property (determined under the principles of paragraph (a) of § 1.47-1).
(3) This paragraph may be illustrated by the following examples:
(ii) Under subparagraph (1) of this paragraph, the $41,000 basis of machine No. 2 is reduced, for purposes of paragraph (a) of this section, by $23,000 (that is, the $23,000 insurance proceeds since such amount is less than the $24,500 adjusted basis of machine No. 1 immediately before it was destroyed) to $18,000 since such reduction (that is, $23,000) is greater than the $20,000 reduction in qualified investment which would be made if paragraph (a) of § 1.47-1 were to apply to machine No. 1 ($20,000 qualified investment less zero recomputed qualified investment).
(ii) The $41,000 basis of machine No. 2 is not reduced, for purposes of paragraph (a) of this section, under this paragraph since the $19,000 reduction which would have been made under this paragraph had it applied (that is, the $19,000 insurance proceeds since such amount is less than the $24,500 adjusted basis of machine No. 1 immediately before it was destroyed) is less than the $20,000 reduction in qualified investment which is made since paragraph (a) of § 1.47-1 applies to machine No. 1 ($20,000 qualified investment less zero recomputed qualified investment).
§ 1.46-4 Limitations with respect to certain persons.
(a) Mutual savings institutions. In the case of an organization to which section 593 applies (that is, a mutual savings bank, a cooperative bank, or a domestic building and loan association)—
(1) The qualified investment with respect to each section 38 property shall be 50 percent of the amount otherwise determined under § 1.46-3, and
(2) The $25,000 amount specified in section 46(a)(2), relating to limitation based on amount of tax, shall be reduced by 50 percent of such amount.
(b) Regulated investment companies and real estate investment trusts. (1) In the case of a regulated investment company or a real estate investment trust subject to taxation under subchapter M, chapter 1 of the Code—
(i) The qualified investment with respect to each section 38 property otherwise determined under § 1.46-3, and
(ii) The $25,000 amount specified in section 46(a)(2), relating to limitation based on amount of tax,
(2) A person’s ratable share of the amount described in subparagraph (1)(i) and the amount described in subparagraph (1)(ii) of this paragraph shall be the ratio which—
(i) Taxable income for the taxable year, bears to
(ii) Taxable income for the taxable year plus the amount of the deduction for dividends paid taken into account under section 852(b)(2)(D) in computing investment company taxable income, or under section 857(b)(2)(B) (section 857(b)(2)(C), as then in effect, for taxable years ending before October 5, 1976) in computing real estate investment trust taxable income, as the case may be.
(3) This paragraph may be illustrated by the following example:
(ii) Under this paragraph, corporation X’s qualified investment for the taxable year 1964 with respect to such property is $2,000, computed as follows: (a) $20,000 (qualified investment under § 1.46-3), multiplied by (b) $10,000 (taxable income), divided by (c) $100,000 (taxable income plus the deduction for dividends paid). For 1964, the $25,000 amount specified in section 46(a)(2) is reduced to $2,500.
(c) Cooperatives. (1) In the case of a cooperative organization described in section 1381(a)—
(i) The qualified investment with respect to each section 38 property otherwise determined under § 1.46-3, and
(ii) The $25,000 amount specified in section 46(a)(2), relating to limitation based on amount of tax,
(2) A cooperative’s ratable share of the amount described in subparagraph (1)(i) and the amount described in subparagraph (1)(ii) of this paragraph shall be the ratio which—
(i) Taxable income for the taxable year, bears to
(ii) Taxable income for the taxable year plus the sum of (a) the amount of the deductions allowed under section 1382(b), (b) the amount of the deductions allowed under section 1382(c), and (c) amounts similar to the amounts described in (a) and (b) of this subdivision the tax treatment of which is determined without regard to subchapter T, chapter 1 of the Code and the regulations thereunder.
(3) This paragraph may be illustrated by the following example:
(ii) Under this paragraph, cooperative X’s qualified investment for the taxable year 1964 with respect to such property is $2,000, computed as follows: (a) $20,000 (qualified investment under § 1.46-3), multiplied by (b) $10,000 (taxable income), divided by (c) $100,000 (taxable income plus the sum of the deductions allowed under sections 1382(b), 1382(c), and 522(b)(1)(B)). For 1964, the $25,000 amount specified in section 46(a)(2) is reduced to $2,500.
(d) Noncorporate lessors. (1) In the case of a lease entered into after September 22, 1971, a credit is allowed under section 38 to a noncorporate lessor of property with respect to the leased property only if—
(i) Such property has been manufactured or produced by the lessor in the ordinary course of his business, or
(ii) The term of the lease (taking into account any options to renew) is less than 50 percent of the estimated useful life of the property (determined under § 1.46-3(e)), and for the period consisting of the first 12 months after the date on which the property is transferred to the lessee the sum of the deductions with respect to such property which are allowable to the lessor solely by reason of section 162 (other than rents and reimbursed amounts with respect to such property) exceeds 15 percent of the rental income produced by such property.
(2) For purposes of subparagraph (1)(ii) of this paragraph, if at the time the lessor files his income tax return for the taxable year in which the property is placed in service, the lessor is unable to show that the more-than-15-percent test has been satisfied, then no credit may be claimed by the lessor on such return with respect to such property unless (i) taking into account the lessor’s obligations under the lease it is reasonable to believe that the more-than-15-percent test will be satisfied, and (ii) the lessor files a statement with his return from which it may be determined that he expects to satisfy the more-than-15-percent test. If the more-than-15-percent test is not satisfied with respect to the property, the taxpayer must file an amended return for the year in which the property is placed in service.
(3)(i) The more-than-15-percent test described in subparagraph (1)(ii) of this paragraph is based on the relationship of the expenses of the lessor relating to or attributable to the property to the gross income from rents of the taxpayer produced by the property. The test is applied with respect to such expenses and gross income as are properly attributable to the period consisting of the first 12 months after the date on which the property is transferred to the lessee. When more than one property is subject to a single lease and, pursuant to subparagraph (4) of this paragraph, the arrangement is considered to be a separate lease of each property, the test is applied separately to each such lease by making an apportionment of the payments received and expenses incurred with respect to each such property, considering all relevant factors. Such apportionment is made in accordance with any reasonable method selected and consistently applied by the taxpayer. For example, under subparagraph (4) of this paragraph, where a taxpayer leases an airplane which he owns to an airline along with a baggage truck, he is treated as having made two separate leases, one covering the airplane and one covering the baggage truck. Thus, the test will be applied by apportioning the related income and expenses between the two leases. Similarly, where a taxpayer leases a factory building erected by him containing section 38 property (machinery and equipment), the test will be applied to the taxpayer as though he had leased (to the lessee) the building and the section 38 property separately. Thus, the rental income and expenses are apportioned between the building and the section 38 property.
(ii) Only those deductions allowable solely by reason of section 162 are taken into account in applying the more-than-15-percent test. Hence, depreciation allowable by reason of section 167 (including amortization allowable in lieu of depreciation); interest allowable by reason of section 163; taxes allowable by reason of section 164; and depletion allowable by reason of section 611 are examples of deductions which are not taken into account in applying the test. Moreover, rents and reimbursed amounts paid or payable by the lessor are not taken into account notwithstanding that a deduction in respect of such rents or reimbursed amounts is allowable solely by reason of section 162. For purposes of this paragraph, a reimbursed amount is any expense for which the lessee or some other party is obligated to reimburse the lessor. Section 162 expenses paid or payable by any person other than the lessor are not taken into account unless the lessor is obligated to reimburse the person paying the expense. Further, if the lessee is obligated to pay to the lessor a charge for services which is separately stated or determinable, the expenses incurred by the lessor with respect to those services are not taken into account.
(iii) For purposes of the more-than-15-percent test, the gross income from rents of the lessor produced by the property is the total amount which is payable to the lessor by reason of the lease agreement other than reimbursements of section 162 expenses and charges for services which are separately stated or determinable. The fact that such amount depends, in whole or in part, on the sales or profits of the lessee or the performance of significant services by the lessor shall not affect the characterization of such amounts as gross income from rents for purposes of this paragraph. Gross income from rents also includes any taxes imposed on the lessor by local law but which are paid directly by the lessee on behalf of the lessor.
(4) For purposes of determining under this paragraph whether property is subject to a lease, the provisions of § 1.57-3(d)(1) (relating to definition of a lease) shall apply. If a noncorporate lessor enters into two or more successive leases with respect to the same or substantially similar items of section 38 property, the terms of such leases shall be aggregated and such leases shall be considered one lease for the purpose of determining whether the term of such leases is less than 50 percent of the estimated useful life of the property subject to such leases. Thus, for example, if an individual owns an airplane with an estimated useful life of 7 years and enters into three successive 3-year leases of such airplane, such leases will be considered to be one lease for a term of nine years for the purpose of determining whether the term of the lease is less than 3
(5) The requirements of this paragraph shall not apply with respect to any property which is treated as section 38 property by reason of section 48(a)(1)(E).
§ 1.46-5 Qualified progress expenditures.
(a) Effective date. This section applies to taxable years ending after December 31, 1974. This section reflects amendments to the Internal Revenue Code made only by the Tax Reduction Act of 1975, the Tax Reform Act of 1976, and the Revenue Act of 1978.
(b) General rule. Under section 46(d), a taxpayer may elect to take the investment credit for qualified progress expenditures (as defined in paragraph (g) of this section). In general, qualified progress expenditures are amounts paid (paid or incurred in the case of self-constructed property) for construction of progress expenditure property. The taxpayer must reasonably estimate that the property will take at least 2 years to construct and that the useful life of the property will be 7 years or more. Qualified progress expenditures may not be taken into account if made before the later of January 22, 1975, or the first taxable year to which an election under section 46(d) applies. In general, qualified progress expenditures are not allowed for the year property is placed in service, nor for the first year or any subsequent year recapture is required under section 47(a)(3). There is a percentage limitation on qualified progress expenditures for taxable years beginning before January 1, 1980. For a special rule relating to transfers of progress expenditure property, see paragraph (r) of this section.
(c) Reduction of qualified investment. Under section 46(c)(4), a taxpayer must reduce qualified investment for the year property is placed in service by qualified progress expenditures taken into account by that person or a predecessor. A “predecessor” of a taxpayer is a person whose election under section 46(d) carries over to the taxpayer under paragraph (o)(3) of this section.
(d) Progress expenditure property. Progress expenditure property is property constructed by or for the taxpayer, with a normal construction period of 2 years or more. The taxpayer must reasonably believe that the property will be new section 38 property with a useful life of 7 years or more when placed in service. Whether property is progress expenditure property is determined on the basis of facts know at the close of the taxable year of the taxpayer in which construction begins (or, if later, at the close of the first taxable year to which an election under section 46(d) applies). For purposes of this paragraph (d), property is constructed by or for the taxpayer only if it is built or manufactured from materials and component parts. Accordingly, progress expenditure property does not include property such as orchards, vineyards, livestock, or motion picture films or videotapes.
(e) Normal construction period—(1) In general. (i) The normal construction period is the period the taxpayer reasonably expects will be required to construct the property. The period begins on the date physical work on construction of the property commences and ends on the date the property is available to be placed in service. The normal construction period does not include, however, construction before January 22, 1975, nor construction before the first day of the first taxable year for which an election under section 46(d) is in effect. Physical work on construction of property does not include preliminary activities such as planning, designing, preparing blueprints, exploring, or securing financing.
(ii) The determination of the time when physical work on construction commences is based on the facts and circumstances of each case. Physical work on construction of property may include the physical work done by a subcontractor on a component specifically designated as part of the property. Also, the commencement of physical work on construction may occur at a site different from the main site of construction of the property. For example, if a shipyard orders a turbine before it begins work on building a ship, the normal construction period of the ship is measured from the time the subcontractor commences physical work on construction of the turbine (if it is normal for such work to precede the work of the main contractor).
(iii) Generally, physical work on construction does not include physical activity that is not necessary to complete construction of the property, nor does it include physical work on construction of a building or other property that will not be new section 38 property when placed in service. Physical work on construction also does not include research and development activities in a laboratory or experimental setting.
(iv) The normal construction period of property ends on the date it is expected the property will be available to be placed in service. Property is considered available to be placed in service when construction is completed and the property is available for delivery to the site of its assigned function. It is not necessary that property be in a state of readiness for a specifically assigned function. Nor is it necessary that it actually be delivered to the site of its assigned function.
(2) Estimates. Taxpayers should refer to normal industry practice in estimating the normal construction period of particular items. A different period may be used if special circumstances exist making it impractical to make the estimate on the basis of normal industry practice. The estimate must be based on information available at the close of the taxable year in which physical work on construction of the property begins, or, if later, at the close of the first taxable year for which an election under section 46(d) is in effect for the taxpayer. If the estimate is reasonable when made, the actual time it takes to complete the work is, in general, irrelevant in determining whether property is progress expenditure property. However, if there is a significant error in estimating the normal construction period, it may be evidence that the estimate was unreasonable when made. For taxable years ending after April 1, 1988, a taxpayer not relying or normal industry practice to estimate the normal construction period of particular property must attach to the tax return for the taxable year in which physical work on construction of the property begins (or, if later, the first taxable year for which an election under section 46(d) is in effect) a statement of the basis relied upon in estimating the normal construction period of the property.
(3) Integrated unit. (i) In determining whether property has a normal construction period of 2 years or more, property that will be placed in service separately is to be considered separately. For example, if two ships are contracted for at the same time, each ship is considered separately under this paragraph. However, for property that will be placed in service as an integrated unit, the taxpayer must determine the normal construction period of the integrated unit. If the normal construction period of the integrated unit is 2 years or more, the normal construction period of each item of new section 38 property that is a part of the integrated unit is considered to be 2 years or more. Thus, the normal construction period of an integrated unit may be 2 years or more even if no part of the unit has a normal construction period of 2 years or more.
(ii) Property is part of an integrated unit only if the operation of that item is essential to the performance of the function to which the unit is assigned. Property essential to the performance of the function to which the unit is assigned includes property the use of which is significantly connected to that function and which effects the safe, proper, or efficient performance of the unit. Generally, property must be placed in service at the same time to be considered part of the same integrated unit. Properties are not an integrated unit, however, solely because they are to be placed in service at the same time.
(iii) The normal construction period for an integrated unit begins on the date the normal construction period of the first item of new section 38 property that is part of the unit begins. It is not necessary that physical work commence at the main construction site of the integrated unit.
(4) Examples. The following examples illustrate this paragraph (e).
(ii) The section of pipeline from city M to city N and the associated pumping station will be available to be placed in service on January 1, 1977. Construction of the section of the pipeline from city N to city O will be completed on June 30, 1977. However, that section of the pipeline will not be available to be placed in service until completion of the associated pumping station on January 1, 1978.
(iii) The section of pipeline from city M to city N and the section from city N to city O must be considered separately in determining the normal construction period of the property. Each section will be placed in service separately. However, each section of the pipeline and the associated pumping station may be considered an integrated unit. The pumping stations are essential to the operation of each section of pipeline. Each section of pipeline and the associated pumping station are placed in service at the same time.
(iv) The section of pipeline from city M to city N and the associated pumping station are not progress expenditure property, because the normal construction period of that unit is only 1 year (January 1, 1976 to January 1, 1977).
(v) The section of pipeline from city N to city O and the associated pumping station are progress expenditure property, because the normal construction of that integrated unit is 2 years (January 1, 1976 to January 1, 1978). It is immaterial that neither the construction period of that section of pipeline (January 1, 1976 to June 30, 1977) nor the construction period of the associated pumping station (June 30, 1977 to January 1, 1978) is 2 years.
(vi) Assume the pumping station associated with the pipeline from city N to city O includes backup pumping equipment that will be used only if the primary pumping equipment fails. The backup equipment is part of the integrated unit because it serves to effect the safe or efficient performance of the unit.
(f) New section 38 property with a 7-year useful life—(1) In general. The taxpayer must determine if property will be new section 38 property with a useful life of 7 years or more when placed in service. The determination must be made at the close of the taxable year in which construction begins or, if later, at the close of the first taxable year to which an election under section 46(d) applies for the taxpayer.
(2) Determination based on reasonably expected use. The determination of whether property will be “new section 38 property” (within the meaning of §§ 1.48-1 and 1.48-2 when placed in service must be based on the reasonably expected use of the property by the taxpayer. There is a presumption that property will be new section 38 property if it would be new section 38 property if placed in service by the taxpayer when the determination is made. For example, in determining if property is an integral part of manufacturing under section 48(a)(1)(B)(i), it will be presumed that property will be new section 38 property if the taxpayer is engaged in manufacturing when the determination is made. Also, significant steps taken to establish a trade or business will be evidence the taxpayer will be engaged in that trade or business when the property is placed in service.
(3) Estimated useful life. The determination of whether property will have an estimated useful life of 7 years or more when placed in service must be made by applying the principles of § 1.46-3(e). If the estimated useful life is less than 7 years when the property is actually placed in service, the credit previously allowed under section 46(d) must be recomputed under section 47(a)(3)(B).
(g) Definition of qualified progress expenditures—(1) In general. A taxpayer’s qualified progress expenditures are the sum of qualified progress expenditures for self-constructed property (determined under paragraph (h) of this section), plus qualified progress expenditures for non-self-constructed property (determined under paragraph (j) of this section). Only amounts includible under § 1.46-3(c) in the basis of new section 38 property may be considered as qualified progress expenditures.
(2) Excluded amounts. Qualified progress expenditures do not include:
(i) In the case of non-self-constructed property, amounts incurred (whether or not paid)—
(A) Before the normal construction period begins, or
(B) Before the later of January 22, 1975, or the first day of the first taxable year for which an election under section 46(d) applies for the taxpayer;
(ii) In the case of self-constructed property, amounts chargeable to capital account—
(A) Before the normal construction period begins, or
(B) Before the later of January 22, 1975, or the first day of the first taxable year for which an election under section 46(d) applies for the taxpayer,
(iii) Expenditures with respect to particular property in the earlier of—
(A) The taxable year in which the property is placed in service, or
(B) The taxable year in which the taxpayer must recapture investment credit under section 47(a)(3) for the property or any subsequent year;
(iv) Expenditures for construction, reconstruction, or erection of property that is not section 38 property; or
(v) Amounts treated as an expense and deducted in the year paid or accrued.
(h) Qualified progress expenditures for self-constructed property—(1) In general. Qualified progress expenditures for self-constructed property (as defined in paragraph (k) of this section) are amounts properly chargeable to capital account in connection with that property. In general, amounts paid or incurred are chargeable to capital account if under the taxpayer’s method of accounting they are properly includible in computing basis under § 1.46-3. Qualified progress expenditures for self-constructed property include both direct costs (e.g., labor, material, parts) and indirect costs (e.g., overhead, insurance) associated with construction of property to the extent those costs are properly chargeable to capital account.
(2) Property partially non-self constructed. If an item of property is self-constructed because more than half of the construction expenditures are made directly by the taxpayer, then any expenditures (whether or not made directly by the taxpayer) for construction of that item of property are not subject to the limitations of section 46(d)(3)(B) and paragraph (j) of this section (relating to actual payment and progress in construction).
(3) Time when amounts paid or incurred are properly chargeable to capital account. (i) In general, expenditures for component parts and materials to be used in construction of self-constructed property are not properly chargeable to capital account until consumed or physically attached in the construction process. Component parts and materials that have been neither consumed nor physically attached in the construction process, but which have been irrevocably allocated to construction of that property are properly chargeable to capital account. Component parts and materials designed specifically for the self-constructed property may be considered irrevocably allocated to construction of that property at the time of manufacture of the component parts and materials. Component parts and materials not designed specifically for the property may be considered irrevocably allocated to construction at the time of delivery to the construction site if they would be economically impractical to remove. For example, pumps delivered to sites of construction of a tundra pipeline may be treated as irrevocably allocated to that pipeline on the date of delivery, even if they would be usable, but for their location on the tundra, in connection with other property. Component parts and materials are not to be considered irrevocably allocated to use in self-constructed property until physical work on construction of that property has begun (as determined under paragraph (e)(1)(ii) of this section). Mere bookkeeping notations are not sufficient evidence that the necessary allocation has been made.
(ii) A taxpayer’s procedure for determining the time when an expenditure is properly chargeable to capital account for self-constructed property is a method of accounting. Under section 446(e), the method of accounting, once adopted, may not be changed without consent of the Secretary.
(4) Records requirement. The taxpayer shall maintain detailed records which permit specific identification of the amounts properly chargeable by the taxpayer during each taxable year to capital account for each item of self-constructed property.
(i) [Reserved]
(j) Qualified progress expenditures for non-self-constructed property—(1) In general. Qualified progress expenditures for non-self-constructed property (as defined in paragraph (l) of this section) are amounts actually paid by the taxpayer to another person for construction of the property, but only to the extent progress is made in construction. For example, such expenditures may include payments to the manufacturer of an item of progress expenditure property, payments to a contractor building progress expenditure property, or payments for engineering designs or blueprints that are drawn up during the normal construction period.
(2) Property partially self-constructed. If an item of property is non-self-constructed, but a taxpayer uses its own employees to construct a portion of the property, expenditures for construction of that portion are made directly by the taxpayer (see § 1.46-5(h)(1)). Subject to the limitations of paragraph (g) of this section, those expenditures are qualified progress expenditures for non-self-constructed property if they satisfy the requirements of paragraphs (j) (4), (5), and (6) of this section. Wages actually paid to the taxpayer’s employees are presumed to correspond to progress in construction. Other amounts, including expenditures for materials, parts, and overhead, must be actually paid, not borrowed from the payee, and attributable to progress made in construction by the taxpayer.
(3) Property constructed by more than one person. The percentage of completion limitation (as prescribed in paragraph (j)(6) of this section), including the presumption of ratable progress in construction, applies to an item of progress expenditure property as a whole. However, if several manufacturers or contractors do work in connection with the same property, the progress that each person makes toward completion of construction of the property must be determined separately. Section 46(d)(3)(B) is then applied separately to amounts paid to each manufacturer or contractor based on each person’s progress in construction. For example, assume the taxpayer contracts with three persons to build an item of equipment. The taxpayer contracts with A to build the frame, B to build the motor, and C to assemble the frame and motor. Assume each contract represents 33
(4) Requirement of actual payment. Qualified progress expenditures for non-self-constructed property must be actually paid and not merely incurred. Amounts paid during the taxable year to another person for construction of non-self-constructed property may be in the form of money or property (e.g., materials). However, property given as payment may be considered only to the extent it will be includible under § 1.46-3(c) in the basis of the non-self-constructed property when it is placed in service.
(5) Certain borrowing disregarded. Qualified progress expenditures for non-self-constructed property do not include any amount paid to another person (the “payee”) for construction if the amount is paid out of funds borrowed directly or indirectly from the payee. Amounts borrowed directly or indirectly from the payee by any person that is related to the taxpayer (within the meaning of section 267) or that is a member of the same controlled group of corporations (as defined in section 1563(a)) will be considered borrowed indirectly from the payee. Similarly, amounts borrowed under any financing arrangement that has the effect of making the payee a surety will be considered amounts borrowed indirectly by the taxpayer from the payee.
(6) Percentage of completion limitation. (i) Under section 46(d)(3)(B)(ii), payments made in any taxable year may be considered qualified progress expenditures for non-self-constructed property only to the extent they are attributable to progress made in construction (percentage of completion limitation). Progress will generally be measured in terms of the manufacturer’s incurred cost, as a fraction of the anticipated cost (as adjusted from year to year). Architectural or engineering estimates will be evidence of progress made in construction. Cost accounting records also will be evidence of progress. Progress will be presumed to occur not more rapidly than ratably over the normal construction period. However, the taxpayer may rebut the presumption by clear and convincing evidence of a greater percentage of completion.
(ii) If, after the first year of construction, there is a change in either the total cost to the taxpayer or the total cost of construction by another person, the taxpayer must recompute the percentage of completion limitation on the basis of revised cost. However, the recomputation will affect only amounts allowed as qualified progress expenditures in the taxable year in which the change occurs and in subsequent taxable years. The recomputation remains subject to the presumption of pro rata completion.
(iii) If, for any taxable year, the amount paid to another person for construction of an item of property under section 46(d)(3)(B)(i) exceeds the percentage of completion limitation in section 46(d)(3)(B)(ii), the excess is treated as an amount paid to the other person for construction for the succeeding taxable year. If for any taxable year the percentage of completion limitation for an item of property exceeds the amount paid to another during the taxable year for construction, the excess is added to the percentage of completion limitation for that property for the succeeding taxable year.
(iv) The taxpayer must maintain detailed records which permit specific identification of the amounts paid to each person for construction of each item of property and the percentage of construction completed by each person for each taxable year.
(7) Example. The following example illustrates paragraph (j)(6) of this section.
(ii) The cost of construction to corporation X is $500,000. The contract price is $550,000. Corporation Y makes a $110,000 payment in each of the years 1980 and 1981, an $85,000 payment in 1982, a $135,000 payment in 1983, and a $110,000 payment in 1984.
(iii) For 1980, corporation Y makes an election under section 46(d). Progress is presumed to occur ratably over the 5-year construction period, which is 20 percent in each year. Twenty percent of the contract price is $110,000. The percentage of completion limitation for each year, thus, is $110,000.
(iv) For each of the years 1980 and 1981, the $110,000 payments may be treated as qualified progress expenditures. The payments equal the percentage of completion limitation.
(v) For 1982, the $85,000 payment may be treated as a qualified progress expenditure, because it is less than the percentage of completion limitation. The excess of the percentage of completion limitation ($110,000) over the 1982 payment ($85,000) is added to the percentage of completion limitation for 1983. One hundred and ten thousand dollars minus $85,000 equals $25,000. Twenty-five thousand dollars plus $110,000 equals $135,000, which is the percentage of completion limitation for 1983.
(vi) For 1983, the entire $135,000 payment may be treated as a qualified progress expenditure. The payment equals the percentage of completion limitation for 1983.
(vii) For 1984, no qualified progress expenditures may be taken into account, because the airplane is placed in service in that year.
(viii) See example 2 of paragraph (r)(4) of this section for the result if Y sells its contract rights to the property on December 31, 1982.
(k) Definition of self-constructed property—(1) In general. Property is self-constructed property if it is reasonable to believe that more than half of the construction expenditures for the property will be made directly by the taxpayer. Construction expenditures made directly by the taxpayer include direct costs such as wages and materials and indirect costs such as overhead attributable to construction of the property. Expenditures for direct and indirect costs of construction will be treated as construction expenditures made directly by the taxpayer only to the extent that the expenditures directly benefit the construction of the property by employees of the taxpayer. Thus, wages paid to taxpayers’s employees and expenditures for basic construction materials, such as sheet metal, lumber, glass, and nails, which are used by employees of the taxpayer to construct progress expenditure property, will be considered made directly by the taxpayer. Construction expenditures made by the taxpayer to a contractor or manufacturer, in general, will not be considered made directly by the taxpayer. Thus, the cost of component parts, such as boilers and turbines, which are purchased and merely installed or assembled by the taxpayer, will not be considered expenditures made directly by the taxpayer for construction. (See paragraph (h)(3) of this section to determine when such cost is properly chargeable to capital account.)
(2) Time when determination made. The determination of whether property is self-constructed is to be made at the close of the taxable year in which physical work on construction of the property begins, or, if later, the close of the first taxable year to which an election under this section applies. Once it is reasonably estimated that more than half of construction expenditures will be made directly by the taxpayer, the fact the taxpayer actually makes half, or less than half, of the expenditures directly will not affect classification of the property as self-constructed property. Similarly, once a determination has been made, classification of property as self-constructed property is not affected by a change in circumstances in a later taxable year. However, a significant error unrelated to a change in circumstances may be evidence that the estimate was unreasonable when made.
(3) Determination based on certain expenditures. For purposes of determining whether more than half of the expenditures for construction of an item of property will be made directly by the taxpayer, the taxpayer may take into account only expenditures properly includable by the taxpayer in the basis of the property under the provisions of § 1.46-3(c). Thus, property is self-constructed property only if more than half of the estimated basis of the property to be used for purposes of determining the credit allowed by section 38 is attributable to expenditures made directly by the taxpayer.
(l) Definition of non-self-constructed property. Non-self-constructed property is property that is not self-constructed property. Thus, property is non-self-constructed property if it is reasonable to believe that only half, or less than half, of the expenditures for construction will be made directly by the taxpayer.
(m) Alternative limitations for public utility, railroad, or airline property. The alternative limitations on qualified investment under section 46(a) (7) and (8) for public utility, railroad, or airline property (whichever applies) apply in determining the credit for qualified progress expenditures. The determination of whether progress expenditure property will be public utility, railroad, or airline property (whichever applies) when placed in service must be made at the close of the taxable year in which physical work on construction begins or, if later, at the close of the first taxable year for which an election under section 46(d) is in effect. If, at that time, the taxpayer is in a trade or business as a public utility, railroad, or airline (as described in section 46(c)(3)(B) and 46(a)(8) (D) and (E), respectively), it is evidence the property will be public utility, railroad, or airline property when placed in service.
(n) Leased property. A lessor of progress expenditure property may not elect under section 48(d) to treat a lessee (or a person who will be a lessee) as having made qualified progress expenditures.
(o) Election—(1) In general. The election under section 46(d)(6) to increase qualified investment by qualified progress expenditures may be made for any taxable year ending after December 31, 1974. Except as provided in paragraph (o)(2) of this section, the election is effective for the first taxable year for which it is made and for all taxable years thereafter unless it is revoked with the consent of the Commissioner. Except as provided in paragraphs (o) (2) and (3) of this section, the election applies to all qualified progress expenditures made by the taypayer during the taxable year for construction of any progress expenditure property. Thus, the taxpayer may not make the election for one item of progress expenditure property and not for other items. If progress expenditure property is being constructed by or for a partnership, S corporation (as defined in section 1361(a)), trust, or estate, an election under section 46(d)(6) must be made separately by each partner or shareholder, or each beneficiary if the beneficiary, in determining his tax liability, would be allowed investment credit under section 38 for property subject to the election. The election may not be made by a partnership or S corporation, and may be made by a trust or estate only if the trust or estate, in determining its tax liability, would be allowed investment credit under section 38 for property subject to the election. The election of any partner, shareholder, beneficiary, trust, or estate will be effective for that person, even if a related partner, shareholder, beneficiary, trust, or estate does not make the election. An election made by a partner, shareholder, beneficiary, trust, or estate applies to all progress expenditure property of that person. For example, an election made by corporation X, which is a partner in the XYZ partnership, applies to progress expenditure property the corporation holds in its own capacity and also to its interest in progress expenditure property of the partnership.
(2) Time and manner of making election. An election under section 46(d)(6) must be made on Form 3468 and filed with the original income tax return for the first taxable year ending after December 31, 1974 to which the election will apply. An election made before March 2, 1988, by filing a written statement (whether or not attached to the income tax return) will be considered valid. The election may not be made on an amended return filed after the time prescribed for filing the original return (including extensions) for that taxable year. However, an election under this section may be made or revoked by filing a statement with an amended return filed on or before May 31, 1988, if the due date for filing a return for the first taxable year to which the election applies is before May 31, 1988.
(3) Carryover of election in certain transactions. In general, and election under section 46(d)(6) does not carry over to the transferee of progress expenditure property (or an interest therein). However, if under section 47(b) the property does not cease to be progress expenditure property because of the transfer, the election will carry over to the transferee. If so, the election will apply only to the property transferred. For rules relating to the determination of qualified progress expenditures of the transferee, see paragraph (r) of this section.
(p) Partnerships, S corporations, trusts, or estates—(1) In general. Each partner, shareholder, trust, estate, or beneficiary of a trust or estate that makes an election under section 46(d) shall take into account its share of qualified progress expenditures (determined under paragraph (p)(2) of this section) made by the partnership, S corporation, trust, or estate. In determining qualified investment for the year in which the property is placed in service, the basis of the property is apportioned as provided in §§ 1.46-3(f), 1.48-6, or 1.48-5 (whichever applies). Each partner, shareholder, trust, estate, or beneficiary that made the election must reduce qualified investment under section 46(c)(4) for the year the property is placed in service by qualified progress expenditures taken into account by that person.
(2) Determination of share of qualified progress expenditures. The share of qualified progress expenditures of each partner, shareholder, trust, estate, or beneficiary that makes an election under section 46(d) must be determined in accordance with the same ratio used under §§ 1.46-3(f)(2), 1.48-5(a)(1), or 1.48-6(a)(1) (whichever applies) to determine its share of basis (or cost). The last sentence of § 1.46-3(f)(2)(i) must be applied by referring to the date on which qualified progress expenditures are paid or chargeable to capital amount (whichever is applicable).
(3) Examples. The following examples illustrate this paragraph (p).
(ii) The AB partnership reports income on the calendar year basis. Partners A and B share profits equally. For A’s taxable year ending December 31, 1980, A makes an election under section 46(d) B does not make the election.
(iii) For each of the years 1980, 1981, 1982, and 1983, the AB partnership makes $25,000 payments to corporation X. The payments made in 1980, 1981, and 1982 are qualified progress expenditures. The 1983 payment is not a qualified progress expenditure, because the ship is placed in service in that year.
(iv) For each of the years 1980, 1981, and 1982, A may take into account qualified progress expenditures of $12,500 because A had a 50 percent partnership interest in each of those years.
(v) For 1983, qualified investment for the ship is $100,000. A and B’s share are $50,000 each, because each had a 50 percent partnership interest in 1983. However, A must reduce its $50,000 share for 1983 by $37,500, the amount of qualified progress expenditures taken into account by A. B’s share is not reduced, because B did not take into account qualified progess expenditures.
(ii) For each of the years 1980, 1981, and 1982, A may take into account qualified progress expenditures of $12,500 because A has a 50 percent partnership interest in those years.
(iii) For 1983, A, B, and C’s share of qualified investment is $33,333 each, because each had a 33
(q) Limitation on qualified progress expenditures for taxable years beginning before 1980—(1) In general. (i) Under section 46(d)(7), qualified progress expenditures for any taxable year beginning before January 1, 1980, are limited. The taxpayer must apply the limitation under section 46(d)(7) on an item by item basis. In general, the taxpayer may take into account the applicable percentage (as determined under the table in section 46(d)(7)(A)) of qualified progress expenditures for each of those years. In addition, the taxpayer may take into account for each of those years 20 percent of qualified investment for each of the preceding taxable years determined without applying the limitations of section 46(d)(7).
(ii) The applicable percentage under section 46(d)(7)(A) may be applied only for one taxable year that ends within a calendar year in determining qualified investment for an item of progress expenditure property. For example, calendar year partners of a calendar year partnership may increase qualified investment for 1976 by 20 percent of qualified progress expenditures made in 1975 for an item of property. If the partnership incorporates in 1976 and the taxable year of the corporation begins on July 1, 1976, and ends on June 30, 1977, qualified investment of the corporation for its taxable year beginning on July 1, 1976, cannot be increased by 20 percent of the 1975 expenditure.
(2) Example. The following example illustrates this paragraph (q).
(ii) For 1976, X may increase qualified investment by $12,000, 40 percent of the payment made in 1976.
(iii) For 1977, corporation X may increase qualified investment by $24,000. Eighteen thousand dollars of that amount is 60 percent of the 1977 payment. The remaining $6,000 is 20 percent of the $30,000 payment made in 1976.
(iv) For 1978, corporation X may increase qualified investment by $36,000. Twenty-four thousand dollars of that amount is 80 percent of the 1978 payment. The remaining $12,000 is 20 percent of the $30,000 payment made in 1976, plus 20 percent of the $30,000 payment made in 1977.
(v) For 1979, corporation X may increase qualified investment by $48,000. Thirty thousand dollars of that amount is 100 percent of the 1979 payment. The remaining $18,000 of that amount is 20 percent of the $30,000 payments made in each of the years 1976, 1977, and 1978.
(vi) Qualified investment for corporation X for 1980 is $30,000. The $30,000 is the basis (or cost) of the generator ($150,000), reduced by qualified progress expenditures allowed with respect to that property ($120,000).
(r) Special rules for transferred property—(1) In general. A transferee of progress expenditure property (or an interest therein) may take into account qualified progress expenditures for the property only if—
(i) The property is progress expenditure property in the hands of the transferee, and
(ii) The transferee makes an election under section 46(d) or the election made by the transferor (or its predecessor) carries over to the transferee under paragraph (o)(3) of this section.
(2) Status as progress expenditure property. (i) If the transfer requires recapture under section 47(a)(3) and § 1.47-1(g) (or would require recapture if the transferor had made an election under section 46(d)), then—
(A) For purposes of determining if the property is progress expenditure property in the hands of the transferee, the normal construction period for the property begins on the date of the transfer, or, if later, on the first day of the first taxable year for which the transferee makes an election under section 46(d), and
(B) For purposes of determining whether the property is self-constructed or non-self-constructed in the hands of the transferee, the amount paid or incurred for the transfer of the property will not be considered a construction expenditure made directly by the transferee.
(ii) If the transfer does not require recapture under section 47(a)(3) and § 1.47-1(g), and the election carries over to the taxpayer under paragraph (o)(3) of this section, the property does not lose its status as progress expenditure property because of the transfer.
(3) Amount of qualified progress expenditures for transferee. (i) If the transfer does not require recapture under section 47(a)(3) and § 147-1(g), and the election carries over to the taxpayer under paragraph (o)(3) of this section, the transferee must determine its qualified progress expenditures—
(A) By using the same normal construction period used by the transferor,
(B) By treating the property as having the same status as self-constructed or non-self-constructed as the property had in the hands of the transferor, and
(C) In the case of non-self-constructed property, by taking into account any excess described in section 46(d)(4)(C)(i) (relating to the excess of payments over the percentage-of-completion limitation) or section 46(d)(4)(C)(ii) (relating to the excess of the percentage-of-completion limitation over the amount of payments) that the transferor would have taken into account with respect to that property.
(ii) If the transfer requires recapture under section 47(a)(3) and § 1.47-1(g) (or would require recapture if the transferor had made an election under section 46(d)), the amount paid or incurred for the transfer will be considered a payment for construction of that property to the extent that—
(A) It is properly includible in the basis of the property under § 1.46-3(c),
(B) The taxpayer can show the amount is attributable to construction costs paid or chargeable to capital account by the transferor or other person after physical work on construction of the property began, and
(C) It does not exceed the amount by which the transferor has increased qualified investment for qualified progress expenditures incurred with respect to the property (or would have increased qualified investment but for the “lesser of” limitation of section 46(d)(3)(B) or the absence of an election under section 46(d)), plus any amount that would have been treated as a qualified progress expenditure by the transferor had the property not been transferred.
(4) Examples. The following examples illustrate this paragraph (r).
(ii) The investment credit allowed Y in 1980 and 1981 for qualified progress expenditures is subject to recapture under section 47(a)(3) and Y may not treat its $85,000 payment in 1982 as a qualified progress expenditure.
(iii) For purposes of determining if the airplane is qualified progress expenditure property with respect to Z, the normal construction period for the property for Z begins on December 31, 1982, the date of transfer. Since the remaining construction period is two years, the property is progress expenditure property if it otherwise qualifies in Z’s hands.
(iv) Only $305,000 of the $340,000 payment to Y can qualify as a qualified progress expenditure, because only that amount is attributable to construction costs paid by Y and does not exceed the sum of the amount by which Y increased qualified investment in 1980 and 1981 for qualified progress expenditures ($220,000) and the amount that Y would have treated as a qualified progress expenditure in 1982 ($85,000).
(v) Assume that Z cannot establish that progress in construction has been completed more rapidly than ratably. If Z makes an election under section 46(d) for 1982, then for purposes of applying the percentage of completion limitation, Z’s normal construction period is considered to begin on January 1, 1980. Progress is presumed to occur ratably over the 5-year construction period, which is 20 percent in each year.
(vi) For 1982, Z may treat the full $305,000 as a qualified progress expenditure because it is less than the percentage of completion limitation, $330,000 ($110,000 a year for 1980, 1981, and 1982).
(vii) For 1983, Z may treat the entire $135,000 payment as a qualified progress expenditure, since it does not exceed the percentage of completion limitation for that year, $135,000 ($110,000 plus the $25,000 excess from 1982).
(viii) For Z’s taxable year ending December 31, 1984, no qualified progress expenditures may be taken into account because the property is placed in service during that year.
§ 1.46-6 Limitation in case of certain regulated companies.
(a) In general—(1) Scope of section. This section does not reflect amendments made to section 46 after enactment of the Revenue Act of 1971, other than the redesignation of section 46(e) as section 46(f) by the Tax Reduction Act of 1975.
(2) Disallowance of credit. Under section 46(f), a credit otherwise allowable under section 38 (“credit”) will be disallowed in certain cases with respect to “section 46(f) property” as defined in paragraph (b)(1) of this section. Paragraph (f) of this section describes circumstances under which a determination put into effect by a regulatory body will result in the disallowance of the credit. Such a determination will result in a disallowance only if section 46(f) (1) or (2) applies to such property and such determination affects the taxpayer’s cost of service or rate base in a manner inconsistent with section 46(f) (1) or (2) (whichever is applicable).
(3) General rules. The provisions of section 46(f) (1) and (2) are limitations on the treatment of the credit for ratemaking purposes and for purposes of the taxpayer’s regulated books of account only. Under the provisions of section 46(f)(1), the credit may not be flowed through to income (i.e., used to reduce taxpayer’s cost of service) but in certain circumstances may be used to reduce rate base (provided that such reduction is restored not less rapidly than ratably). If an election is made under section 46(f)(2), the credit may be flowed through to income (but not more rapidly than ratably) and there may not be any reduction in rate base. If an election is made under section 46(f)(3), none of the limitations of section 46(f) (1) or (2) apply to certain section 46(f) property of the taxpayer. Thus, under the provisions of section 46(f)(3), no credit is disallowed if the credit is treated in any manner for ratemaking purposes, including any manner of treatment permitted under the limitations of section 46(f) (1) or (2).
(4) Elections. For rules relating to the manner of making, on or before March 9, 1972, the three elections listed in section 46(f) (1), (2), and (3), see 26 CFR 12.3. For rules relating to the application of such elections, see paragraph (h) of this section.
(5) Cross references. For rules with respect to the treatment of corporate reorganizations, asset acquisitions, and taxpayers subject to the jurisdiction of more than one regulatory body, etc., see paragraph (j) of this section.
(6) Nonapplication of prior law. Under section 105 (e) of the Revenue Act of 1971, section 203 (e) of the Revenue Act of 1964, 78 Stat. 35, does not apply to section 46(f) property.
(b) Definitions. For purposes of this section, the following definitions apply:
(1) Section 46(f) property. “Section 46(f) property” is property described in section 50 that is—
(i) Public utility property within the meaning of section 46(c)(3)(B) (other than nonregulated communication property described in § 1.46-3(g)(2)(iv)) or
(ii) Property used predominantly in the trade or business of the furnishing or sale of steam through a local distribution system or of the transportation of gas or steam by pipeline, if the rates for the trade or business are regulated within the meaning of § 1.46-3(g)(2)(iii).
(2) Cost of service. (i)(A) For purposes of this section, “cost of service” is the amount required by a taxpayer to provide regulated goods or services. Cost of service includes operating expenses (including salaries, cost of materials, etc.) maintenance expenses, depreciation expenses, tax expenses, and interest expenses. For purposes of this section, any effect on a taxpayer’s permitted return on investment that results from a reduction in the taxpayer’s rate base does not constitute a reduction in cost of service, even though, as a technical ratemaking term, “cost of service” ordinarily includes a permitted return on investment. In addition, taking into account a deduction for the additional interest that the taxpayer would pay or accrue if the credit were unavailable in determining Federal income tax expense (“synchronization of interest”) does not constitute a reduction in cost of service for purposes of section 46(f)(2). This adjustment to Federal income tax expense may be taken into account in determining cost of service for the regulated accounting period or periods that include the taxable year to which the adjustment relates or for any subsequent regulated accounting period.
(B) See paragraph (b)(3)(ii)(B) of this section for rules relating to the amount of additional interest that the taxpayer would pay or accrue if the credit were unavailable.
(ii) In determining whether, or to what extent, a credit has been used to reduce cost of service, reference shall be made to any accounting treatment that affects cost of service. Examples of such treatment include reducing by all or a portion of the credit the amount of Federal income tax expense taken into account for ratemaking purposes and reducing the depreciable bases of property by all or a portion of the credit for ratemaking purposes.
(3) Rate base. (i) For purposes of this section, “rate base” is the monetary amount that is multiplied by a rate of return to determine the permitted return on investment.
(ii)(A) In determining whether, or to what extent, a credit has been used to reduce rate base, reference shall be made to any accounting treatment that affects rate base. In addition, in those cases in which the rate of return is based on the taxpayer’s cost of capital, reference shall be made to any accounting treatment that reduces the permitted return on investment by treating the credit less favorably than the capital that would have been provided if the credit were unavailable. Thus, the credit may not be assigned a “cost of capital” rate that is less than the overall cost of capital rate, determined on the basis of a weighted average, for the capital that would have been provided if the credit were unavailable.
(B) For purposes of determining the cost of capital rate assigned to the credit and the amount of additional interest that the taxpayer would pay or accrue, the composition of the capital that would have been provided if the credit were unavailable may be determined—
(1) On the basis of all the relevant facts and circumstances; or
(2) By assuming for both such purposes that such capital would be provided solely by common shareholders, preferred shareholders, and long-term creditors in the same proportions and at the same rates of return as the capital actually provided to the taxpayer by such shareholders and creditors.
(C) If a taxpayer’s overall rate of return is based on a deemed or hypothetical capital structure, paragraph (b)(3)(ii)(B) of this section shall be applied by treating the deemed or hypothetical capital as if it were the capital actually provided to the taxpayer and determining the composition of the capital that would have been provided if the credit were unavailable in a manner consistent with such treatment.
(iii) Whether, or to what extent, a credit has been used to reduce rate base for any period to which pre-June 23, 1986 rates apply will be determined under 26 CFR 1.46-6(b) (3) and (4) (revised as of April 1, 1985) if such a determination avoids disallowance of a credit that would be disallowed under paragraph (b)(3)(ii) or (4)(ii) of this section. For this purpose, a period of which pre-June 23, 1986 rates apply is any period for which the effect of the credit on rate base for ratemaking purposes is established under a determination put into effect (within the meaning of paragraph (f) of this section) before June 23, 1986.
(4) Indirect reductions to cost of service or rate base. (i) Cost of service or rate base is also considered to have been reduced by reason of all or a portion of a credit if such reduction is made in an indirect manner.
(ii) One type of such indirect reduction is any ratemaking decision in which the credit is treated as operating income (subject to ratemaking regulation) or is treated less favorably than the capital that would have been provided if the credit were unavailable. For example, if the credit is accounted for as nonoperating income on a company’s regulated books of account but a ratemaking decision has the effect of treating the credit as operating income in determining rate of return to common shareholders, then cost of service has been indirectly reduced by reason of the credit.
(iii) A second type of indirect reduction is any ratemaking decision intended to achieve an effect similar to a direct reduction to cost of service or rate base. In determining whether a ratemaking decision is intended to achieve this effect, consideration is given to all the relevant facts and circumstances of each case, including, but not limited to—
(A) The record of the proceeding,
(B) The regulatory body’s orders or opinions (including any dissenting views), and
(C) The anticipated effect of the ratemaking decision on the company’s revenues in comparison to a direct reduction to cost of service or rate base by reason of the investment tax credits available to the regulated company.
(iv) This paragraph (b)(4)(iv) describes a situation that is not an indirect reduction to cost of service or rate base by reason of all or a portion of a credit. The ratemaking treatment of credits may affect the financial condition of a company, including the company’s ability to attract new capital, the cost of that capital, the company’s future financial requirements, the market price of the company’s securities, and the degree of risk attributable to investment in those securities. The financial condition may be reflected in certain customary financial indicators such as the comparative capital structure of the company, coverage ratios, price/earnings ratios, and price/book ratios. Under the facts and circumstances test of paragraph (b)(4)(iii) of this section, the consideration of a company’s financial condition by a regulatory body is not an indirect reduction to cost of service or rate base, even though such condition, as affected by the ratemaking treatment of the company’s investment tax credits, is considered in the development of a reasonable rate of return on common shareholders’ investment.
(c) General rule—(1) In general. Section 46(f)(1) applies to all of the taxpayer’s section 46(f) property except property to which an election under section 46(f) (2) or (3) applies. Under section 46(f)(1), the credit for the taxpayer’s section 46(f) property will be disallowed if—
(i) The taxpayer’s cost of service for ratemaking purposes is reduced by reason of any portion of such credit, or
(ii) The taxpayer’s rate base is reduced by reason of any portion of the credit and such reduction in rate base is not restored or is restored less rapidly than ratably within the meaning of paragraph (g) of this section.
(2) Insufficient natural domestic supply. The provisions of paragraph (c)(1)(ii) of this section shall not apply to permit any reduction in taxpayer’s rate base with respect to its “short supply property” if it made an election under the last sentence of section 46(f)(1) on or before March 9, 1972.
(3) Short supply property. For purposes of this section, section 46(f) property is “short supply property” if—
(i) The property is described in paragraph (b)(1)(ii) of this section,
(ii) The regulatory body described in section 46(c)(3)(B) that has jurisdiction for ratemaking purposes with respect to such trade or business is an agency or instrumentality of the United States, and
(iii) This regulatory body makes a short supply determination and the determination is in effect on the date such property is placed in service.
(4) Short supply determination. A short supply determination is made or revoked on the date of its publication in the
(5) Dates short supply determination in effect. (i) A short supply determination is considered to be in effect with respect to section 46(f) property placed in service at any time before the determination is revoked. However, a short supply determination made after June 20, 1979 is not considered to be in effect with respect to section 46(f) property placed in service before such determination was made.
(d) Special rule for ratable flow-through. If an election was made under section 46(f)(2) on or before March 9, 1972, section 46(f)(2) applies to all of the taxpayer’s section 46(f) property except property to which an election under section 46(f)(3) applies. Under section 46(f)(2), the credit for the taxpayer’s section 46(f) property will be disallowed if—
(1) The taxpayer’s cost of service, for ratemaking purposes or in its regulated books of account, is reduced by more than a ratable portion of such credit within the meaning of paragraph (g) of this section or
(2) The taxpayer’s rate base is reduced by reason of any portion of such credit.
(e) Flow-through property. If a taxpayer made an election under section 46(f)(3) on or before March 9, 1972, section 46(f) (1) and (2) do not apply to the taxpayer’s section 46(f) property to which section 167(l)(2)(C) applies. In the case of an election under section 46(f)(3), a credit will not be disallowed, notwithstanding a determination by a regulatory body having jurisdiction over such taxpayer that reduces the taxpayer’s cost of service or rate base by reason of such credit. In general, section 167(l)(2)(C) applies to property with respect to which a taxpayer may use a flow-through method of accounting (within the meaning of section 167(l)(3)(H)) to take into account the allowance for depreciation under section 167(a). Section 167(l)(2)(C) applies to property even though the taxpayer does not use a flow-through method of accounting with respect to the property. Section 167(l)(2)(C) does not apply to property if the taxpayer can not use a flow-through method of accounting with respect to the property. For example, section 167(l)(2)(C) does not apply to property with respect to which an election under section 167(l)(4)(A) applies. Thus, such property does not qualify for an election under section 46(f)(3).
(f) Limitations—(1) In general. This paragraph provides rules relating to limitations on the disallowance of credits under section 46(f)(4). Key terms are defined in paragraphs (f) (7), (8), and (9) of this section.
(2) Disallowance postponed. There is no disallowance of a credit before the first final inconsistent determination is put into effect for the taxpayer’s section 46(f) property.
(3) Time of disallowance. A credit is disallowed—
(i) When the first final inconsistent determination is put into effect and
(ii) When any inconsistent determination (whether or not final) is put into effect after the first final inconsistent determination is put into effect.
(4) Credits disallowed. A credit is disallowed for section 46(f) property placed in service (within the meaning of § 1.46-3(d)) by the taxpayer—
(i) Before the date any inconsistent determination described in paragraph (f)(2) of this section is put into effect and
(ii) On or after such date and before the date a subsequent consistent determination (whether or not final) is put into effect.
(5) Barred years. No amount of credit for a taxable year is disallowed under paragraph (f)(3) of this section if, for such year, assessment of a deficiency is barred by any law or rule of law.
(6) Notification and other requirements. The taxpayer shall notify the district director of a disallowance of a credit under paragraph (f)(3) of this section within 30 days of the date that the applicable determination is put into effect. In the case of such a disallowance, the taxpayer shall recompute its tax liability for any affected taxable year, and such recomputation shall be made in the form of an amended return where necessary.
(7) Determinations. For purposes of this paragraph, the term “determination” refers to a determination made with respect to section 46(f) property (other than property to which an election under section 46(f)(3) applies) by a regulatory body described in section 46(c)(3)(B) that determines the effect of the credit—
(i) For purposes of section 46(f)(1), on the taxpayer’s cost of service or rate base for ratemaking purposes or
(ii) In the case of a taxpayer that made an election under section 46(f)(2), on the taxpayer’s cost of service, for ratemaking purposes or in its regulated books of account, or on the taxpayer’s rate base for ratemaking purposes.
(8) Types of determinations. For purposes of this paragraph—
(i) The term “inconsistent” refers to a determination that is inconsistent with section 46(f) (1) or (2) (as the case may be). Thus, for example, a determination to reduce the taxpayer’s cost of service by more than a ratable portion of the credit would be a determination that is inconsistent with section 46(f)(2). As a further example, such a determination would also be inconsistent if section 46(f)(1) applied because no reduction in cost of service is permitted under section 46(f)(1).
(ii) The term “consistent” refers to a determination that is consistent with section 46(f) (1) or (2) (as the case may be).
(iii) The term “final determination” means a determination with respect to which all rights to appeal or to request a review, a rehearing, or a redetermination have been exhausted or have lapsed.
(iv) The term “first final inconsistent determination” means the first final determination put into effect after December 10, 1971, that is inconsistent with section 46(f) (1) or (2) (as the case may be).
(9) Put into effect. A determination is put into effect on the latter of—
(i) The date it is issued (or, if a first final inconsistent determination, the date it becomes final) or
(ii) The date it becomes operative.
(10) Examples. The provisions of this paragraph may be illustrated by the following examples:
(g) Ratable methods—(1) In general. Under this paragraph (g), rules are prescribed for purposes of determining whether or not, under section 46(f)(1), a reduction in the taxpayer’s rate base with respect to the credit is restored less rapidly than ratably and whether or not under section 46(f)(2) the taxpayer’s cost of service for ratemaking purposes is reduced by more than a ratable portion of such credit.
(2) Regulated depreciation expense. What is “ratable” is determined by considering the period of time actually used in computing the taxpayer’s regulated depreciation expense for the property for which a credit is allowed. “Regulated depreciation expense” is the depreciation expense for the property used by a regulatory body for purposes of establishing the taxpayer’s cost of service for ratemaking purposes. Such period of time shall be expressed in units of years (or shorter periods), units of production, or machine hours and shall be determined in accordance with the individual useful life system or composite (or other group asset) account system actually used in computing the taxpayer’s regulated depreciation expense. A method of restoring, or reducing, is ratable if the amount to be restored to rate base, or to reduce cost of service (as the case may be), is allocated ratably in proportion to the number of such units. Thus, for example, assume that the regulated depreciation expense is computed under the straight line method by applying a composite annual percentage rate to “original cost” (as defined for purposes of computing regulated depreciation expense). If, with respect to an item of section 46(f) property, the amount to be restored annually to rate base is computed by applying a composite annual percentage rate to the amount by which the rate base was reduced, then the restoration is ratable. Similarly, if cost of service is reduced annually by an amount computed by applying a composite annual percentage rate to the amount of the credit, cost of service is reduced by a ratable portion. If such composite annual percenage rate were revised for purposes of computing regulated depreciation expense beginning with a particular accounting period, the computation of ratable restoration or ratable portion (as the case may be) must also be revised beginning with such period. A composite annual percentage rate is determined solely by reference to the period of time actually used by the taxpayer in computing its regulated depreciation expense without reduction for salvage or other items such as over and under accruals. A composite annual percentage rate determined by taking into account salvage value or other items shall be considered to be ratable in the case of a determination (whether or not final) issued before March 22, 1979, and any rate order (whether or not final) that is entered into before June 20, 1979, in response to a rate case filed before April 23, 1979. For this purpose, the term “rate order” does not include an order by a regulatory body that perfunctorily adopts rates as filed if such rates are suspended or subject to rebate.
(h) Elections—(1) Applicability of elections. (i) Any election under section 46(f) applies to all of the taxpayer’s property eligible for the election, whether or not the taxpayer is regulated by more than one regulatory body.
(ii) Section 46(f)(1) applies to all of the taxpayer’s section 46(f) property in the absence of an election under either section 46(f) (2) or (3). If an election is made under section 46(f)(2), section 46(f)(1) does not apply to any of the taxpayer’s section 46(f) property.
(iii) An election made under the last sentence of section 46(f)(1) applies to that portion of the taxpayer’s section 46(f) property to which section 46(f)(1) applies and which is short supply property within the meaning of paragraph (c)(2) of this section.
(iv) If a taxpayer makes an election under section 46(f)(2) and makes no election under section 46(f)(3), the election under section 46(f)(2) applies to all of the taxpayer’s section 46(f) property.
(v) If a taxpayer makes an election under section 46(f)(3), such election applies to all of the taxpayer’s section 46(f) property to which section 167(l)(2)(C) applies. Section 46(f) (1) or (2) (as the case may be) applies to that portion of the taxpayer’s section 46(f) property that is not property to which section 167(f)(2)(C) applies. Thus, for example, if a taxpayer makes an election under section 46(f)(2) and also makes an election under section 46(f)(3), section 46(f)(3) applies to all of the taxpayer’s section 46(f) property to which section 167(l)(2)(C) applies, and section 46(f)(2) applies to the remainder of the taxpayer’s section 46(f) property.
(2) Method of making elections. See 26 CFR 12.3 for rules relating to the method of making the elections described in section 46(f) (1), (2), or (3).
(i) [Reserved]
(j) Reorganizations, asset acquisitions, multiple regulation, etc.—(1) Taxpayers not entirely subject to jurisdiction of one regulatory body. (i) If a taxpayer is required by a regulatory body having jurisdiction over less than all of its property to account for the credit under a determination that is inconsistent with section 46(f) (1) or (2) (as the case may be), such credit shall be disallowed only with respect to property subject to the jurisdiction of such regulatory body.
(ii) For purposes of this paragraph (j), a regulatory body is considered to have jurisdiction over property of a taxpayer if the property is included in the rate base for which the regulatory body determines an allowable rate of return for ratemaking purposes or if expenses with respect to the property are included in cost of service as determined by the regulatory body for ratemaking purposes. For example, if regulatory body A, having jurisdiction over 60 percent of an item of corporation X’s section 46(f) property, makes a determination which is inconsistent with section 46(f), and if regulatory body B, having jurisdiction over the remaining 40 percent of such item of property, makes a consistent determination (or if the remaining 40 percent is not subject to the jurisdiction of any regulatory body), then 60 percent of the credit for such item will be disallowed. For a further example, if regulatory body A, having jurisdiction over 60 percent of X’s section 46(f) property, has jurisdiction over 100 percent of a particular generator, 100 percent of the credit for such generator will be disallowed.
(iii) For rules which provide that the 3 elections under section 46(f) may not be made with respect to less than all of the taxpayer’s property eligible for the election, see paragraph (h)(1)(i) of this section.
(2) [Reserved]
(k) Treatment of accumulated deferred investment tax credits upon the deregulation of public utility property—(1) Scope—(i) In general. This paragraph (k) provides rules for the application of former sections 46(f)(1) and 46(f)(2) of the Internal Revenue Code to a taxpayer with respect to public utility property that ceases, whether by disposition, deregulation, or otherwise, to be public utility property with respect to the taxpayer and that is not described in paragraph (k)(1)(ii) of this section (deregulated public utility property).
(ii) Exception. This paragraph (k) does not apply to property that ceases to be public utility property with respect to the taxpayer on account of an ordinary retirement within the meaning of § 1.167(a)-11(d)(3)(ii).
(2) Ratable amount—(i) Restoration of rate base reduction. A reduction in the taxpayer’s rate base on account of the credit with respect to public utility property that becomes deregulated public utility property is restored ratably during the period after the property becomes deregulated public utility property if the amount of the reduction remaining to be restored does not, at any time during the period, exceed the restoration percentage of the recoverable stranded cost of the property at such time. For this purpose—
(A) The stranded cost of the property is the cost of the property reduced by the amount of such cost that the taxpayer has recovered through regulated depreciation expense during the period before the property becomes deregulated public utility property;
(B) The recoverable stranded cost of the property at any time is the stranded cost of the property that the taxpayer will be permitted to recover through rates after such time; and
(C) The restoration percentage for the property is determined by dividing the reduction in rate base remaining to be restored with respect to the property immediately before the property becomes deregulated public utility property by the stranded cost of the property.
(ii) Cost of service reduction. Reductions in the taxpayer’s cost of service on account of the credit with respect to public utility property that becomes deregulated public utility property are ratable during the period after the property becomes deregulated public utility property if the cumulative amount of the reduction during such period does not, at any time during the period, exceed the flowthrough percentage of the cumulative stranded cost recovery for the property at such time. For this purpose—
(A) The stranded cost of the property is the cost of the property reduced by the amount of such cost that the taxpayer has recovered through regulated depreciation expense during the period before the property becomes deregulated public utility property;
(B) The cumulative stranded cost recovery for the property at any time is the stranded cost of the property that the taxpayer has been permitted to recover through rates on or before such time; and
(C) The flowthrough percentage for the property is determined by dividing the amount of credit with respect to the property remaining to be used to reduce cost of service immediately before the property becomes deregulated public utility property by the stranded cost of the property.
(3) Cross reference. See § 1.168(i)-(3) for rules relating to the treatment of balances of excess deferred income taxes when public utility property becomes deregulated public utility property.
(4) Effective/applicability dates—(i) In general. Except as provided in paragraph (k)(4)(ii) of this section, this paragraph (k) applies to public utility property that becomes deregulated public utility property with respect to a taxpayer after December 21, 2005.
(ii) Property that becomes public utility property of the transferee. This paragraph (k) does not apply to property that becomes deregulated public utility property with respect to a taxpayer an account of a transfer on or before March 20, 2008 if after the transfer the property is public utility property of the transferee.
(iii) Application of regulation project (REG-104385-01). A reduction in the taxpayer’s cost of service will be treated as ratable if it is consistent with the proposed rules in regulation project (REG-104385-01) (68 FR 10190) March 4, 2003, and occurs during the period beginning on March 5, 2003, and ending on the earlier of—
(A) The last date on which the utility’s rates are determined under the rate order in effect on December 21, 2005; or
(B) December 21, 2007.
§ 1.46-7 Statutory provisions; plan requirements for taxpayers electing additional investment credit, etc.
As amended by sections 802(b)(7), and 803 (c), (d), and (e) of the Tax Reform Act of 1976 (90 Stat. 1520), section 301 (d), (e), and (f) of the Tax Reduction Act of 1975 (89 Stat. 38) provides as follows:
Sec. 301. Increase in investment credit * * *
(d) Plan requirements for taxpayers electing additional credit. In order to meet the requirements of this subsection—
(1) Except as expressly provided in subsections (e) and (f), a corporation (hereinafter in this subsection referred to as the “employer”) must establish an employee stock ownership plan (described in paragraph (2)) which is funded by transfers of employer securities in accordance with the provisions of paragraph (6) and which meets all other requirements of this subsection.
(2) The plan referred to in paragraph (1) must be a defined contribution plan established in writing which—
(A) Is a stock bonus plan, a stock bonus and a money purchase pension plan, or a profit-sharing plan,
(B) Is designed to invest primarily in employer securities, and
(C) Meets such other requirements (similar to requirements applicable to employee stock ownership plans as defined in section 4975(e)(7) of the Internal Revenue Code of 1954) as the Secretary of the Treasury or his delegate may prescribe.
(3) The plan must provide for the allocation of all employer securities transferred to it or purchased by it (because of the requirements of section 46(a)(2)(B) of the Internal Revenue Code of 1954) to the account of each participant (who was a participant at any time during the plan year, whether or not he is a participant at the close of the plan year) as of the close of each year in an amount which bears substantially the same proportion to the amount of all such securities allocated to all participants in the plan for that plan year as the amount of compensation paid to such participant (disregarding any compensation in excess of the first $100,000 per year) bears to the compensation paid to all such participants during that year (disregarding any compensation in excess of the first $100,000 with respect to any participant). Notwithstanding the first sentence of this paragraph, the allocation to participants’ accounts may be extended over whatever period may be necessary to comply with the requirements of section 415 of the Internal Revenue Code of 1954. For purposes of this paragraph, the amount of compensation paid to a participant for a year is the amount of such participant’s compensation within the meaning of section 415(c)(3) of such Code for such year.
(4) The plan must provide that each participant has a nonforfeitable right to any stock allocated to his account under paragraph (3), and that no stock allocated to a participant’s account may be distributed from that account before the end of the eighty-fourth month beginning after the month in which the stock is allocated to the account except in the case of separation from the service, death, or disability.
(5) The plan must provide that each participant is entitled to direct the plan as to the manner in which any employer securities allocated to the account of the participant are to be voted.
(6) On making a claim for credit, adjustment, or refund under section 38 of the Internal Revenue Code of 1954, the employer states in such claim that it agrees, as a condition of receiving any such credit, adjustment, or refund—
(A) In the case of a taxable year beginning before January 1, 1977, to transfer employer securities forthwith to the plan having an aggregate value at the time of the claim of 1 percent of the amount of the qualified investment (as determined under section 46 (c) and (d) of such Code) of the taxpayer for the taxable year, and
(B) In the case of a taxable year beginning after December 31, 1976—
(i) To transfer employer securities to the plan having an aggregate value at the time of the claim of 1 percent of the amount of the qualified investment (as determined under section 46 (c) and (d) of such Code) of the employer for the taxable year,
(ii) Except as provided in clause (iii), to effect the transfer not later than 30 days after the time (including extensions) for filing its income tax return for a taxable year, and
(iii) In the case of an employer whose credit (as determined under section 46(a)(2)(B) of such Code) for a taxable year beginning after December 31, 1976, exceeds the limitations of paragraph (3) of section 46(a) of such Code—
(I) To effect that portion of the transfer allocable to investment credit carrybacks of such excess credit at the time required under clause (ii) for the unused credit year (within the meaning of section 46(b) of such Code), and
(II) To effect that portion of the transfer allocable to investment credit carryovers of such excess credit at the time required under clause (ii) for the taxable year to which such portion is carried over.
(7) Notwithstanding any other provision of law to the contrary, if the plan does not meet the requirements of section 401 of the Internal Revenue Code of 1954—
(A) Stock transferred under paragraph (6) or subsection (e)(3) and allocated to the account of any participant under paragraph (3) and dividends thereon shall not be considered income of the participant or his beneficiary under the Internal Revenue Code of 1954 until actually distributed or made available to the participant or his beneficiary and, at such time, shall be taxable under section 72 of such Code (treating the participant or his beneficiary as having a basis of zero in the contract),
(B) No amount shall be allocated to any participant in excess of the amount which might be allocated if the plan met the requirements of section 401 of such Code, and
(C) The plan must meet the requirements of sections 410 and 415 of such Code.
(8)(A) Except as provided in subparagraph (B)(iii), if the amount of the credit determined under section 46(a)(2)(B) of the Internal Revenue Code of 1954 is recaptured or redetermined in accordance with the provisions of such Code, the amounts transferred to the plan under this subsection and subsection (e) and allocated under the plan shall remain in the plan or in participant accounts, as the case may be, and continue to be allocated in accordance with the plan.
(B) If the amount of the credit determined under section 46(a)(2)(B) of the Internal Revenue Code of 1954 is recaptured in accordance with the provisions of such Code—
(i) The employer may reduce the amount required to be transferred to the plan under paragraph (6) of this subsection, or under paragraph (3) of subsection (e), for the current taxable year or any succeeding taxable years by the portion of the amount so recaptured which is attributable to the contribution to such plan,
(ii) Notwithstanding the provisions of paragraph (12), the employer may deduct such portion, subject to the limitations of section 404 of such Code (relating to deductions for contributions to an employees’ trust or plan), or
(iii) If the requirements of subsection (f)(1) are met, the employer may withdraw from the plan an amount not in excess of such portion.
(C) If the amount of the credit claimed by an employer for a prior taxable year under section 38 of the Internal Revenue Code of 1954 is reduced because of a redetermination which becomes final during the taxable year, and the employer transferred amounts to a plan which were taken into account for purposes of this subsection for that prior taxable year, then—
(i) The employer may reduce the amount it is required to transfer to the plan under paragraph (6) of this subsection, or under paragraph (3) of subsection, (e), for the taxable year or any succeeding taxable year by the portion of the amount of such reduction in the credit or increase in tax which is attributable to the contribution to such plan, or
(ii) Notwithstanding the provisions of paragraph (12), the employer may deduct such portion subject to the limitations of section 404 of such Code.
(9) For purposes of this subsection, the term—
(A) “Employer securities” means common stock issued by the employer or a corporation which is a member of a controlled group of corporations which includes the employer (within the meaning of section 1563 (a) of the Internal Revenue Code of 1954, determined without regard to section 1563 (a)(4) and (e)(3)(C) of such Code) with voting power and dividend rights no less favorable than the voting power and dividend rights of other common stock issued by the employer or such controlling corporation, or securities issued by the employer or such controlling corporation, convertible into such stock, and
(B) “Value” means the average of closing prices of the employer’s securities, as reported by a national exchange on which securities are listed, for the 20 consecutive trading days immediately preceding the date of transfer or allocation of such securities or, in the case of securities not listed on a national exchange, the fair market value as determined in good faith and in accordance with regulations issued by the Secretary of the Treasury or his delegate.
(10) The Secretary of the Treasury or his delegate shall prescribe such regulations and require such reports as may be necessary to carry out the provisions of this subsection and subsections (e) and (f).
(11) If the employer fails to meet any requirement imposed under this subsection or subsection (e) or (f) or under any obligation undertaken to comply with the requirement of this subsection or subsection (e) or (f), he is liable to the United States for a civil penalty of an amount equal to the amount involved in such failure. The preceding sentence shall not apply if the taxpayer corrects such failure (as determined by the Secretary of the Treasury or his delegate) within 90 days after notice thereof. For purposes of this paragraph, the term “amount involved” means an amount determined by the Secretary or his delegate, but not in excess of 1 percent of the qualified investment of the taxpayer for the taxable year under section 46(a)(2)(B) and not less than the product of one-half of one percent of such amount multiplied by the number of months (or parts thereof) during which such failure continues. The amount of such penalty may be collected by the Secretary of the Treasury in the same manner in which a deficiency in the payment of Federal income tax may be collected.
(12) Notwithstanding any provision of the Internal Revenue Code of 1954 to the contrary, no deductions shall be allowed under section 162, 212, or 404 of such Code for amounts transferred to an employee stock ownership plan and taken into account under this subsection.
(13)(A) As reimbursement for the expense of establishing the plan, the employer may withhold from amounts due the plan for the taxable year for which the plan is established, or the plan may pay, so much of the amounts paid or incurred in connection with the establishment of the plan as does not exceed the sum of 10 percent of the first $100,000 that the employer is required to transfer to the plan for that taxable year under paragraph (6) (including any amounts transferred under subsection (e)(3)) and 5 percent of any amount in excess of the first $100,000 of such amount.
(B) As reimbursement for the expense of administering the plan, the employer may withhold from amounts due the plan, or the plan may pay, so much of the amounts paid or incurred during the taxable year as expenses of administering the plan as does not exceed the smaller of—
(i) The sum of 10 percent of the first $100,000 and 5 percent of any amount in excess of $100,000 of the income from dividends paid to the plan with respect to stock of the employer during the plan year ending with or within the employer’s taxable year, or
(ii) $100,000.
(14) The return of a contribution made by an employer to an employee stock ownership plan designed to satisfy the requirements of this subsection or subsection (e) (or a provision for such a return) does not fail to satisfy the requirements of this subsection, subsection (e), section 401(a) of the Internal Revenue Code of 1954, or section 403(c)(1) of the Employee Retirement Income Security Act of 1974 if—
(A) The contribution is conditioned under the plan upon determination by the Secretary of the Treasury that such plan meets the applicable requirements of this subsection, subsection (e), or section 401(a) of such Code.
(B) The application for such a determination is filed with the Secretary not later than 90 days after the date on which the credit under section 38 is allowed, and
(C) The contribution is returned within one year after the date on which the Secretary issues notice to the employer that such plan does not satisfy the requirements of this subsection, subsection (e), or section 401(a) of such Code.
(e) Plan requirements for taxpayers electing additional one-half percent credit—(1) General rule. For purposes of clause (ii) of section 46(a)(2)(B) of the Internal Revenue Code of 1954, the amount determined under this subsection for a taxable year is an amount equal to the sum of the matching employee contributions for the taxable year which meet the requirements of this subsection.
(2) Election; basic plan requirements. No amount shall be determined under this subsection for the taxable year unless the corporation elects to have this subsection apply for that year. A corporation may not elect to have the provisions of this subsection apply for a taxable year unless the corporation meets the requirements of subsection (d) and the requirements of this subsection.
(3) Employer contribution. On making a claim for credit, adjustment, or refund under section 38 of the Internal Revenue Code of 1954, the employer shall state in such claim that the employer agrees, as a condition of receiving any such credit, adjustment, or refund attributable to the provisions of section 46(a)(2)(B)(ii) of such Code, to transfer at the time described in subsection (d)(6)(B) employer securities (as defined in subsection (d)(9)(A)) to the plan having an aggregate value at the time of the transfer of not more than one-half of one percent of the amount of the qualified investment (as determined under subsections (c) and (d) of section 46 of such Code) of the taxpayer for the taxable year. For purposes of meeting the requirements of this paragraph, a transfer of cash shall be treated as a transfer of employer securities if the cash is, under the plan, used to purchase employer securities.
(4) Requirements relating to matching employee contributions. (A) An amount contributed by an employee under a plan described in subsection (d) for the taxable year may not be treated as a matching employee contribution for that taxable year under this subsection unless—
(i) Each employee who participates in the plan described in subsection (d) is entitled to make such a contribution,
(ii) The contribution is designated by the employee as a contribution intended to be used for matching employer amounts transferred under paragraph (3) to a plan which meets the requirements of this subsection, and
(iii) The contribution is in the form of an amount paid in cash to the employer or plan administrator not later than 24 months after the close of the taxable year in which the portion of the credit allowed by section 38 of such Code (and determined under clause (ii) of section 46 (a)(2)(B) of such Code which the contribution is to match) is allowed, and is invested forthwith in employer securities (as defined in subsection (d)(9)(A)).
(B) The sum of the amounts of matching employee contributions taken into account for purposes of this subsection for any taxable year may not exceed the value (at the time of transfer) of the employer securities transferred to the plan in accordance with the requirements of paragraph (3) for the year for which the employee contributions are designated as matching contributions.
(C) The employer may not make participation in the plan a condition of employment and the plan may not require matching employee contributions as a condition of participation in the plan.
(D) Employee contributions under the plan must meet the requirements of section 401(a)(4) of such Code (relating to contributions).
(5) A plan must provide for allocation of all employer securities transferred to it or purchased by it under this subsection to the account of each participant (who was a participant at any time during the plan year, whether or not he is a participant at the close of the plan year) as of the close of the plan year in an amount equal to his matching employee contributions for the year. Matching employee contributions and amounts so allocated shall be deemed to be allocated under subsection (d)(3).
(f) Recapture—(1) General rule. Amounts transferred to a plan under subsection (d)(6) or (e)(3) may be withdrawn from the plan by the employer if the plan provides that while subject to recapture—
(A) Amounts so transferred with respect to a taxable year are segregated from other plan assets, and
(B) Separate accounts are maintained for participants on whose behalf amounts so transferred have been allocated for a taxable year.
(2) Coordination with other law. Notwithstanding any other law or rule of law, an amount withdrawn by the employer will neither fail to be considered to be nonforfeitable nor fail to be for the exclusive benefit of participants or their beneficiaries merely because of the withdrawal from the plan of—
(A) Amounts described in paragraph (1), or
(B) Employer amounts transferred under subsection (e)(3) to the plan which are not matched by matching employee contributions or which are in excess of the limitations of section 415 of such Code,
[Sec. 301(d) of the Tax Reduction Act of 1975 (89 Stat. 38) as amended by sec. 802(b)(7) and sec. 803 (c) and (e) of the Tax Reform Act of 1976 (90 Stat. 1520); sec. 301 (e) and (f) of the Tax Reduction Act of 1975 as added by sec. 803(d) of the Tax Reform Act of 1976]
§ 1.46-8 Requirements for taxpayers electing additional one-percent investment credit (TRASOP’s).
(a) Introduction—(1) In general. A corporation may elect under section 46(a)(2)(B) of the Code to obtain an additional investment credit for property described in section 46(a)(2)(D). This section provides rules for electing to have the provisions of section 46(a)(2)(B) apply and for implementing an employee stock ownership plan under section 301(d) of the Tax Reduction Act of 1975 (“1975 TRA”). The plan must meet the formal requirements of paragraph (d), and the operational requirements of paragraph (e), of this section. An additional credit may be obtained for the periods described in section 46(a)(2)(D). Unless otherwise indicated, statutory references in this section are to the Internal Revenue Code of 1954 as in effect prior to the amendments made by the Revenue Act of 1978.
(2) Reports. The returns required by section 6058(a) must be filed on behalf of a plan established under paragraph (c)(7) of this section, whether or not the plan is qualified under section 401(a).
(3) Cross-references. The following table indicates where in this section provisions appear relating to each provision of section 301 (d) and (f) of the 1975 TRA.
Section 301 | Section 1.46-8 | Subject |
---|---|---|
(d)(1) | (c)(7)(i), (c)(8)(i) | Establishing a TRASOP, in general; funding a TRASOP, in general. |
(2)(A) | (c)(7)(ii) | Type of plan. |
(B) | (d)(3), (e)(10) | Investment design. |
(C) | (d)(1) | Plan requirements, in general. |
(3) | (d)(6) | Allocation. |
(b)(8) | Compensation, definition. | |
(4) | (d)(7) | Nonforfeitability. |
(d)(9) | Distributions. | |
(5) | (d)(8) | Voting rights. |
(6) | (c) | Procedures for additional credit. |
(7)(A) | (c)(7)(ii) | Taxability, non-401(a) TRASOP. |
(B) | (e)(3) | Allocations under 401(a). |
(C) | (e)(3) | Section 410 and section 415 requirements. |
(8) | (e)(9) | Reductions of investment credit. |
(9)(A) | (b)(4) | Employer securities, definition. |
(e)(10), (f) | Employer securities, requirements. | |
(B) | (b)(7) | Value, definition. |
(10) | (a)(2) | Reporting requirements. |
(11) | (h) | Failure to comply. |
(12) | (c)(10) | Deductibility. |
(13) | (e) (6) and (7) | Reimbursement for expenses. |
(14) | (c)(8)(v) and (d)(7)(i) | Contingent contributions. |
(f) | (d)(7), (e)(8)(vii), (f) | Withdrawals of TRASOP securities. |
(b) Definitions. When used in this section, the terms listed below have the indicated meanings:
(1) TRASOP. A “TRASOP” is an employee stock ownership plan that meets the requirements of section 301(d) of the 1975 TRA. See § 1.46-7. It is a type of plan described in paragraph (d)(1) of this section and may, but need not, be an ESOP under § 54.4975-11 of this chapter (Pension Excise Tax Regulations). See § 1.46-8(d)(5) concerning use of TRASOP assets as collateral for debts and expenses of the plan.
(2) Additional credit. An “additional credit” is the additional one-percent investment credit under section 46(a)(2)(B)(i).
(3) Employer. An “employer” is a corporation that establishes a TRASOP.
(4) Employer securities—(i) In general. “Employer securities” are common stock, and securities convertible into common stock, of the employer or of a corporation that is a member of a controlled group of corporations including the employer. Employer securities must meet the requirements of paragraph (g) of this section. Membership in a controlled group for purposes of this section is determined under section 414(b) of the Code.
(ii) Pre-1977 employer securities. In addition, employer securities acquired by a TRASOP before January 1, 1977, include common stock, and securities convertible into common stock, of a corporation in control of the employer within the meaning of section 368(c).
(iii) Caution. An employer security under this section is not necessarily a qualifying employer security as defined in section 407(d)(5) of the Employee Retirement Income Security Act of 1974 (ERISA) or section 4975(e)(8). Moreover, sections 406, 407, and 408 of ERISA in certain cases limit the acquisition and disposition of qualifying employer securities as defined in section 407(d)(5) of ERISA.
(5) TRASOP securities. “TRASOP securities” are employer securities that—
(i) Are transferred to a TRASOP, or acquired with cash transferred to a TRASOP, to obtain an additional credit, and
(ii) Except as provided under paragraphs (g) (4) and (5) of this section, or as required by applicable law, are subject to no other put, call, or other option, or buy-sell or similar arrangement while held by the plan.
(6) Publicly traded. The term “publicly traded” has the meaning specified in § 54.4975-7(b)(1)(iv) of this chapter.
(7) Value—(i) In general. With respect to the transfer of TRASOP securities by a corporation to a TRASOP or the acquisition of TRASOP securities with cash transferred by a corporation to a TRASOP, “value” means fair market value determined in good faith and based on all relevant factors as of the date of transfer or acquisition of the TRASOP securities. If the plan acquires TRASOP securities from other than a disqualified person within the meaning of section 4975(e)(2), a good faith determination of value includes a determination of fair market value based on an appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any person from whom the TRASOP securities are acquired.
(ii) Twenty-day average rule. A special 20-day average valuation rule applies to certain publicly traded securities transferred by a corporation to a TRASOP. It does not apply to securities acquired with cash transferreed by a corporation to a TRASOP. Under the special rule, the term “value” refers to an average of daily closing prices for a security, as reported on any national securities exchange or as quoted on any system sponsored by a national securities association, over the 20 consecutive trading days immediately preceding the applicable last day described in paragraph (c)(8)(i) of this section. The average is based on the closing prices for each day when the security is in fact traded during the 20-day period. However, the special rule does not apply unless the security is in fact traded for at least 10 of the 20 days.
(iii) 20-day average transitional exception. If a TRASOP security is transferred before March 20, 1979, the plan may value the security on the basis of the 20 consecutive trading days preceding the date on which the security is transferred or the date as of which the security is allocated to a participant’s account.
(8) Compensation. “Compensation” means “participant’s compensation” under section 415(c)(3) and § 1.415-2(d). However, except for purposes of applying section 415, compensation must be determined for a plan year, not a limitation year.
(c) Procedures for additional credit—(1) Applicable year—(i) General rule. With respect to a qualified investment, the “applicable year” of a corporation is generally the taxable year in which the investment is made. For purposes of this section, an investment is made either in a year when section 38 property is placed in service or in a year when qualified progress expenditures are incurred.
(ii) Carryover option. A corporation may determine the applicable years for qualified investments made in any taxable year beginning after December 31, 1976, under the following method: The first applicable year with respect to the additional credit for a given year’s qualified investment is the year the qualified investment is made or, if later, the first taxable year for which any additional credit is allowable if claimed for that qualified investment. If there is an investment credit carryover from the first applicable year, each taxable year to which any part of the additional credit for that qualified investment is carried over is also an applicable year. If the carryover treatment is elected for the additional credit attributable to a year’s qualified investment, all applicable years for the additional credit attributable to that investment must be determined under the carryover option.
(iii) Increased credit. A taxable year in which a corporation’s additional credit is increased because of a redetermination is also an applicable year. See paragraph (c)(9)(iv) of this section.
(iv) Illustration. To illustrate the application of paragraphs (c)(1) (i) and (ii) of this section, assume that a calendar-year corporation makes a qualified investment in 1977 and that 1977 is an unused credit year described in section 46(b)(1). If the general rule is applied, 1977 is an applicable year. However, because 1977 is an unused credit year (at least with respect to the additional credit), if the corporation does not elect to treat 1977 as an applicable year but carries over its entire additional credit for 1977 to 1978 and uses it in 1978, then 1978 is an applicable year. If part of the additional credit is carried over further to 1979, the year 1979 is also an applicable year.
(v) Change in method. The choice between the general rule and carryover option methods of determining the additional credit attributable to applicable years is made with respect to each year’s qualified investment, and does not bind the corporation with respect to selection of methods for the additional credit attributable to other years’ qualified investment. A failure to comply does not occur merely because a corporation elects to apply either method for the additional credit attributable to separate years’ qualified investment.
(2) Time and manner of electing. A corporation with a qualified investment must elect to be eligible for an additional credit by attaching a statement of election—
(i) To its income tax return, filed on or before the due date including extensions of time, for a taxable year not later than its first applicable year with respect to a qualified investment, or
(ii) In the case of a return filed before December 31, 1975, to an amended return filed on or before December 31, 1975.
(3) Statement of election. The statement of election must contain the name and taxpayer identification number of the corporation. Also, it must declare in the following words, or in words having substantially the same meaning, that:
(i) The corporation elects to have section 46(a)(2)(B)(i) of the Internal Revenue Code of 1954 apply; and
(ii) The corporation agrees to implement (or continue to implement, as appropriate) a TRASOP and to claim the additional credit as required by § 1.46-8 of the Income Tax Regulations.
(4) Separate election. A separate election must be made for each taxable year’s qualified investment to obtain an additional credit for that qualified investment. If a corporation does not make a timely election to obtain an additional credit for a taxable year, it may not subsequently make the election on an amended return or otherwise.
(5) No partial election. An election to obtain an additional credit applies to a corporation’s entire qualified investment for a taxable year. Thus, a corporation may not elect to obtain a partial additional credit for any year’s qualified investment. However, the partial disallowance of an additional credit will not result in an election being treated as a partial election. Also, an election by a member of a controlled group of corporations that applies only to the electing member’s qualified investment is not a partial election. See § 1.46-8(h)(9) with respect to transitional rules for elections made before January 19, 1979.
(6) No revocation of election. After the time for electing the additional credit has expired for a taxable year, a corporation may not revoke its election for that year.
(7) Establishing a TRASOP—(i) In general. A corporation electing to obtain an additional credit must establish a TRASOP with accompanying trust on or before the last day for making the election regardless of when in fact the election is made. A TRASOP is considered to be in existence on a particular date if it meets the requirements of § 1.410(a)-2(c)(1). A new plan need not be established if an existing plan qualifies as a TRASOP, or is amended to meet the requirements of this section, on or before the last day for making the election. The requirements of this section are not satisfied merely by establishing and crediting a separate “TRASOP” account on the corporation’s books.
(ii) Type of plan. A TRASOP need not meet the requirements of section 401(a). However, it must be a stock bonus plan, a combination stock bonus plan and money purchase pension plan, or a profit-sharing plan under § 1.401-1(b)(1) of this chapter. See section 301(d)(7)(A) of the 1975 TRA for the tax consequences relating to a TRASOP that does not meet the requirements of section 401(a). See also title I of ERISA for additional provisions applicable to a TRASOP as an employee pension benefit plan under section 3(2) of ERISA.
(8) Funding a TRASOP—(i) In general. A corporation electing to obtain an additional credit must fund its TRASOP by transferring TRASOP securities or cash to it no later than 30 days after the applicable last day. That day is the last day for electing the additional credit, irrespective of when the election is actually made. However, in the case of an investment credit that was carried over and claimed in a subsequent applicable year by reason of paragraph (c)(1)(ii) of this section, that day is the last day (including extensions) for filing its income tax return for the subsequent applicable year. TRASOP securities may be transferred to a plan at any time during the applicable year, but not before the first day of an applicable year. If TRASOP securities are transferred to the plan within the permissible time period after the close of the applicable year, they are treated as transferred during that applicable year first until all TRASOP securities required by this paragraph (c) for that applicable year are transferred to, and taken into account under, the TRASOP. Thus, for example, assume that on a return filed on September 17, 1979 (with extensions, the last day for filing a return for 1978), a calendar-year corporation claims an additional credit of $5,000 for 1978, an applicable year under the TRASOP. No contributions were made in 1978 on account of the 1978 credit, but TRASOP securities with a value of $6,000 were contributed in 1979. The corporation also expects to be able to claim an additional credit of $10,000 for 1979. TRASOP securities transferred between January 1, 1979, and October 17, 1979, must be taken into account under the plan for 1978 before they are taken into account for 1979. Accordingly, securities having a value of $5,000 are applied against the obligation for 1978, and $1,000 of the contribution is retained to be applied to the eventual obligation for 1979.
(ii) Cash transfers. A corporation may transfer cash to the TRASOP instead of TRASOP securities only if the TRASOP uses the cash to acquire TRASOP securities no later than 30 days after the time for funding the TRASOP.
(iii) Valuation. The value of the TRASOP securities for an applicable year must equal one percent of the corporation’s qualified investment for that year. However, if paragraph (c)(1)(ii) of this section is followed by a corporation, the value of TRASOP securities for an applicable year must equal the amount of additional credit claimed for that year.
(iv) Cash reserve. The value of TRASOP securities acquired with cash transferred by a corporation may be reduced by two items. The first item is an amount not more than the value of fractional shares allocable to participants entitled to receive an immediate distribution at the time of the transfer. The second item is start-up expenses and administrative expenses to the extent permitted under section 301(d)(13) of the 1975 TRA and paragraphs (e) (6) and (7) of this section.
(v) Conditional funding. The funding of a TRASOP may be conditional if the TRASOP satisfies the provisions of section 301(d)(14) of the 1975 TRA. For purposes of section 301(d)(14), an investment credit is considered to be allowed on the date the election for the applicable year is made under paragraph (c)(2) of this section.
(vi) Certain benefit offset mechanisms. A TRASOP will be deemed to be not funded to the extent that TRASOP securities are used to offset benefits under a defined benefit plan.
(9) Claiming additional credit—(i) In general. Section 46(a)(3) subjects the amount of investment credit earned with respect to a taxpayer’s qualified investment for a taxable year to a limitation based on the corporation’s tax liability.
(ii) Unused credit year. Section 46(a)(1) provides a first-in-first-out rule for the investment credit in a taxable year. Section 46(b)(1) provides for the carryback and carryover of unused credits. If less than all of a taxpayer’s credit earned for a taxable year is allowable, the 10-percent credit determined under section 46(a)(2)(A) earned for a particular year is allowed first. Any portion of the additional credit for a taxable year that is not allowable may be carried back or carried over to the extent permitted by section 46(b)(1). However, an additional credit which is allowed for a taxable year is not reduced by a carryback to that year of an unused credit from a succeeding taxable year.
(iii) Example. Paragraph (c)(9)(ii) of this section is illustrated by the following example:
1975 | 1976 | |
---|---|---|
Facts: | ||
1. Qualified investment | $500,000 | $500,000 |
2. Credits earned: | ||
a. 10% credit | 50,000 | 50,000 |
b. Additional credit | 5,000 | 5,000 |
c. Carryover of additional credit from prior year, line 5 | 3,000 | |
3. Sec. 46(a)(3) limitation | 52,000 | 47,000 |
Treatment of credits: | ||
4. Credits allowed: | ||
a. Carryover of additional credit | 3,000 | |
b. Current 10% credit | 50,000 | 44,000 |
c. Current additional credit | 2,000 | 0 |
5. Unused credits: | ||
a. 10% credit | 0 | 6,000 |
b. Additional credit | 3,000 | 5,000 |
(iv) Redeterminations increasing credit. If a corporation’s allowable additional credit is increased because of a redetermination, the increase is treated as if it were an unused credit carryover for purposes of paragraphs (c)(1)(ii) and (c)(8)(i) of this section. For purposes of this subdivision (iv), the date of the increase is determined under paragraph (e)(9)(iii) of this section as if it were the date of a reduction. Thus, for example, assume that a calendar-year corporation claims an additional credit of $100,000 in 1978 because of a qualified investment in that year. In 1980, the additional credit attributable to 1978 qualified investment is redetermined to be $110,000. With respect to the 1978 qualified investment, 1980 is also an applicable year to the extent of $10,000. The increased credit is reflected on the employer’s return for 1980. The corporation must fund the TRASOP with this $10,000 under paragraph (c)(8) of this section.
(v) Redeterminations increasing tax liability. If a corporation’s tax liability for a year is increased such that an additional credit carried forward and claimed in a later year is allowable in the earlier year, the claim of the additional credit will be considered timely if it was otherwise timely under this section. Thus, for example, assume that a calendar-year corporation makes qualified investment of $5,000,000 in 1978 but, based on its income tax liability, is unable to use any of the credit until 1979, when the entire $50,000 additional credit can be used. The corporation adopts the TRASOP, elects the full $50,000 credit and funds in a timely manner for tax year 1979. However, as a result of a 1981 redetermination of the 1978 tax liability, the corporation is able to use $30,000 of the additional credit in 1978 and the remaining $20,000 in 1979. The allowable credit for 1978 is increased by $30,000 and the increase is treated as an unused credit carryover, for which the year of redetermination, 1981, is the applicable year. Assuming that no other credits are available, the 1979 credit is reduced from $50,000 to $20,000, and this reduction is taken into account in the redetermination year by offsetting the reduction against amounts due the plan or by deducting the amount of the reduction. The adoption of the TRASOP for 1979, rather than 1978, is considered timely.
(10) Deductions at expiration of carryover period. Under paragraph (c)(1)(i) of this section, a corporation that uses no additional credit in the year of a qualifed investment may nonetheless treat the year in which the qualified investment is made as the first applicable year. If the carryover period under section 46(b)(1)(B) expires before the corporation uses the entire additional credit with respect to the qualified investment, contributions attributable to the unused credit are deductible, subject to the limitations of section 404(a), as if made in the taxable year when the carryover period expires. The amount deductible is the dollar amount of the unused credit irrespective of the current value of the securities contributed with respect to the credit.
(d) Formal plan requirements—(1) In general. To be a TRASOP, a plan must meet the formal requirements of this paragraph (d).
(2) Plan year. To be a TRASOP, a plan must specify a plan year that begins with or within the corporation’s taxable year.
(3) Designed to invest primarily in employer securities. To be a TRASOP, a plan must state that it is designed to invest primarily in employer securities. A TRASOP intended to qualify as an ESOP under § 54.4975-11 must state that it is designed to invest primarily in employer securities. See paragraph (e)(10) of this section concerning the requirement that a plan invest in employer securities on an ongoing basis.
(4) Separate accounting. To be a TRASOP, a plan must state that TRASOP securities are to be accounted for separately from any other contributions to the plan.
(5) Debts and expenses of the TRASOP. To be a TRASOP, a plan must state that TRASOP securities cannot be used to satisfy a loan made to the TRASOP or be used as collateral for a loan made to a TRASOP. However, if the plan so provides, to the extent permitted under section 301(d)(13) of the 1975 TRA and paragraphs (e) (6) and (7) of this section, certain amounts may be used for the TRASOP’s start-up expenses and administrative expenses.
(6) Allocation of TRASOP securities—(i) General rules. To be a TRASOP, a plan must provide for the allocation of TRASOP securities under section 301(d)(3) of the 1975 TRA and this subparagraph (6).
(ii) Timing. TRASOP securities are allocated as of the last day of the plan year beginning with or within the appropriate applicable year.
(iii) Participants. Each employee who is a participant at any time during the plan year for which allocation is made must receive an allocation as of the end of that year even though not then employed by the employer. However, to receive allocations, employees must satisfy the minimum participation requirements of the plan (for example, 1,000 hours of service).
(iv) Compensation considered. Under section 301(d)(3) of the 1975 TRA, allocations must be based on the proportion that each participant’s compensation bears to all participants’ compensation. Compensation in excess of $100,000 must be disregarded in making these allocations. A plan may have a lower stated ceiling on compensation (from $0 to $100,000) and if the plan has such a lower ceiling, compensation in excess of this ceiling must likewise be disregarded. Also, allocations must be based on a participant’s compensation while actually employed, not just while actually participating, in the plan year.
(v) Section 415 priority rule; transitional rule. For purposes of section 415, this subdivision (v) applies only to limitation years beginning after November 30, 1982. If a TRASOP security is not allocated to a participant’s account for a plan year because of section 415 and section 301(d)(3) of the 1975 TRA, no other amount may be allocated for that participant under any defined contribution plan of the same employer after the actual allocation date for that TRASOP plan year, until all unallocated TRASOP securities have been allocated as provided in paragraphs (d)(6) (vi) and (vii) of this section. This subdivision (v) applies to a TRASOP when, under section 415(f)(1)(B), the TRASOP is treated along with an employer’s other defined contribution plans as one plan for purposes of section 415.
(vi) Unallocated amounts. Under section 301(d)(3) of the 1975 TRA, TRASOP securities unallocated for a plan year to participants’ accounts because of section 415 must be allocated proportionately to the accounts of other participants until the addition to the account of each participant reaches the limits of section 415.
(vii) Suspense account. If, after these allocations, TRASOP securities remain unallocated, they must be held in an unallocated suspense account under the TRASOP. Any income produced by these securities must also be held in the account. A plan with such an account will not fail to qualify under section 401(a) merely because of the account. In each successive TRASOP plan year (whether or not an applicable year), the unallocated assets are released from this account for allocation on a first-in-first-out basis. They are then allocated to the participants’ accounts proportionately under paragraph (d)(6) (i) through (vi) of this section for each later year until no TRASOP securities remain unallocated. Value for this allocation is determined under paragraph (b)(7) of this section as of the date of transfer from the suspense account or, if the special 20-day average rule applies, the value is determined on the basis of the 20 consecutive trading days immediately preceding the date of transfer from the suspense account.
(viii) Escrow account. A TRASOP may provide for the establishment of an escrow account instead of a suspense account. The escrow account must satisfy paragraph (d)(6)(vii) of this section. The beneficiary of the escrow account is to be the TRASOP. The corporation may establish the escrow account and contribute stock or cash to it. In such a case, the escrow agent must transfer assets to the plan each year equal to the amount to be allocated proportionately under paragraph (d)(6)(i)-(vi) of this section. Assets held in an escrow account are plan assets.
(ix) Treatment of certain plan terminations. To be a TRASOP, a plan must provide that, if a plan terminates because the corporation ceases to exist, unallocated amounts described in paragraph (d)(6)(vi) of this section must be allocated to the extent possible under section 415 for the year of termination. The remaining unallocated amounts must then be withdrawn. These unallocated amounts are treated as recaptured under all the rules of paragraph (e)(9)(vii) of this section except its last sentence. See paragraph (d)(9)(i) of this section concerning distributions of allocated TRASOP securities.
(x) No integration. No TRASOP may be integrated, directly or indirectly, with contributions or benefits under title II of the Social Security Act or any other state or federal law.
(xi) Fractional securities. Participants’ accounts are to be allocated fractional securities or fractional rights to securities.
(xii) Accounting for amounts withheld by employer or paid by plan as start-up or administrative expenses. An employer may withhold certain start-up and administrative expenses from TRASOP securities due the plan. Also, a plan may reduce amounts to be allocated to the extent that certain plan assets are used to reimburse the employer, for example for salaries of employees providing services to the plan, or to pay fees directly to independent contractors for expenses. These expenses do not reduce the amount of additional credit claimed and are not allowable as expenses in computing taxable income. Additional rules concerning these expenses are in paragraphs (e) (6) and (7) of this section.
(7) Nonforfeitability. To be a TRASOP, a plan must state that each participant has a nonforfeitable right to allocated TRASOP securities. For purposes of this section, forfeitures described in section 411(a)(3) are not permitted. However, amounts shall not fail to be considered to be nonforfeitable if the plan provides for their return to the corporation—
(i) In the case of conditional contributions, under section 301(d)(14) of the 1975 TRA and paragraph (c)(8)(v) of this section, and
(ii) In the case of investment credit recapture or an event deemed to be a recapture, under section 301(f) of the 1975 TRA and paragraph (f) of this section.
(8) Voting rights—(i) Provision for passthrough. To be a TRASOP, a plan must state that each participant is entitled to direct a designated fiduciary how to exercise any voting rights on TRASOP securities allocated to the account of the participant. The plan need not permit participants to direct the voting of unallocated TRASOP or other securities held by the trust. It may authorize the designated fiduciary to exercise voting rights for unallocated securities.
(ii) Notification by the employer. To be a TRASOP, the plan must obligate the corporation to furnish the designated fiduciary and participants with notices and information statements when voting rights are to be exercised. The time and manner for furnishing participants with a notice or information statement must comply with both applicable law and the corporation’s charter and bylaws as generally applicable to security holders. In general, the content of the statement must be the same for plan participants as for other security holders.
(iii) Fractional securities. To be a TRASOP, the plan must allow the participants to vote any allocated fractional securities or fractional rights to securities. This requirement is met if the designated fiduciary votes the combined fractional securities or rights to the extent possible to reflect the direction of the voting participants.
(iv) Unexercised voting rights. To be a TRASOP, the plan may not permit the designated fiduciary to exercise voting rights which a participant fails to exercise. However, the plan may permit the solicitation and exercise of participants’ voting rights by management and others under a proxy provision applicable to all security holders.
(9) Distributions—(i) In general. To be a TRASOP, a plan must permit the distribution of allocated TRASOP securities only as provided under section 301(d)(4) of the 1975 TRA. Also, under § 1.401-1(b)(1)(i) of this chapter, to the extent that a TRASOP is a money purchase pension plan, it can only provide for a distribution in the case of separation from service, death, or disability. No TRASOP may provide for the distribution of TRASOP securities upon plan termination within the 84-month holding period. For purposes of section 301(d)(4) of the 1975 TRA, the 84-month holding period begins on the date as of which TRASOP securities are allocated.
(ii) Certain fractional securities. A stock bonus TRASOP may distribute cash instead of fractional securities.
(e) Operational plan requirements—(1) General rule. To be a TRASOP, a plan in operation must meet the requirements of this paragraph (e). However, the provisions under paragraph (e)(8) of this section apply only to TRASOPs qualified under section 401(a).
(2) Compliance with plan provisions. To be a TRASOP, a plan must operate in compliance with its provisions. Failure to operate in compliance with plan provisions constitutes an operational failure to comply. See paragraph (h)(5)(iii) of this section.
(3) Compliance with certain Code provisions. To be a TRASOP, a plan must meet the requirements of section 301(d)(7) of the 1975 TRA. Thus, whether or not it is qualified under section 401(a), a TRASOP must meet the requirements of section 401(a) with respect to allocations, section 410 with respect to participation, and section 415 with respect to limitations on contributions and benefits. However, these requirements are modified by paragraph (d)(6) of this section, relating to allocations and section 415.
(4) Employee contributions. Under a TRASOP, the participants’ receipt of benefits attributable to TRASOP securities contributed for the additional credit (but not the extra additional credit) must not depend on contributions by participants. If a corporation has a plan in existence which requires employee contributions, a portion of the plan may be a TRASOP if employee contributions are not required with respect to that portion of the plan.
(5) Controlled group of corporations, etc. Whether or not a TRASOP is qualified under section 401(a), all employees who by reason of section 414 (b) and (c) are treated as employees of an electing corporation are treated as employed by the corporation in determining whether the plan satisfies the requirements of sections 301(d)(7) (B) and (C) of the 1975 TRA. A member of a controlled group under paragraph (b)(4)(i) of this section with a qualified investment but with no actual employees may obtain an additional credit even though the only participants in the corporation’s TRASOP are actually employed by another member of the controlled group.
(6) Start-up expenses—(i) In general. For purposes of this section, the term “start-up expense” means any ordinary and necessary amount of a nonrecurring nature paid or incurred by the corporation or by the plan in connection with the establishment of a TRASOP under paragraph (c)(7) of this section. Thus, for example, start-up expenses may include expenses relating to: the drafting or amending of plan documents to establish a TRASOP under section 301(d) or (e) of the 1975 TRA, the seeking of agency approval for these documents and related transactions, the obtaining of shareholder approval for establishing a TRASOP, and the registering of securities for initial funding of a TRASOP.
(ii) Treatment of start-up expenses. Start-up expenses may be withheld by the employer from amounts that would otherwise be due the plan under paragraph (c)(8) of this section, to the extent that these amounts are known by the employer when funding first occurs for an applicable year. To the extent that these amounts are not withheld by the employer, the plan may pay remaining amounts from plan assets within a reasonable time after the amounts are known by the plan.
(iii) Ceiling on start-up expenses. Reimbursement for start-up expenses is limited to a ceiling. This ceiling is the sum of 10 percent of the first $100,000 that an employer is first required to transfer under paragraph (c)(8) of this section for an applicable year and 5 percent of that amount in excess of $100,000. If this first year is an unused credit year from which there is a carryover, amounts required to be transferred in subsequent years for claiming carryovers from this first year are considered in determining this ceiling. Thus, for example, assume that a calendar-year corporation first earns an additional credit in 1977 of $9,000 and that $3,000 of this amount is claimed on the income tax return for 1977, for 1978 and for 1979. The corporation’s ceiling on start-up expenses is $300 when its 1977 return is filed. The total ceiling increases to $600 when its 1978 return is filed and to $900 when its 1979 return is filed, with the claiming of an additional $3,000 credit for each of the three years.
(iv) Special rule for taxable years ending before January 1, 1977. Special treatment is available for expenses paid or incurred before January 1, 1977, that were not taken into account in the manner provided by section 301(d)(13) of the 1975 TRA. These expenses may be withdrawn under paragraph (e)(9)(vii) of this section in the same manner as reductions in the corporation’s additional credit caused by a recapture. This withdrawal may only be made during the first taxable year ending after March 20, 1979. It is subject to the ceiling of section 301(d)(13) of the 1975 TRA. Expenses previously deducted by a corporation must be reduced on a timely-filed amended return by the amount of this withdrawal.
(7) Administrative expenses—(i) In general. For purposes of this section, the term “administrative expense” means any amount, other than a start-up expense, paid or incurred by the corporation or by the plan that is ordinary and necessary in maintaining the TRASOP. Thus, for example, administrative expenses may include expenses relating to: compensating plan fiduciaries and administrators, leasing office space and equipment, reproducing and mailing information to participants and beneficiaries, and filing reports, returns, and amendments relating to a TRASOP. Paragraph (e)(6) (ii) and (iv), relating to treatment of start-up expenses and to a special rule for taxable years ending before January 1, 1977, also applies to administrative expenses.
(ii) Ceiling on administrative expenses. Reimbursement for administrative expenses under paragraph (e)(6)(ii) of this section is limited to the smaller of two amounts for each plan year. The first amount is $100,000. The second amount is the sum of 10 percent of the first $100,000 of dividend income paid with respect to TRASOP securities held by the plan during the plan year ending with or within the corporation’s taxable year and 5 percent of any such dividend income in excess of $100,000.
(8) TRASOP qualification under section 401(a)—(i) Permanence. A TRASOP is not required to be a qualified plan under section 401(a). However, to meet the requirements of section 401(a), a TRASOP must be a permanent plan, as described in § 1.401-1(b)(2) of this chapter. Under section 401(a)(21), a plan will not fail to be considered permanent merely because the amount of employer contributions under the plan is determined solely by reference to the amount of additional credit allowable under this section. Thus, for example, it will not fail to be considered permanent merely because employer contributions are not made for a year for which an additional credit is not available by reason of no qualified investment for which an additional credit can be obtained. Section 401(a)(21) applies only to the extent the TRASOP is funded with TRASOP securities and cash in lieu of TRASOP securities.
(ii) Partial discontinuance of contributions. A plan that meets the requirements of section 401(a) may receive contributions of TRASOP securities as well as other contributions. If the other contributions continue on a permanent basis, the plan’s qualification under section 401(a) will not be adversely affected merely because TRASOP securities cease to be contributed to it. The discontinuance of TRASOP contributions does not alter the requirement that past TRASOP contributions remain invested in employer securities. See paragraph (e)(10) of this section.
(iii) Income distribution. Income paid with respect to employer securities acquired by a TRASOP may be distributed at any time after receipt by the plan to participants on whose behalf such securities have been allocated without adversely affecting the qualified status of the plan under section 401(a). (See the last sentence of section 803(h), Tax Reform Act of 1976.) However, under a TRASOP that is a stock bonus or profit-sharing plan, income held by the plan for a 2-year period or longer must be distributed under rules generally applicable to stock bonus and profit-sharing plans qualified under section 401(a). Income distributed by a TRASOP is not subject to the partial exclusion of dividends provided in section 116, whether or not the income is held by the plan for two or more years.
(9) Reductions in investment credit—(i) General rule. Certain reductions in a corporation’s investment credit result from either a recapture under section 47 of the corporation’s investment credit or a redetermination of the allowable credit. If these reductions are taken into account under a TRASOP, the plan may only use one or more of the methods described in paragraphs (e)(9), (v), (vi), and (vii) of this section for taking into account these reductions. Thus, for example, more than one method is permitted upon a recapture with respect to a qualified investment made in a particular year. However, the method described in paragraphs (e)(9)(vii) of this section applies only to a recapture and not to a redetermination.
(ii) Ratable reduction. A reduction is allocated ratably between the 10-percent credit and the additional credit. Thus, for example, if a calendar-year corporation claims a $33,000 investment credit for 1976, including $3,000 additional credit, and $11,000 of the total credit is recaptured in 1978, the $3,000 additional credit is reduced by $1,000. This subdivision (ii) does not apply to a reduction solely of the additional credit as could occur, for example, in the case of a redetermination caused by a mathematical error in computing the additional credit or in the case of a recapture caused by a bad faith failure to comply under paragraph (h) of this section.
(iii) Date of reduction. A reduction in investment credit occurs under this paragraph (e)(9) on the earliest of these dates: (A) The date an income tax return (or an amended return) is filed reflecting the reduction; (B) the date a judicial determination affecting the amount of the reduction becomes final; and (C) the date specified in a closing agreement made under section 7121 that is approved by the Commissioner. For purposes of this subdivision (iii), a judicial determination becomes final at the time prescribed in § 1.547-2(b)(1) (ii) or (iii), relating to personal holding company tax.
(iv) Year for taking reduction into account. A reduction in investment credit must be taken into account in the earliest year or years possible under the applicable method beginning no later than the year in which the date of the reduction falls.
(v) Decrease future contributions. The reduction may be taken into account as a decrease in the value of TRASOP securities to be transferred to the plan. The amount of the decrease is equal to the dollar amount of the reduction.
(vi) Deduct under section 404. On the date of the reduction, the amount of the reduction may be treated as an amount paid to the TRASOP for purposes of, and as a deduction to the extent allowed under, section 404.
(vii) Withdraw TRASOP securities. If an additional credit allowed for a taxable year is recaptured, the corporation may withdraw from the plan TRASOP securities transferred to, or acquired by, the plan for claiming that year’s credit. The withdrawal must only be from assets segregated under paragraph (f)(2) of this section and must be first from assets accounted for in an unallocated suspense account for the particular year. The amount of assets actually withdrawn bears the same proportion to the amount of assets subject to withdrawal as the amount of additional credit recaptured bears to the amount of additional credit claimed. Thus, for example, if the assets subject to withdrawal consist of 300 shares of one class of employer stock and one-third of the additional credit is recaptured, 100 shares of the stock are withdrawn. However, if the current value of the assets subject to withdrawal exceeds the dollar amount of the additional credit claimed, assets may be withdrawn only to the extent that their current value does not exceed the dollar amount of the recaptured portion of the additional credit. Thus, for example, if the 300 segregated shares in the prior example have a current value of $9,000 and the dollar value of the additional credit claimed is $4,500, when one-third of the additional credit is recaptured, only 50 shares, not 100 shares, are withdrawn. Current value is determined under paragraph (b)(7) of this section as of the withdrawal date or, if the special 20-day average rule is applied, it is based on the 20 consecutive trading days immediately preceding the withdrawal date. Withdrawals from an individual’s account for the year with respect to which recapture occurs must bear the same ratio to the total amount withdrawn for that year as the individual’s TRASOP account balance for that year bears to the total TRASOP account balances for that year. In the case of a TRASOP security acquired after March 20, 1979, the corporation may not withdraw it unless the plan meets the requirements of paragraph (d)(7)(ii) of this section when the plan acquires the TRASOP security.
(viii) Prior distribution rule. If a TRASOP distributes an amount allocated with respect to an investment credit for a taxable year and the credit for that year is later recaptured, withdrawals may not reduce participants’ accounts below the level to which they would have been reduced had the prior distribution not occurred. Recaptured amounts above this level may only be deducted under paragraph (e)(9)(vi) of this section. They may not be used to decrease future contributions under paragraph (e)(9)(v).
(ix) Illustration. The operation of paragraph (e)(9)(viii) of this section is illustrated as follows:
(10) Continued investment in employer securities. The requirement that a plan be designed to invest primarily in employer securities is a continuing obligation. Therefore, a transaction changing the status of a corporation as an employer may require the conversion of certain plan assets into other securities. See paragraphs (d)(9) and (g)(6) of this section. In general, cash or other assets derived from the disposition of employer securities must be reinvested in employer securities not later than the 90th day following the date of disposition. However, the Commissioner may grant an extension of the period for reinvestment in employer securities depending on the facts and circumstances of each case.
(f) Section 301(f) withdrawals—(1) In general. No assets may be withdrawn by a corporation under section 301(f) of the 1975 TRA unless the assets are either TRASOP securities or plan assets into which TRASOP securities have been converted (“withdrawal assets”). See paragraph (e)(10) concerning restrictions on investment of TRASOP assets in assets other than employer securities. Withdrawal assets must meet the segregated accounting requirements of this paragraph. The physical segregation of assets is not required.
(2) Segregated accounting. The segregated accounting requirements are that—
(i) Withdrawal assets must be segregated from other plan assets on a taxable-year-by-taxable-year basis; and
(ii) Separate accounts must be maintained on a taxable-year-by-taxable-year basis for each participant on whose behalf withdrawal assets are allocated.
(3) Aggregate plan year accounting. Withdrawal assets for taxable years beginning before October 4, 1976, also meet the segregated accounting requirements if they are aggregated and accounted for in one separate account apart from withdrawal assets in separate accounts for later taxable years.
(g) Requirements for employer securities—(1) General rules. The term “employer security” does not include stock rights, warrants and options. An employer security that is not common stock must at all times be immediately convertible into common stock that is an employer security at a conversion price which is no greater than the fair market value of that common stock at the time the plan acquires the security.
(2) Common stock—(i) In general. To be an employer security, common stock must meet certain voting power and dividend right requirements. For purposes of this paragraph (g), stock held by the TRASOP is not treated as outstanding.
(ii) Dividend right limitations. If dividend rights are subject to a limitation, then stock representing at least 50 percent of the fair market value of the employer’s outstanding common stock at the time the common stock is transferred to or purchased by the TRASOP must be subject to the same limitation. However, common stock that satisfies paragraph (g)(3)(ii) of this section is not subject to this subdivision (ii).
(3) Voting power and dividend rights. To be an employer security, common stock must have voting power and dividend rights which, when taken together, are “no less favorable” than the voting power and dividend rights of any other common stock issued by the employer. Common stock which meets one of the following tests is “no less favorable”.
(i) Ten-percent shareholder test. The stock is part of, or identical to, a class of outstanding stock of which at least 50 percent is not owned by 10-percent shareholders. For this purpose, a 10-percent shareholder is one who owns at least 10 percent of the outstanding shares in a class, including shares constructively owned under section 318.
(ii) Substantial proportionality test. More than one class of common stock is outstanding and an identical percentage of shares from each class is transferred to the TRASOP.
(iii) Voting power test. The stock is part of, or identical to, the existing class of stock having the greatest number of votes per unit of fair market value. For example, assume there are only two classes of common stock, Class A and Class B. Their fair market values per share are $1 and $.50, respectively, and the owner of each share of each class is entitled to one vote per share. Thus, Class B has two votes per $1 and Class A has one vote per $1. Accordingly, the Class B stock has the greatest number of votes per unit of fair market value.
(4) Right of first refusal. TRASOP securities may, but need not, be subject to a right of first refusal. However, whether or not the plan is an ESOP, any such right must meet the requirements of § 54.4975-7(b)(9) of this chapter.
(5) Put option. A TRASOP security that is transferred to a TRASOP after September 30, 1976, must be subject to a put option if it is not publicly traded when distributed or if it is subject to a trading limitation when distributed. The provisions of § 54.4975-7(b)(10)-(12) and § 54.4975-11(a)(3) of this chapter apply to such securities whether or not the plan is an ESOP.
(6) Change of employer security status. In general, a transaction changing the status of a corporation as an employer, or as a member of a controlled group of corporations including the employer, adversely affects the status as employer securities of common stock and securities held by a plan (“old employer securities”). However, to the extent that the transaction causing the change in status of the old employer securities does not result in a recapture under section 47 of any investment credit underlying the transfer to, or acquisition by, the plan of the old employer securities, common stock and securities (“new employer securities”) substituted for old employer securities are treated as if they were the old employer securities if—
(i) The plan is not terminated,
(ii) The old employer securities and the new employer securities are of equal value at the time of the transaction changing the status of the old employer securities, and
(iii) The new employer securities otherwise meet the requirements of this section.
(h) Failure to comply—(1) General rule—(i) Effect of failure. If a corporation elects under paragraphs (c)(2) through (5) of this section to obtain an additional credit and fails to comply with respect to that credit at any time, it is liable to the United States for a civil penalty equal to the amount involved in the failure to comply. If the corporation fails to comply with respect to an additional credit during the 84-month period described in section 301(d)(4) of the 1975 TRA, the credit is also recaptured. A separate failure to comply occurs for each taxable year in which a failure continues to exist.
(ii) Illustration of continuing failure’s effect. Assume that in 1975 an additional credit is allowed and a failure to comply occurs in 1975 with respect to that credit. Assume also that in 1976 the 1975 failure continues uncorrected, another additional credit is allowed, and a failure to comply occurs with respect to the 1976 credit. Under these circumstances, on the last day of 1976 three separate failures to comply exist: (A) The 1975 failure with respect to the 1975 credit, (B) the 1976 failure with respect to the 1975 credit, and (C) the 1976 failure with respect to the 1976 credit.
(2) Assessment and collection. The civil penalty must be assessed and collected in the same manner in which a deficiency in the payment of federal income tax is assessed and collected.
(3) Exception. If a failure to comply is corrected within the correction period described in paragraph (h)(5) of this section—
(i) The corporation is not liable for a civil penalty; and
(ii) If the corporation establishes that at the time of the failure a good faith effort to comply was made, its additional credit is not disallowed.
(4) Failure to comply (penalty classifications)—(i) In general. An electing corporation fails to comply if a defect described in paragraphs (h)(4) (ii) through (iv) of this section occurs with respect to an additional credit allowed for a particular taxable year. The characterization of the defect in this subparagraph (4) determines the amount involved under paragraph (h)(8) of this section for the purpose of assessing the civil penalty.
(ii) Funding defect. A funding defect occurs if a corporation or its TRASOP fails to satisfy the requirements of paragraph (c) (8) or (9) of this section, relating to funding a TRASOP and claiming an additional credit.
(iii) Special operational defect. A special operational defect occurs if a TRASOP fails in operation to satisfy the requirements described in paragraphs (d) (5) through (9) of this section, relating to debts and expenses of a TRASOP, allocation of TRASOP securities, nonforfeitability, voting rights, and distributions, or paragraph (e)(3) of this section, relating to compliance with certain Code provisions.
(iv) De minimis defect. A de minimis defect occurs if a corporation or its TRASOP fails to satisfy any requirement of this section other than those enumerated either in paragraph (h)(4) (ii) and (iii) of this section or in paragraphs (a)(2) and (c) (2) through (5) of this section. A failure to comply under this subdivision (iv) may be formal or operational in nature.
(5) Failure to comply (correction rules classifications)—(i) In general. If for an electing corporation a defect described in paragraph (h)(4) of this section occurs, the procedure for correcting the failure to comply depends upon whether the failure is classified as a “formal” failure or an “operational” failure under this subparagraph (5).
(ii) Formal failure to comply. Formal failures are corrected by retroactive amendment. If a formal plan requirement is not met, the plan must be retroactively amended by no later than the expiration of the correction period under paragraph (h)(6) of this section. A plan fails to meet a formal plan requirement of paragraph (d) of this section if, for example, it does not state, as required by paragraph (d)(3) of this section, that it is designed to invest primarily in employer securities.
(iii) Operational failure to comply. Operational failures are corrected by undoing the defective transaction and by making the plan and the participants whole. If the value of TRASOP securities transferred to the TRASOP is less than the amount of the additional credit, the corporation must make up any resulting funding deficiency within the correction period. This is done, for example, by contributing additional TRASOP securities plus an amount equal to the dividends or interest that would have been paid between the time that the TRASOP securities should have been transferred and the actual time for the transfer. The contribution of additional TRASOP securities is based on their value under paragraph (b)(7) of this section as of the date by which they were required to be transferred to the plan. An electing corporation fails to meet an obligation undertaken under this section if, for example, it fails to comply with paragraph (c)(8) of this section.
(6) Correction period—(i) In general. For purposes of this paragraph (h), the “correction period” begins when the failure to comply occurs and ends 90 days after receipt by the corporation of a notice of deficiency under section 6212 with respect to the civil penalty and the investment credit.
(ii) Extensions of correction period. Extensions of the correction period are determined under § 53.4941(e)-1(d)(2) (i), (ii), and (iv) of this chapter (Foundation Excise Tax Regulations). For this purpose, a failure to comply is treated as an act of self-dealing, the corporation is treated as a foundation, and a civil penalty is treated as a tax under section 4941(a)(1).
(7) Good faith. The corporation has the burden of establishing under paragraph (h)(3)(ii) of this section that it made a good faith effort to comply. For example, if a corporation shows that it has made a good faith effort to establish the fair market value of the employer securities transferred to the TRASOP, it may be entitled to the additional credit even if, on later examination of the return, it is determined that more securities should have been transferred. For purposes of this paragraph (h)(7), reasonable reliance on Technical Information Release 1413 (1975-50 I.R.B. 16), questions and answers relating to ESOP’s, is a good faith effort to comply.
(8) Amount involved—(i) In general. The amount involved in a failure to comply is an amount described in this subparagraph (8). A maximum amount and a minimum amount are determined with respect to an additional credit allowed for a particular taxable year.
(ii) Maximum amount involved. Notwithstanding any other rule in this paragraph (h), all amounts involved with respect to an additional credit allowed for a particular taxable year may not exceed the amount of that credit.
(iii) Minimum amount involved. The minimum amount is
(iv) Funding amount involved. The amount involved for a funding defect is the greater of the minimum amount involved or the amount required to place the plan in the position it would have been in if no funding defect had occurred.
(v) Special operational amount involved. The amount involved for a special operational defect is the maximum amount involved.
(vi) De minimis amount involved. The amount involved for a de minimis defect is the minimum amount involved.
(9) Certain permissible actions—(i) Elections prior to January 19, 1979. A corporation does not fail to comply (within the meaning of this paragraph (h)) merely because it revokes an election made prior to January 19, 1979, under the general rule described in paragraph (c)(1)(i) of this section and with respect to which no additional credit was claimed in the taxable year for which the election was made. Such a revocation is permitted irrespective of whether the carryover option described in paragraph (c)(1)(ii) is elected with respect to qualified investment made in a year for which a general rule election is revoked.
(ii) Pro rata use of credit. A corporation does not fail to comply merely because, for an applicable year ending prior to January 19, 1979, it provides for pro rata use of the regular 10-percent credit and the 1-percent additional credit to the extent that less than all of a taxpayer’s credit earned for a taxable year is allowable.
(iii) Transitional rule. The Commissioner, based on the particular facts and circumstances of individual cases, may determine that a good faith failure to comply before January 19, 1979, with a final or temporary rule adopted under this section on or after that date does not require retroactive correction under paragraph (h)(5)(ii) of this section.
§ 1.46-9 Requirements for taxpayers electing an extra one-half percent additional investment credit.
(a) Introduction—(1) In general. A corporation that qualifies for an additional credit under § 1.46-8 may elect under section 46(a)(2)(B)(ii) of the Code to obtain an extra one-half percent additional investment credit for property described in section 46(a)(2)(D). Paragraph (c) of this section provides additional procedures for electing this extra credit. This section also provides rules for implementing an employee stock ownership plan that meets the requirements of sections 301 (d) and (e) of the Tax Reduction Act of 1975 (“1975 TRA”). The plan must meet the additional formal requirements of paragraph (d), and the additional operational requirements of paragraph (e) of this section. Unless otherwise indicated, statutory references in this section are to the Internal Revenue Code of 1954, as applicable for the year in which a qualified investment is made.
(2) Applicability of one-percent TRASOP provisions. Subject to the exceptions and additional rules of this section, the provisions of § 1.46-8 apply to an election made, and to a plan implemented, under this section. However, this section does not change the requirements of § 1.46-8 for purposes of obtaining an additional one-percent credit.
(3) Effective date. This section applies only to taxable years beginning after December 31, 1976. See section 803(j)(2)(A) of the Tax Reform Act of 1976.
(b) Definitions—(1) One-percent terms. When used in this section, the terms listed below have the same meanings as in § 1.46-8(b):
(i) TRASOP. See § 1.46-8(b)(1).
(ii) Employer. See § 1.46-8(b)(3).
(iii) Employer securities. See § 1.46-8(b)(4).
(iv) TRASOP securities. See § 1.46-8(b)(5).
(v) Publicly traded. See § 1.46-8(b)(6).
(vi) Value. See § 1.46-8(b)(7).
(vii) Compensation. See § 1.46-8(b)(8).
(2) Additional credit. An “additional credit” or “extra additional credit” is the extra one-half percent additional investment credit under section 46(a)(2)(B)(ii)—
(i) For purposes of applying this section, and
(ii) When the context requires, for purposes of applying § 1.46-8 to this extra credit.
(3) Matching employee contribution. A “matching employee contribution” is a contribution that meets the requirements of paragraph (f) of this section.
(4) Basic amount. A “basic amount” is a matching employee contribution which is equal to the maximum credit multiplied by a fraction. The numerator of this fraction is a participant’s compensation for the plan year. (See § 1.46-9(f)(3)(ii), concerning disregarded compensation.) The denominator is the aggregate of all participants’ compensation for the plan year. The “maximum credit” is the estimated value of all employer contributions under paragraph (c)(4)(i) of this section for the applicable year, determined as if the maximum possible matching employee contributions were made.
(5) Supplemental contribution. A “supplemental contribution” is a matching employee contribution made in addition to a basic amount.
(c) Special procedures for extra additional credit—(1) Statement of election. A corporation’s statement of election described in § 1.46-8(c)(3) must contain the name and taxpayer identification number of the corporation. Also, it must declare in the following words, or in words having substantially the same meaning, that:
(i) The corporation elects to have section 46(a)(2)(B) (i) and (ii) of the Internal Revenue Code of 1954 apply; and
(ii) The corporation agrees to implement (or continue to implement, as appropriate) a TRASOP and to claim the additional credit as required by § 1.46-8 and § 1.46-9 of the Income Tax Regulations.
(2) Separate election. A separate election must be made for each year’s qualified investment to obtain the extra additional credit for the qualified investment. If a corporation does not make a timely election to obtain an extra additional credit for a taxable year, it may not subsequently make the election on an amended return or otherwise.
(3) No partial election. To reduce administrative costs, a plan may establish a ceiling on matching employee contributions. Thus, for example, it may provide for the contribution of only a basic amount without supplemental contributions under paragraph (f)(2)(iv) of this section. Such a ceiling that in effect limits the additional credit to less than one-half percent of the qualified investment is not a partial election prohibited by § 1.46-8(c)(5).
(4) Funding a TRASOP—(i) Employer contributions. The carryover option under § 1.46-8(c)(1)(ii) is available for both the one-percent and one-half percent additional credits or for the one-half percent additional credit alone. In applying § 1.46-8(c)(8)(iii), the value of TRASOP securities, other than those acquired with matching employee contributions, for an applicable year must equal one-half percent of the corporation’s qualified investment for that year or, if less, the amount of matching employee contributions received (including pledges, where permitted by the plan) by the time the election for that year is made. However, if a corporation exercises the carryover option in § 1.46-8(c)(1)(ii), the value of these TRASOP securities for an applicable year must equal the amount of additional credit claimed for that year determined after being reduced, if necessary, to equal contributions received (including pledges, if permitted) by the time the credit is claimed for that year. The value of these TRASOP securities, but not the amount of credit claimed, is further reduced to the extent that the employer withholds TRASOP securities to take into account start-up and administrative expenses under paragraph (e)(1) of this section or an investment tax credit reduction under paragraph (e)(2) of this section.
(ii) Employee contributions. Paragraph (f)(4) of this section, but not § 1.46-8(c)(8) (i) through (iii), applies to TRASOP securities acquired with matching employee contributions.
(5) Claiming additional credit. In applying § 1.46-8(c)(9)(ii), if less than all of a corporation’s credit earned for a taxable year is allowed, the extra additional credit under this section for that year is allowed last.
(d) Additional formal plan requirements—(1) Contributions by employees—(i) In general. The plan must contain statements relating to matching employee contributions as required under paragraph (f) of this section.
(ii) Aggregate floor. A plan may provide for the return of all matching employee contributions for a year if the aggregate amount of such contributions is not at least equal to an amount stated in the plan. See also § 1.46-9(f)(3)(iv).
(2) Separate accounting. The plan must state that employer contributions and matching employee contributions respectively described in paragraph (c)(4)(i) and (ii) of this section are accounted for separately from each other as well as from other contributions, including those described in § 1.46-8(c)(8).
(3) Allocation of TRASOP securities contributed by employer. The plan must provide for the allocation under section 301(e)(5) of the 1975 TRA and this subparagraph (3) of TRASOP securities contributed by the employer. These allocations reflect a ratable reduction for TRASOP securities withheld by the employer under paragraph (c)(4)(i) of this section. TRASOP securities so allocated are deemed to be allocated under section 301(d) of the 1975 TRA. In applying § 1.46-8(d)(6) to this section, only subdivisions (ii), (iv), (ix), (x), (xi) and (xii) thereof apply to allocations under this section.
(4) Effect of section 415. In applying the limitations of section 415 to limitation years beginning after January 19, 1979, allocations of TRASOP securities are considered in the following order: first, allocations under § 1.46-8; second, allocations under this section. See § 1.46-8(d)(6)(v) concerning the allocation of amounts under any other defined contribution plan. No suspense or escrow account may be maintained to hold contributions under this section that are unallocated because of section 415. Thus, section 415 in effect limits the availability of an extra additional credit in a particular year. However, if the plan so provides, a potential extra additional credit is treated as an investment credit carryover under the carryover option described in § 1.46-8(c)(1)(ii) to the extent that it is not used in a particular year because of section 415.
(5) Nonforfeitability. Employer contributions are also not considered to be forfeitable under § 1.46-8(d)(7) merely because the plan provides for their return to the corporation in an amount equal to the excess of employer contributions under this section over matching employee contributions or in the case of discriminatory operation under paragraph (f)(3) of this section. See paragraph (f)(3)(iv).
(6) Distributions. Notwithstanding § 1.46-8(d)(9)(i), a plan may not distribute from a participant’s employer contribution account cash or employer securities attributable to unpaid pledges of the participant.
(e) Additional operational plan requirements—(1) Start-up and administrative expenses—(i) In general. The expense of establishing plan features relating to the extra additional credit is a start-up expense. The expense of collecting matching employee contributions is an administrative expense.
(ii) Payment. Under § 1.46-8(e) (6) and (7), an employee may withhold or a plan may use, to the extent not withheld, TRASOP securities for start-up and administrative expense payments. However, withdrawals must be either limited to employer contributions under § 1.46-8(c)(8) or reasonably apportioned between these employer contributions and contributions under paragraph (c)(4)(i) of this section. An example of reasonable apportionment is earmarking expenses attributable to each of the additional credits and allocating any remaining non-earmarked expenses on either a 2:1 or 1:1 ratio between the additional credits. Another example is simply apportioning expenses between the additional credits on a 2:1 or 1:1 ratio basis without earmarking. However, if one-percent and one-half percent start-up expenses are attributable to different qualified investments, withdrawals for one-half percent expenses are limited to employer contributions under paragraph (c)(4)(i) of this section.
(iii) Ceiling. In determining the ceiling on start-up expenses under § 1.46-8(e)(6)(iii), only employer contributions under § 1.46-8(c)(8) and paragraph (c)(4)(i) of this section are considered. In determining the ceiling on administrative expenses under § 1.46-8(e)(7)(ii), dividends on all TRASOP securities, including those acquired with matching employee contributions, are considered.
(2) Redeterminations and recaptures. A reduction in investment credit because of a redetermination or recapture is allocated ratably under the principles of § 1.46-8(e)(9)(ii) among the 10-percent credit, the one-percent credit, and the one-half percent credit for a particular year. However, as illustrated in § 1.46-8(e)(9)(ii), this subparagraph (3) does not apply to a redetermination solely of one or both of the additional credits.
(3) Withdrawal asset segregation. The segregated accounting provisions of § 1.46-8(f) apply independently to withdrawal assets attributable to TRASOP securities under § 1.46-8 and to TRASOP securities under this section.
(f) Matching employee contributions—(1) Designation by employee. The plan must state that each employee on whose behalf an allocation is made under § 1.46-8(d)(6) for an applicable year is eligible to designate and contribute an amount to the TRASOP for that year as a matching employee contribution.
(2) Form and timing of contribution—(i) Cash. A participant may contribute in a manner provide under the plan a designated amount in cash directly to the plan or indirectly by the employer’s withholding from amounts otherwise due the participant. The full amount, or pledge in lieu of an amount, for an applicable year must be contributed by the applicable last day described in § 1.46-8(c)(8)(i).
(ii) Optional pledges in lieu of cash. The plan need not permit a pledge. However, when permitted by the plan, an irrevocable written pledge made in good faith by a participant is treated as a matching employee contribution of cash, whether or not the pledge is in fact contractually binding. The pledge must be to contribute, by no later than a time specified in the TRASOP, a designated amount in cash directly to the plan or indirectly by authorizing the employer to withhold from compensation otherwise due a participant. The specified time may not be later than 24 months after the close of the applicable year for which the amount is treated as a matching employee contribution.
(iii) Transitional rule. A plan may provide for the receipt of employee pledges at any time before the later of the applicable last day or January 15, 1980. If the last day for receipt of pledges for an applicable year is January 15, 1980, the one-half percent TRASOP credit for the applicable year may be elected on an amended return filed not later than that date, and employer contributions for the applicable year must be made by that date. A plan may provide that pledges which otherwise would have been payable on or before December 31, 1979 may be paid on or before January 15, 1980.
(iv) Basic and supplemental contributions. A plan formula may limit a matching employee contribution to a basic amount. It may also permit matching employee contributions of supplemental amounts to the extent that total basic amount contributions do not equal the amount of the additional credit claimed under this section. Employees may make supplemental contributions covering unpaid pledges only after the employer has disclosed the value of securities and income attributable to the unpaid pledge.
(3) Prohibited discrimination—(i) General rule. Matching employee contributions must be based on a formula stated in the plan that does not result in prohibited discrimination under section 401(a)(4) either in form or in operation. Thus, for example, a flat dollar amount required as a matching employee contribution to qualify for employer-provided benefits under this section may not be too high for lower paid employees to contribute under the plan. Further, lower paid employees must participate to such an extent that allocations under this section do not result in prohibited discrimination
(ii) Compensation disregarded. Compensation disregarded in allocations under § 1.46-8(d)(6)(iv) is disregarded under this paragraph and for purposes of determining basic amounts as defined in paragraph (b)(4) of this section.
(iii) Former employees. A TRASOP must give all participants a reasonable opportunity to make matching employee contributions. However, neither a former employee who is a participant at the end of the plan year by reason of § 1.46-8(d)(6)(iii), nor the estate of a deceased employee, need have the same options as are available to other participants. Thus, for example, a former employee may be limited to cash contributions even though other participants are permitted to make pledges. Also, if former employees of estates of deceased employees fail to make matching employee contributions, they are not considered in determining whether or not a TRASOP is discriminatory.
(iv) Return of contributions. A plan may provide for the return of employee and employer contributions for a year to the extent that plan operation would otherwise result in prohibited discrimination.
(4) Investment in employer securities—(i) General rule. Matching employee contributions must be invested in TRASOP securities no later than 30 days after the time for funding a TRASOP under § 1.46-8(c)(8)(ii) or, if later, the time specified under the special rule for pledges.
(ii) Special rule for pledges. Cash contributed to pay a pledge permitted by paragraph (f)(2)(ii) of this section must be invested in employer securities so that the cash is not held more than 3 months. The 3-month period includes the period, if any, that the cash is held by the employer.
(5) Reduction of matching employee contribution—(i) In general. Matching employee contributions must be reduced in three cases. First, they are reduced to the extent that there are no corresponding employer contributions described in paragraph (c)(4)(i) of this section. This occurs, for example, when the aggregate of the basic amounts of matching employee contributions exceeds the allowable credit. Second, they are reduced to the extent that corresponding employer contributions matching them under paragraph (c)(4)(i) of this section are withdrawn under section 301(f) of the 1975 TRA. Third, they are reduced by the amount of any pledge unpaid at the time specified in paragraph (f)(2)(ii) of this section.
(ii) Apportioning reductions. Generally, the account of each contributor under this section for an applicable year is reduced by a percentage of the account. This percentage equals the total reduction of all matching employee contributions for that year divided by the total, before the reduction, of all matching employee contributions. However, if a reduction is directly attributable to a particular contributor, only that contributor’s account is reduced. A reduction is directly attributable to a particular contributor when, for example, the limits of section 415 prohibit a full allocation of employer contributions equal to the contributor’s matching employee contribution for an applicable year or when a contributor fails to pay a pledge. A reduction may not yield a negative balance in a participant’s account.
(iii) Disposing of reductions. If a participant’s matching employee contribution is reduced, the amount of the reduction must either be treated as a voluntary contribution or returned to the participant by the later of two dates. The first date is 30 days after the time for investing in TRASOP securities under paragraph (f)(4) of this section. The second date is the 30th day after the date on which the withdrawal of employer contributions occurs that causes the reduction. It may be treated as a voluntary contribution only if, as stated in the plan, the participant so indicates in writing when making the matching employee contribution.
(iv) Supplemental contributions covering unpaid pledges. Notwithstanding the timing requirements of paragraph (f)(2) of this section, supplemental contributions covering unpaid pledges must be made no later than 60 days after accounting for the corresponding reduction under paragraph (f)(5)(ii) of this section.
(v) Effect of reduction on credit. For the purpose of applying section 415 to an additional allocation to the account of a participant attributable to a supplemental contribution covering an unpaid pledge, the contribution is treated as an annual addition to the supplemental contributor’s account in the applicable year for which the reduction occurred. An amount in excess of the contribution may be allocated in equal amounts for each year from the applicable year to the year of the reduction. The employer’s credit is reduced only to the extent that a proportionate transfer of assets is not made from the account of the participant to whom the reduction is attributable to the accounts of supplemental contributors.
(vi) Example. The rules contained in paragraphs (f) (2) and (5) of this section are illustrated by the following example:
(g) Failure to comply—(1) General rule. If a corporation elects under § 1.46-8(c) (2) through (5) and paragraph (c)(1) of this section to obtain an additional credit, § 1.46-8(h) (1), (2), (3), (5), (6), and (7) as modified by this paragraph (g) apply.
(2) Failure to comply (penalty classifications)—(i) In general. A corporation fails to comply with an extra additional credit election if a defect described in paragraph (g)(2) (ii)-(iv) of this section occurs in a taxable year.
(ii) Funding defect. A funding defect occurs under this section if a corporation or its TRASOP fails to satisfy the requirements of § 1.46-8(c) (8) or (9) or paragraph (c)(4) of this section, as they apply directly to the extra additional credit.
(iii) Special operational defect. A special operational defect occurs if a TRASOP fails in operation to satisfy the requirements decribed in § 1.46-8(d) (5) through (9) (except (6) (i), (iii), and (v) through (viii)) or (e)(3), or paragraphs (d) (5), (6), and (e)(3) of this section, as they apply directly to the extra additional credit.
(iv) De minimis defect. A de minimis defect occurs if a corporation or its TRASOP fails to satisfy the requirements, other than those enumerated in paragraphs (c) (1) and (2) and (g)(2) (ii) and (iii), of this section or of § 1.46-8 other than those excluded under § 1.46-8(h)(4)(iv).
(3) Amount involved. The amount involved in a failure to comply under this section is based upon the extra additional credit within the meaning of section 46(a)(2)(B)(ii).
(4) Coordination of civil penalties. The civil penalties under § 1.46-8 and this section are determined separately. In no case may the amount involved with respect to a particular failure to comply in one year exceed under both sections the full additional credit within the meaning of section 46(a)(2)(B) (i) and (ii).
§ 1.46-10 [Reserved]
§ 1.47-1 Recomputation of credit allowed by section 38.
(a) General rule—(1) In general. (i) If during the taxable year any section 38 property the basis (or cost) of which was taken into account, under paragraph (a) of § 1.46-3, in computing the taxpayer’s qualified investment is disposed of, or otherwise ceases to be section 38 property or becomes public utility property (as defined in paragraph (g) of § 1.46-3) or is a qualifying commuter highway vehicle (as defined in paragraph (a) of § 1.46-11) which undergoes a change in use (as defined in paragraph (m)(2) of this section) with respect to the taxpayer, before the close of the estimated useful life (as determined under subparagraph (2)(i) of this paragraph) which was taken into account in computing such qualified investment, then the credit earned for the credit year (as defined in subdivision (ii)(a) of this subparagraph) shall be recomputed under the principles of paragraph (a) of § 1.46-1 and paragraph (a) of § 1.46-3 substituting, in lieu of the estimated useful life of the property that was taken into account originally in computing qualified investment, the actual useful life of the property as determined under subparagraph (2)(ii) of this paragraph. There shall also be recomputed under the principles of §§ 1.46-1 and 1.46-2 the credit allowed for the credit year and for any other taxable year affected by reason of the reduction in credit earned for the credit year, giving effect to such reduction in the computation of carryovers or carrybacks of unused credit. If the recomputation described in the preceding sentence results in the aggregate in a decrease (taking into account any recomputations under this paragraph in respect of prior recapture years, as defined in subdivision (ii)(b) of this subparagraph) in the credits allowed for the credit year and for any other taxable year affected by the reduction in credit earned for the credit year, then the income tax for the recapture year shall be increased by the amount of such decrease in credits allowed. For treatment of such increase in tax, see paragraph (b) of this section. For rules relating to “disposition” and “cessation”, see § 1.47-2. For rules relating to certain exceptions to the application of this section, see § 1.47-3. For special rules in the case of an electing small business corporation (as defined in section 1371(b)), an estate or trust, or a partnership, see respectively, §§ 1.47-4, 1.47-5, or 1.47-6. For rules applicable to energy property, see paragraph (h) of this section. For special rules relating to recomputation of credit allowed by section 38 if progress expenditure property (as defined in § 1.46-5(d)) ceases to be progress expenditure property with respect to the taxpayer, see paragraph (g) of this section.
(ii) For purposes of this section and §§ 1.47-2 through 1.47-6—
(a) The term “credit year” means the taxable year in which section 38 property was taken into account in computing a taxpayer’s qualified investment.
(b) The term “recapture year” means the taxable year in which section 38 property the basis (or cost) of which was taken into account in computing a taxpayer’s qualified investment is disposed of, or otherwise ceases to be section 38 property or becomes public utility property with respect to the taxpayer, before the close of the estimated useful life which was taken into account in computing such qualified investment.
(c) The term “recapture determination” means a recomputation made under this paragraph.
(2) Rules for applying subparagraph (1). For purposes of subparagraph (1) of this paragraph—
(i) In determining whether section 38 property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the estimated useful life which was taken into account in computing the taxpayer’s qualified investment, the term “estimated useful life” means the shortest life of the useful life category within which falls the estimated useful life which was assigned to such property under paragraph (e) of § 1.46-3. Thus, section 38 property which is assigned, under paragraph (e) of § 1.46-3, an estimated useful life of 6 years shall not be treated, for purposes of subparagraph (1) of this paragraph, as having been disposed of before the close of its estimated useful life if such property is sold 5 years (that is, the shortest life of the 5 years or more but less than 7 years useful life category) after the date on which it was placed in service. Likewise, section 38 property with an estimated useful life of 15 years which is placed in service on January 1, 1972, shall not be treated as having been disposed of before the close of its estimated useful life if such property is sold at any time after January 1, 1979 (that is, 7 years or more after the date on which it was placed in service).
(ii) In determining the recomputed qualified investment with respect to property which is disposed of or otherwise ceases to be section 38 property the term “actual useful life” means, except as otherwise provided in this section and §§ 1.47-2 through 1.47-6, the period beginning with the date on which the property was placed in service by the taxpayer and ending with the date of such disposition or cessation. See paragraph (c) of this section.
(iii) In determining the recomputed qualified investment with respect to property which ceases to be section 38 property with respect to the taxpayer after August 15, 1971, or which becomes public utility property after such date, such property shall be treated as if it were property described in section 50 at the time it was placed in service (whether or not it was property described in section 50 at such time). Thus, if property was placed in service on October 15, 1968, and was assigned an estimated useful life of 4 years, there would be no increase in tax under section 47 if the property were disposed of at any time after October 14, 1971, that is, 3 years or more after the property was placed in service.
(b) Increase in income tax and reduction of investment credit carryover—(1) Increase in tax. Except as provided in subparagraph (2) of this paragraph, any increase in income tax under this section shall be treated as income tax imposed on the taxpayer by chapter 1 of the Code for the recapture year notwithstanding that without regard to such increase the taxpayer has no income tax liability, has a net operating loss for such taxable year, or no income tax return was otherwise required for such taxable year.
(2) Special rule. Any increase in income tax under this section shall not be treated as income tax imposed on the taxpayer by chapter 1 of the Code for purposes of determining the amount of the credits allowable to such taxpayer under—
(i) Section 33 (relating to taxes of foreign countries and possessions of United States),
(ii) Section 34 (relating to dividends received by individuals before January 1, 1965),
(iii) Section 35 (relating to partially tax-exempt interest received by individuals),
(iv) Section 37 (relating to retirement income), and
(v) Section 38 (relating to investment in certain depreciable property).
(3) Reduction in credit allowed as a result of a net operating loss carryback. (i) If a net operating loss carryback from the recapture year or from any taxable year subsequent to the recapture year reduces the amount allowed as a credit under section 38 for any taxable year up to and including the recapture year, then there shall be a new recapture determination under paragraph (a) of this section for each recapture year affected, taking into account the reduced amount of credit allowed after application of the net operating loss carryback.
(ii) Subdivision (i) of this subparagraph may be illustrated by the following examples:
(b) For the taxable year 1965, X Corporation has a net operating loss which is carried back to the taxable year 1962 and reduces its liability for tax, as defined in paragraph (c) of § 1.46-1, for such taxable year to $200. As a result of such net operating loss carryback, X Corporation’s credit allowed under section 38 for the taxable year 1962 is limited to $200 and the excess of $500 ($700 credit earned minus $200 limitation based on amount of tax) is an investment credit carryover to the taxable year 1963.
(c) For 1965, there is a recapture determination under subdivision (i) of this subparagraph for the 1963 recapture year. The $700 increase in the income tax imposed on X Corporation for the taxable year 1963 is redetermined to be $200 (that is, the $200 credit allowed after taking into account the 1965 net operating loss minus zero credit which would have been allowed taking into account the 1963 recapture determination). In addition, X Corporation’s $500 investment credit carryover to the taxable year 1963 is reduced by $500 ($700 minus $200) to zero and X Corporation is entitled to a $500 refund of the tax paid as a result of the 1963 determination.
(b) As a result of such net operating loss carryback, X Corporation’s credit allowed under section 38 for the taxable year 1962 is limited to $100 and the excess of $600 ($700 credit earned minus $100 limitation based on amount of tax) is an investment credit carryover to the taxable year 1963.
(c) Since the actual useful life of the item of section 38 property sold to Y Corporation was only 3 years, there is a recapture determination under paragraph (a) of this section. X Corporation’s $600 investment credit carryover to 1963 is reduced by $600 to zero. The income tax imposed by chapter 1 of the Code on X Corporation for the taxable year 1965 is increased by the $100 reduction in credit allowed by section 38 for 1962.
(4) Statement of recomputation. The taxpayer shall attach to his income tax return for the recapture year a separate statement showing in detail the computation of the increase in income tax imposed on such taxpayer by chapter 1 of the Code and the reduction in any investment credit carryovers.
(c) Date placed in service and date of disposition or cessation—(1) General rule. For purposes of this section and §§ 1.47-2 through 1.47-6, in determining the actual useful life of section 38 property—
(i) Such property shall be treated as placed in service on the first day of the month in which such property is placed in service. The month in which property is placed in service shall be determined under the principles of paragraph (d) of § 1.46-3.
(ii) If during the taxable year such property ceases to be section 38 property with respect to the taxpayer—
(a) As a result of the occurrence of an event on a specific date (for example, a sale, transfer, retirement or other disposition), such cessation shall be treated as having occurred on the actual date of such event.
(b) For any reason other than the occurrence of an event on a specific date (for example, because such property is used predominantly in connection with the furnishing of lodging during such taxable year), such cessation shall be treated as having occurred on the first day of such taxable year.
(2) Special rule. Notwithstanding subparagraph (1) of this paragraph, if a taxpayer uses an averaging convention (see § 1.167(a)(10)) in computing depreciation with respect to section 38 property, then, for purposes of this section and §§ 1.47-2 through 1.47-6, he may use the assumed dates of additions and retirements in determining the actual useful life of such property provided such assumed dates are used consistently for purposes of subpart B of part IV of subchapter A of chapter 1 of the Code with respect to all section 38 property for which such convention is used for purposes of depreciation. This subparagraph shall not apply in any case where from all the facts and circumstances it appears that the use of such assumed dates results in a substantial distortion of the investment credit allowed by section 38. Thus, for example, if the taxpayer computes depreciation under a convention under which the average of the beginning and ending balances of the asset account for the taxable year are taken into account, he may use July 1 as the assumed date of all additions and retirements to such account. Similarly, if the taxpayer computes depreciation under a convention under which the average of the beginning and ending balances of the asset account for each month is taken into account, he may use the date determined by reference to the weighted average of the monthly averages as the assumed date of all additions and retirements to such account.
(3) Example. This paragraph may be illustrated by the following example:
(d) Examples. Paragraphs (a) through (c) of this section may be illustrated by the following examples:
(ii) The actual useful life of the item of property which is sold on December 2, 1965, is three years and eleven months. The recomputed qualified investment with respect to such item of property is zero ($12,000 basis multiplied by zero applicable percentage) and X Corporation’s recomputed credit earned for the taxable year 1962 is $1,680 (7 percent of $24,000). The income tax imposed by chapter 1 of the Code on X Corporation for the taxable year 1965 is increased by the $840 decrease in its credit earned for the taxable year 1962 (that is, $2,520 original credit earned minus $1,680 recomputed credit earned).
(ii) The actual useful life of the item of property which is sold on December 2, 1966, is four years and eleven months. The recomputed qualified investment with respect to such item of property is $4,000 ($12,000 basis multiplied by 33
(ii) The actual useful life of the item of property which is sold on December 2, 1965, is three years and eleven months. The recomputed qualified investment with respect to such item of property is zero ($12,000 basis multiplied by zero applicable percentage) and X Corporation’s recomputed credit earned for the taxable year 1962 is $1,680 (7 percent of $24,000). If such $1,680 recomputed credit earned had been taken into account in place of the $2,520 original credit earned, X’s credit allowed for 1962 would have been $1,520, and of the $160 unused credit from 1962 $100 would have been allowed as a credit under section 38 for 1963, and $60 would have been allowed for 1964. X Corporation’s $800 investment credit carryover to the taxable year 1965 is reduced by $800 to zero. The income tax imposed by chapter 1 of the Code on X Corporation for the taxable year 1965 is increased by $40 (that is, the aggregate reduction in the credits allowed by section 38 for 1962, 1963, and 1964).
(ii) The actual useful life of such item of property is three years and three months. The recomputed qualified investment with respect to such property is zero ($12,000 basis multipled by zero) and X Corporation’s recomputed credit earned for the taxable year 1962 is zero. If such zero recomputed credit earned had been taken into account in place of the $840 original credit earned, the entire $400 unused credit from 1963 (including the $200 portion which was originally allowed as a credit for 1965) and the $400 unused credit from 1964 would have been allowed as investment credit carrybacks against X Corporation’s liability for tax of $840 for 1962. (See § 1.46-2 for rules relating to the carryback of unused credits.)
(iii) Therefore, the $600 carryover from 1963 and 1964 to 1966 is eliminated and the income tax imposed by chapter 1 of the Code on X Corporation for the taxable year 1966 is increased by the $240 aggregate reduction in the credits allowed by section 38 for the taxable years 1962 and 1965 (that is, $1,040 credit allowed minus $800 which would have been allowed).
(ii) The actual useful life of the item of property is three years and eight months. The recomputed qualified investment with respect to such item of property is zero and X Corporation’s recomputed credit earned for the taxable year 1962 is zero. Notwithstanding the $3,000 net operating loss for the taxable year 1966, the income tax imposed by chapter 1 of the Code on X Corporation for such year is $700 (that is, the decrease in its credit earned for the taxable year 1962).
(e) Identification of property—(1) General rule—(i) Record requirements. In general, the taxpayer must maintain records from which he can establish, with respect to each item of section 38 property, the following facts:
(a) The date the property is disposed of or otherwise ceases to be section 38 property,
(b) The estimated useful life which was assigned to the property under paragraph (e) of § 1.46-3,
(c) The month and the taxable year in which the property was placed in service, and
(d) The basis (or cost), actually or reasonably determined, of the property.
(ii) Recapture determination. For purposes of determining whether section 38 property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of its estimated useful life, and for purposes of determining recomputed qualified investment, the taxpayer must establish from his records the facts required by subdivision (i) of this subparagraph.
(iii) Examples. If the taxpayer fails to maintain records from which he can establish the facts required by subdivision (i) of this subparagraph, then this section shall be applied to the taxpayer in the manner indicated in the following examples:
(2) Treatment of “mass assets”. (i) If, in the case of mass assets (as defined in subparagraph (4) of this paragraph), it is impracticable for the taxpayer to maintain records from which he can establish with respect to each item of section 38 property the facts required by subparagraph (1) of this paragraph, and if he adopts other reasonable recordkeeping practices, consonant with good accounting and engineering practices, and consistent with his prior recordkeeping practices, then he may substitute data from an appropriate mortality dispersion table. An appropriate mortality dispersion table must be based on an acceptable sampling of the taxpayer’s actual experience or other acceptable statistical or engineering techniques. In lieu of such mortality dispersion table, the taxpayer may use a standard mortality dispersion table prescribed by the Commissioner. If the taxpayer uses such standard mortality dispersion table for any taxable year, it must be used for all subsequent taxable years unless the taxpayer obtains the consent of the Commissioner to change. If mass assets are placed in a multiple asset account and if the depreciation rate for such account is based on the maximum expected life of the longest lived asset in such account, in applying a mortality dispersion table (including a standard mortality dispersion table) the average expected useful life of the mass assets in such account must be used.
(ii) Subdivision (i) of this subparagraph shall not apply with respect to assets placed in service in a taxable year ending on or after June 30, 1967, and beginning before January 1, 1971, or with respect to assets placed in service for a taxable year beginning after December 31, 1970, for which the taxpayer has not made the election provided by section 167(m), unless the estimated useful lives which were assigned to such assets for purposes of determining qualified investment—
(a) Were separate lives based on the estimated range of years taken into account in establishing the average useful life of assets similar in kind under paragraph (e)(3)(ii)(b) of § 1.46-3, and
(b) Were determined by use of a mortality dispersion table (including a standard mortality dispersion table).
(iii) Any standard mortality dispersion table prescribed by the Commissioner shall be based on average useful life categories and with respect to each category shall contain five columns, the first four of which shall state the percentage of property assumed to have a useful life of—
Column (1): Less than 4 years,
Column (2): 4 years or more but less than 6 years,
Column (3): 6 years or more but less than 8 years, and
Column (4): 8 years or more.
(iv) Whenever the standard mortality dispersion table is used for a taxable year under subdivision (i) of this subparagraph (whether or not such table was used in determining qualified investment), the percentage of property shown in column (1) of the table shall (for purposes of section 47, this section, and §§ 1.47-2 through 1.47-6) be deemed to have been disposed of on the day before the expiration of the 4-year period beginning on the date on which it was considered as placed in service under § 1.47-1(c); the percentage of property shown in column (2) of the table shall be deemed to have been disposed of on the day before the expiration of the 6-year period beginning on the date on which it was so considered as placed in service; and the percentage of property shown in column (3) shall be deemed to have been disposed of on the day before the expiration of the 8-year period beginning on the date on which it was so considered as placed in service. In applying this subdivision for purposes of recomputing qualified investment, the proper average useful life category shall be used whether or not such category was used in determining qualified investment. In the case of property which is described in section 50 or property which is treated as property described in section 50 under paragraph (a)(2)(iii) of this section (other than property the qualified investment with respect to which was determined by use of the standard or an appropriate mortality dispersion table), this subdivision shall be applied by substituting “3-year period” for “4-year period”, “5-year period” for “6-year period”, and “7-year period” for “8-year period”.
(v) In lieu of using subdivision (iv) of this subparagraph for purposes of recomputing qualified investment, a taxpayer may, for the first recapture year (as defined in paragraph (a)(1)(ii)(b) of this section) to which such subdivision (iv) would otherwise apply with respect to any mass asset account, recompute qualified investment on the basis of the difference between (a) the proper total qualified investment based on the percentage shown in column (5) of the table, and (b) the total qualified investment actually claimed by the taxpayer for the year in which the property was placed in service.
The taxpayer elects to use the standard mortality dispersion table prescribed by the Commissioner to determine the amount of recapture with respect to these mass assets. Assume that the table prescribed by the Commissioner shows with respect to mass assets with an average useful life of 6 years the following:
Percent of property assumed to have a useful life of— | Total qualified investment (percent) (5) | |||
---|---|---|---|---|
Less than 4 years (1) | 4 years or more, but less than 6 years (2) | 6 years or more, but less than 8 years (3) | 8 years or more (4) | |
15.87 | 34.13 | 34.13 | 15.87 | 50.00 |
(b) No recapture determination is required for 1968 since no assets are deemed to have been disposed of in that year. During 1969, 34.13 percent of the mass assets placed in service in 1963 are deemed to have been disposed of. With respect to these assets, the amount of qualified investment for 1963 was $22,753.34 ($34,130 ×
(c) If the taxpayer chooses to recompute qualified investment by using the method provided in subdivision (v) of this subparagraph, the increase in tax for 1967 (the first recapture year) would be $1,167.67, i.e., the original credit earned, $4,667.67, minus the recomputed credit earned, $3,500 (50 percent, the percentage shown in column (5), of $100,000 multiplied by 7 percent). As long as the same average useful life category reflects the taxpayer’s experience for subsequent years, no recapture determination will be required for any future year, except as provided by subparagraph (3)(iv) of this paragraph.
(vi) Subdivision (i) of this subparagraph shall not apply with respect to section 38 property to which an election under section 167(m) applies unless the taxpayer assigns actual retirements of such section 38 property for all taxable years to the same vintage account for purposes of section 47 and for purposes of computing the allowance for depreciation under section 167. The assignment of actual retirements of section 38 property for a taxable year to particular vintage accounts may be made on the basis of an appropriate mortality dispersion table (based on an acceptable sampling of the taxpayer’s actual experience or other statistical or engineering techniques) or on the basis of a standard mortality dispersion table prescribed by the Commissioner. If the taxpayer assigns actual retirements for any taxable year to particular vintage accounts on the basis of such standard mortality dispersion table, actual retirements for all subsequent taxable years must be assigned to particular vintage accounts on the basis of such table. Actual retirements of section 38 property for a taxable year shall be assigned to particular vintage accounts by—
(a) Determining the expected retirements for such taxable year from each vintage account containing such section 38 property, and
(b) Ratably allocating such actual retirements to each vintage account containing such section 38 property.
(3) Special rules. (i) Taxpayers who properly determine estimated useful lives under § 1.46-3(e)(3) (ii)(b) or (iii) may treat such assets as having been disposed of or having ceased to be section 38 assets in the order of the estimated useful lives that were assigned to such assets. Thus, the asset that is first disposed of or first ceases to be section 38 property may be treated as the asset to which there was assigned the shortest estimated useful life; the next asset disposed of or ceasing to be section 38 property may be treated as the asset to which there was assigned the second shortest life, etc.
(ii) In the case of taxpayers who use the rule of subdivision (i) of this subparagraph with respect to mass assets for which the estimated useful life was determined under § 1.46-3(e)(3)(iii), if the dispersion shown by the mortality dispersion table effective for a taxable year subsequent to the credit year is the same as the dispersion shown by the mortality table that was effective for the credit year (for example, if the same average useful life on the standard mortality dispersion table reflects the taxpayer’s experience for both such years), no recapture determination is required for such subsequent taxable year.
(iii) Notwithstanding subdivision (i) of this subparagraph, taxpayers who, for purposes of determining qualified investment, do not use a mortality dispersion table with respect to certain section 38 assets similar in kind but who consistently assign under paragraph (e)(3)(ii)(b) of § 1.46-3 to such assets separate lives based on the estimated range of years taken into consideration in establishing the average useful life of such assets, may select the order in which such assets shall be considered as having been disposed of, regardless of the taxable years in which such assets were placed in service. If a taxpayer uses the method provided in this subdivision to determine that any asset is considered as having been disposed of, then, in addition to complying with the record requirements of subparagraph (1)(i) of this paragraph, such taxpayer must maintain records from which he can establish to the satisfaction of the district director that such asset has not previously been considered as having been disposed of. In addition, if, for any taxable year, a taxpayer uses the method provided in this subdivision for any asset, he must use for such year and for each subsequent taxable year (unless he obtains the district director’s consent to change) with respect to all assets similar in kind to such asset—
(a) The method of determining estimated useful lives described in paragraph (e)(3)(ii)(b) of § 1.46-3, and
(b) The method he has selected under this subdivision for determining the order in which such assets are considered as having been disposed of.
(iv) Notwithstanding subdivisions (i), (ii), and (iii) of this subparagraph, there shall be taken into account separately any abnormal retirement of section 38 property of substantial value for which the estimated useful life was determined under § 1.46-3(e)(3) (ii)(b) or (iii). For definition of abnormal retirement, see paragraph (b) of § 1.167(a)-8.
(4) [Reserved]
(5) Example. This paragraph may be illustrated by the following example:
Percent of assets | Useful life (years) |
---|---|
10 | 3 |
20 | 6 |
40 | 5 |
20 | 6 |
10 | 7 |
Useful life | Basis | Applicable percentage | Qualified investment |
---|---|---|---|
4 | $200,000 | 33 | $66,666 |
5 | 400,000 | 33 | 133,334 |
6 | 200,000 | 66 | 133,334 |
7 | 100,000 | 66 | 66,666 |
400,000 |
Percent of assets | Useful life (years) |
---|---|
30 | 3 |
20 | 4 |
30 | 5 |
10 | 6 |
10 | 7 |
(iv) The mortality study effective for 1970 shows the same results as the mortality study effective for 1968. Thus, it shows that 3 million containers were retired in 1970 (an actual life of 5 years). Under the rule of subparagraph (3)(i) of this paragraph, the 3 million are treated as having been assigned useful lives as follows: 2 million as having been assigned a useful life of 5 years, and 1 million as having been assigned a useful life of 6 years. Taking into account only the fact that 10 percent of the containers placed in service in 1965 had an actual life of 5 years rather than the 6 years estimated useful life assigned to them, A’s recomputed qualified investment is $300,000 and A’s credit earned for 1965 is $21,000. Thus, taking into account the 1968 recapture determination A’s income tax for 1970 is increased by $2,333.
(f) Public utility property—(1) Recomputed qualified investment. In recomputing qualified investment with respect to section 38 property which becomes public utility property (as defined in paragraph (g) of § 1.46-3)—
(i) If such property becomes public utility property less than 3 years from the date on which it was placed in service, then such property shall be treated as public utility property for its entire useful life.
(ii) If such property becomes public utility property 3 years or more but less than 5 years from the date on which it was placed in service, then such property shall be treated as section 38 property which is not public utility property for the first 3 years of its estimated useful life and as public utility property for the remaining period of its estimated useful life.
(iii) If such property becomes public utility property 5 years or more but less than 7 years from the date on which it was placed in service, then such property shall be treated as section 38 property which is not public utility property for the first 5 years of its estimated useful life and as public utility property for the remaining period of its estimated useful life.
(2) Examples. Subparagraph (1) of this paragraph may be illustrated by the following examples:
(ii) Such item of section 38 property is treated as section 38 property which is not public utility property for the first 3 years of its 8-year estimated useful life and is treated as public utility property for the remaining 5 years. The recomputed qualified investment with respect to such item of section 38 property is $7,428, computed as follows:
$12,000 basis × 33 | $4,000 |
$12,000 basis × | 3,428 |
Total recomputed qualified investment | 7,428 |
(ii) The actual useful life of such item of property is 6 years. For the first 3 years of its 8-year estimated useful life such item is treated as section 38 property which is not public utility property and for the remaining 3 years is treated as public utility property. The recomputed qualified investment with respect to such item of property is $5,714, computed as follows:
$12,000 basis × 33 | $4,000 |
$12,000 basis × | 1,714 |
Total recomputed qualified investment | 5,714 |
(g) Special rules for progress expenditure property. Under section 47(a)(3), a recapture determination is required if property ceases to be progress expenditure property (as defined in § 1.46-5(d)). Property ceases to be progress expenditure property if it is sold or otherwise disposed of before it is placed in service. For example, cancellation of the contract for progress expenditure property or abandonment of the project by the taxpayer will be considered a “disposition” within the meaning of § 1.47-2. A cessation occurs if progress expenditure property ceases to be property that will be section 38 property with a useful life of 7 years or more when placed in service. In general, a sale and leaseback is treated as a cessation. However, see paragraph (g)(2) of § 1.47-3 for special rules for certain sale and leaseback transactions. Recapture determinations for progress expenditure property are to be made in a way similar to that provided under §§ 1.47-1 through 1.47-6. Reduction of qualified investment must begin with the most recent credit year (i.e., the most recent taxable year the property is taken into account in computing qualified investment under § 1.46-3 or 1.46-5).
(h) Special rules for energy property—(1) In general. A recapture determination is required for the investment credit attributable to the energy percentage (energy credit) if property is (i) disposed of or (ii) otherwise ceases to be energy property (as defined in section 48(l)) with regard to the taxpayer before the close of the estimated useful life (as determined under paragraph (a)(2)(i) of this section) which was taken into account in computing qualified investment.
(2) Dispositions. The term “disposition” is described in § 1.47-2(a)(1). A transfer of energy property that is a “disposition” requiring a recapture determination for the investment credit attributable to the regular percentage (regular credit) and the ESOP percentage (ESOP credit) will also be a “disposition” requiring a recapture determination for the energy credit.
(3) Cessation. (i) The term “cessation” is described in § 1.47-2(a)(2). For energy property, a cessation occurs during a taxable year if, by reason of a change in use or otherwise, the property would not have qualified for an energy credit if placed in service during that year. A change in use will not require a recapture determination for the regular or ESOP credit unless, by reason of the change, the property would not have qualified for the regular or ESOP credit if placed in service during that year.
(ii) A qualified intercity bus described in § 1.48-9(q) must meet the predominant use test (of § 1.48-9(q)(7)) for the remainder of the taxable year from the date it is placed in service and for each taxable year thereafter. A cessation occurs in any taxable year in which the bus is no longer a qualifying bus under § 1.48-9(q)(6). A qualified intercity bus does not cease to be energy property for a taxable year subsequent to the one in which it was placed in service by reason of a decrease in operating capacity (see § 1.48-9(q)(9)) for that year compared to any prior taxable year.
(4) Recordkeeping requirement. For recordkeeping requirements with respect to dispositions or cessations, the rules of paragraph (e)(1) of this section apply. For example, the taxpayer must maintain records for each recycling facility indicating the percentage of virgin materials used each year. See, § 1.48-9(g)(5)(ii).
(5) Examples. The following examples illustrate this paragraph (h).
(b) For 1981, a recapture determination is not required. For 1982, the entire energy credit must be recaptured, although none of the regular credit is recaptured. If in 1989 the computer first ceased to perform an energy conserving function, no part of the energy credit would be recaptured.
(i)-(l) [Reserved]
(m) Commuter highway vehicles—(1) Recomputed qualified investment. (i) If a qualifying commuter highway vehicle (as defined in § 1.46-11(a) undergoes a change in use but does not cease to be section 38 property, qualified investment for that vehicle is recomputed as if the vehicle was section 38 property which is not a qualifying commuter highway vehicle for its entire useful life.
(ii) The following example illustrates this paragraph (m)(1).
(2) Change in use—(i) A qualifying commuter highway vehicle undergoes a change in use if the vehicle does not meet the commuter use requirement (as defined in § 1.46-11(d)) for each computation period.
(ii) Each of the following is a computation period:
(A) The period beginning on the date the vehicle was placed in service and ending on the last day of the taxpayer’s taxable year in which the vehicle was placed in service;
(B) Each of the taxpayer’s taxable years beginning after the date the vehicle was placed in service and ending before the end of the first 36 months after the vehicle was placed in service; and
(C) The period ending at the end of the first 36 months after the vehicle was placed in service and beginning on the first day of the taxpayer’s taxable year in which the end of those first 36 months falls.
(iii) The following example illustrates this paragraph (m)(2).
Taxable year ending | Total miles | Commuter miles | Ratio |
---|---|---|---|
1979 | 10,000 | 9,000 | .90 |
1980 | 10,000 | 8,000 | .80 |
1981 | 10,000 | 8,000 | .80 |
1982 (1-14) | 1,000 | 100 | .10 |
(c) As of the computation period beginning 1-1-82 and ending 1-14-82, the ratio of commuter use to total mileage is .10 (100 miles ÷ 1,000 miles). Since that ratio is less than .80, the vehicle does not meet the commuter use requirement for the period and the vehicle has undergone a change in use.
§ 1.47-2 “Disposition” and “cessation”.
(a) General rule—(1) “Disposition”. For purposes of this section and § 1.47-1 and §§ 1.47-3 through 1.47-6, the term “disposition” includes a sale in a sale-and-leaseback transaction, a transfer upon the foreclosure of a security interest and a gift, but such term does not include a mere transfer of title to a creditor upon creation of a security interest. See paragraph (g) of § 1.47-3 for treatment of certain sale-and-leaseback transactions.
(2) “Cessation”. (i) A determination of whether section 38 property ceases to be section 38 property with respect to the taxpayer must be made for each taxable year subsequent to the credit year. Thus, in each such taxable year the taxpayer must determine, as if such property were placed in service in such taxable year, whether such property would qualify as section 38 property (within the meaning of § 1.48-1) in the hands of the taxpayer for such taxable year.
(ii) Section 38 property does not cease to be section 38 property with respect to the taxpayer in any taxable year subsequent to the credit year merely because under the taxpayer’s depreciation practice no deduction for depreciation with respect to such property is allowable to the taxpayer for the taxable year, provided that the property continues to be used in the taxpayer’s trade or business (or in the production of income) and otherwise qualifies as section 38 property with respect to the taxpayer.
(iii) This subparagraph may be illustrated by the following examples:
(b) Leased property—(1) In general. For purposes of paragraph (a) of § 1.47-1, generally the mere leasing of section 38 property by a lessor who took the basis of such property into account in computing his qualified investment for the credit year shall not be considered to be a disposition. However, in a case where a lease is treated as a sale for income tax purposes such transaction is considered to be a disposition. Leased section 38 property ceases to be section 38 property with respect to the lessor if, in any taxable year subsequent to the credit year, such property would not qualify as section 38 property (as defined in § 1.48-1) in the hands of the lessor, the lessee, or any sublessee. Thus, if, in a taxable year subsequent to the credit year, a lessee uses the property predominantly outside the United States, such property shall be considered to have ceased to be section 38 property with respect to the lessor.
(2) Where lessor elects to treat lessee as purchaser. For purposes of paragraph (a) of § 1.47-1, if, under § 1.48-4, the lessor of new section 38 property made a valid election to treat the lessee as having purchased such property for purposes of the credit allowed by section 38, the following rules apply in determining whether such property is disposed of, or otherwise ceases to be section 38 property with respect to the lessee:
(i) Generally, a mere disposition by the lessor of property subject to a lease shall not be considered to be a disposition by the lessee.
(ii) If the lessor makes a disposition of property subject to a lease to a person who may not, under § 1.48-4, make a valid election to treat the lessee as having purchased such property for purposes of the credit allowed by section 38 (such as a person described in paragraph (a)(5) of § 1.48-4), such property shall be considered to have ceased to be section 38 property with respect to the lessee on the date of such disposition.
(iii) If a lease is terminated and the property is transferred by the lessee to the lessor or to any other person, such transfer shall be considered to be a disposition by the lessee.
(iv) If the lessee actually purchases such property in the credit year or in a taxable year subsequent to the credit year, such purchase shall not be considered to be a disposition.
(v) The property ceases to be section 38 property with respect to the lessee if in any taxable year subsequent to the credit year such property would not qualify as section 38 property (as defined in § 1.48-1) in the hands of the lessor, the lessee, or any sublessee. Thus, for example, if, in a taxable year subsequent to the credit year, a sublessee uses the property predominantly outside the United States, the property ceases to be section 38 property with respect to the lessee.
(c) Reduction in basis of section 38 property—(1) General rule. If, in the credit year or in any taxable year subsequent to the credit year, the basis (or cost) of section 38 property is reduced, for example, as a result of a refund of part of the cost of the property, then such section 38 property shall be treated as having ceased to be section 38 property with respect to the taxpayer to the extent of the amount of such reduction in basis (or cost) on the date the refund which results in such reduction in basis (or cost) is received or accrued, except that for purposes of § 1.47-1(a) the actual useful life of the property treated as having ceased to be section 38 property shall be considered to be less than 3 years.
(2) Example. Subparagraph (1) of this paragraph may be illustrated by the following example:
(ii) Under subparagraph (1) of this paragraph, on June 1, 1963, the item of section 38 property ceases to be section 38 property with respect to A to the extent of $10 of the original $100 basis.
(d) Retirements. A retirement of section 38 property, including a normal retirement (as defined in paragraph (b) of § 1.167(a)-8, relating to definition of normal and abnormal retirements), whether from a single asset account or a multiple asset account, and an abandonment, are dispositions for purposes of paragraph (a) of § 1.47-1.
(e) Conversion of section 38 property to personal use. (1) If, for any taxable year subsequent to the credit year—
(i) A deduction for depreciation is allowable to the taxpayer with respect to only a part of section 38 property because such property is partially devoted to personal use, and
(ii) The part of the property (expressed as a percentage of its total basis (or cost)) with respect to which a deduction for depreciation is allowable for such taxable year is less than the part of the property with respect to which a deduction for depreciation was allowable in the credit year,
(2) Examples. Subparagraph (1) of this paragraph may be illustrated by the following examples:
(ii) Under subparagraph (1) of this paragraph, on January 1, 1963, the automobile ceases to be section 38 property with respect to A to the extent of 20 percent (80 percent minus 60 percent) of the $2,400 basis of the automobile.
(ii) Under subparagraph (1) of this paragraph, on January 1, 1964, the automobile ceases to be section 38 property with respect to A to the extent of 20 percent (60 percent minus 40 percent) of the $2,400 basis of the automobile.
§ 1.47-3 Exceptions to the application of § 1.47-1.
(a) In general. Notwithstanding the provisions of § 1.47-2, relating to “disposition” and “cessation,” paragraph (a) of § 1.47-1 shall not apply if paragraph (b) of this section (relating to transfers by reason of death), paragraph (c) of this section (relating to property destroyed by casualty), paragraph (d) of this section (relating to reselection of used section 38 property), paragraph (e) of this section (relating to transactions to which section 381(a) applies), paragraph (f) of this section (relating to mere change in form of conducting a trade or business), paragraph (g) of this section (relating to sale-and-leaseback transactions), or paragraph (h) of this section (relating to certain property replaced after Apr. 18, 1969) applies with respect to such disposition or cessation.
(b) Transfers by reason of death—(1) General rule. Notwithstanding the provisions of § 1.47-2, relating to “disposition” and “cessation”, paragraph (a) of § 1.47-1 shall not apply to a transfer of section 38 property by reason of the death of the taxpayer. Thus, for example, with respect to section 38 property held in joint tenancy, paragraph (a) of § 1.47-1 shall not apply to the transfer of the deceased taxpayer’s interest to the surviving joint tenant. If, under § 1.48-4, the lessor of new section 38 property made a valid election to treat the lessee as having purchased such property for purposes of the credit allowed by section 38, paragraph (a) of § 1.47-1 does not apply if, by reason of the death of the lessee, there is a termination of the lease and transfer of the leased property to the lessor, or there is an assignment of the lease and transfer of the leased property to another person. Moreover, paragraph (a) of § 1.47-1 does not apply to the transfer of a partner’s interest in a partnership, a beneficiary’s interest in an estate or trust, or shares of stock of a shareholder of an electing small business corporation (as defined in section 1371(b)) by reason of the death of such partner, beneficiary, or shareholder. Paragraph (a) of § 1.47-1 shall not apply to property prior to his death even if the value of such gift is included in his gross estate for estate tax purposes (such as, a gift in contemplation of death under section 2035). The effect of this subparagraph is that any section 38 property held by a taxpayer at the time of his death is deemed to have been held by him for its entire estimated useful life.
(2) Examples. Subparagraph (1) of this paragraph may be illustrated by the following examples:
(ii) Under subparagraph (1) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the transfer, as a result of A’s death, of his interest in such item of section 38 property to the testamentary trust. Moreover, paragraph (a) of § 1.47-1 does not apply to the February 1, 1967, transfer of such item of section 38 property by the trust to its beneficiaries.
(ii) Under subparagraph (1) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the transfer, as a result of A’s death, of his eight shares of stock in X Corporation to his wife. Moreover, with respect to the July 10, 1965, sale paragraph (a) of § 1.47-1 applies only to the 20 percent of the basis of the item of section 38 property which was apportioned to B.
(c) Property destroyed by casualty—(1) Dispositions after April 18, 1969. Notwithstanding the provisions of § 1.47-2, relating to “disposition” and “cessation”, paragraph (a) of § 1.47-1 shall not apply to property which, after April 18, 1969, and before August 16, 1971, is disposed of or otherwise ceases to be section 38 property with respect to the taxpayer on account of its destruction or damage by fire, storm, shipwreck, or other casualty, or by reason of its theft.
(2) Dispositions before April 19, 1969. (i) In the case of property which, before April 19, 1969, is disposed of or otherwise ceases to be section 38 property with respect to the taxpayer on account of its destruction or damage by fire, storm, shipwreck or other casualty, or by reason of its theft, paragraph (a) of § 1.47-1 shall apply except to the extent provided in subdivisions (ii) and (iii) of this subparagraph.
(ii) Paragraph (a) of § 1.47-1 shall not apply if—
(a) Section 38 property is placed in service by the taxpayer to replace (within the meaning of paragraph (h) of § 1.46-3) the destroyed, damaged, or stolen property, and
(b) The basis (or cost) of the section 38 property which is placed in service by the taxpayer to replace the destroyed, damaged, or stolen property is reduced under paragraph (h) of § 1.46-3.
(iii) If property which would be section 38 property but for section 49 is placed in service by the taxpayer to replace the destroyed, damaged, or stolen property, then the provisions of paragraph (h) of this section (other than the requirement that the replacement take place within 6 months after the disposition) shall apply.
(3) Examples. The provisions of subparagraph (2)(ii) of this paragraph may be illustrated by the following examples:
(ii) Under subparagraph (1) of this paragraph, paragraph (a) of § 1.47-1 does not apply with respect to machine No. 1 since machine No. 2 is placed in service to replace machine No. 1 and the $41,000 basis of machine No. 2 is reduced, under paragraph (h) of § 1.46-3, by $23,000. (See example 1 of paragraph (h)(3) of § 1.46-3.)
(ii) Although machine No. 2 is placed in service to replace machine No. 1, subparagraph (1) of this paragraph does not apply with respect to machine No. 1 since the basis of machine No. 2 is not reduced under paragraph (h) of § 1.46-3. Paragraph (a) of § 1.47-1 applies with respect to the January 1, 1963, destruction of machine No. 1. The actual useful life of machine No. 1 is 1 year. The recomputed qualified investment with respect to such machine is zero ($30,000 basis multiplied by zero applicable percentage) and A’s recomputed credit earned for the taxable year 1962 is zero. The income tax imposed by chapter 1 of the Code on A for the taxable year 1963 is increased by $1,400.
(d) Reselection of used section 38 property—(1) Reselection. If—
(i) Used section 38 property (as defined in § 1.48-3) the cost of which was taken into account in computing the taxpayer’s qualified investment is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the estimated useful life which was taken into account in computing such qualified investment, and
(ii) For the taxable year in which the property described in subdivision (i) of this subparagraph was placed in service, the sum of (a) the cost of used section 38 property placed in service by the taxpayer, and (b) the cost of used section 38 property apportioned to such taxpayer exceeded $50,000,
(2) Application of paragraph (a) of § 1.47-1. (i) If a taxpayer treats, under subparagraph (1) of this paragraph, the cost of any used section 38 property which was not originally selected as having been selected in place of the cost of used section 38 property described in subparagraph (1)(i) of this paragraph, then, not withstanding the provisions of § 1.47-2 (relating to “disposition” and “cessation”), paragraph (a) of § 1.47-1 shall not apply to the property described in subparagraph (1)(i) of this paragraph to the extent of the cost of the newly selected used section 38 property.
(ii) If the cost of the used section 38 property described in subparagraph (1)(i) of this paragraph exceeds the cost of the newly selected used section 38 property, then the property described in subparagraph (1)(i) of this paragraph shall cease to be section 38 property with respect to the taxpayer to the extent of such excess.
(iii) If the newly selected used section 38 property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the estimated useful life of the property described in subparagraph (1)(i) of this paragraph, then, unless he reselects other used section 38 property, paragraph (a) of § 1.47-1 shall apply with respect to such newly selected used section 38 property. For purposes of recomputing qualified investment with respect to such newly selected used section 38 property the actual useful life shall be deemed to be the period beginning with the date on which the property described in subparagraph (1)(i) of this paragraph was placed in service by the taxpayer and ending with the date of the disposition or cessation with respect to such newly selected used section 38 property. See paragraph (c) of § 1.47-1, relating to date placed in service and date of disposition or cessation.
(3) Information requirement. (i) If in any taxable year this paragraph applies to a taxpayer, such taxpayer shall attach to his income tax return for such taxable year a statement containing the information required by subdivision (ii) of this subparagraph.
(ii) The statement referred to in subdivision (i) of this subparagraph shall contain the following information:
(a) The taxpayer’s name, address and taxpayer account number; and
(b) With respect to the originally selected used section 38 property and the newly selected used section 38 property, the month and year placed in service, cost, and estimated useful life.
(4) Examples. This paragraph may be illustrated by the following examples:
(ii) Under subparagraph (1) of this paragraph, X Corporation treats the $50,000 cost of machine No. 2 as having been selected to be taken into account in computing its qualified investment for the taxable year 1962 in place of the $50,000 cost of machine No. 1. Therefore, under subparagraph (2)(i) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the January 2, 1965, disposition of machine No. 1.
(ii) Under subparagraph (2)(iii) of this paragraph, paragraph (a) of § 1.47-1 applies with respect to the December 2, 1966, disposition of machine No. 2. The actual useful life of machine No. 2 is four years and eleven months (that is, the period beginning on January 1, 1962, and ending on December 2, 1966). The recomputed qualified investment with respect to machine No. 2 is $16,667 ($50,000 cost multiplied by 33
(ii) Under subparagraph (1) of this paragraph, X Corporation treats the $30,000 cost of machine No. 2 as having been selected to be taken into account in computing its qualified investment for the taxable year 1962 in place of the $50,000 cost of machine No. 1. Therefore, under subparagraph (2)(i) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the January 2, 1965, disposition of machine No. 1 to the extent of $30,000 of the $50,000 cost of machine No. 1. However, under subparagraph (2)(ii) of this paragraph, paragraph (a) of § 1.47-1 applies to the January 2, 1965, disposition of machine No. 1 to the extent of $20,000 (that is, $50,000 cost of machine No. 1 minus $30,000 cost of machine No. 2). The actual useful life of such $20,000 portion of machine No. 1 is three years (that is, the period beginning on January 1, 1962, and ending on January 2, 1965). The recomputed qualified investment with respect to the $20,000 portion of the cost of machine No. 1 is zero ($20,000 portion of the cost multiplied by zero applicable percentage) and X Corporation’s recomputed credit earned for the taxable year 1962 is $2,100 (7 percent of $30,000). The income tax imposed by chapter 1 of the Code on X Corporation for the taxable year 1965 is increased by the $1,400 decrease in its credit earned for the taxable year 1962 (that is, $3,500 original credit earned minus $2,100 recomputed credit earned).
(e) Transactions to which section 381(a) applies—(1) General rule. Notwithstanding the provisions of § 1.47-2, relating to “disposition” and “cessation”, paragraph (a) of § 1.47-1 shall not apply to a disposition of section 38 property in a transaction to which section 381(a) (relating to carryovers in certain corporate acquisitions) applies. If the section 38 property described in the preceding sentence is disposed of, or otherwise ceases to be section 38 property with respect to the acquiring corporation, before the close of the estimated useful life which was taken into account in computing the transferor corporation’s qualified investment, then paragraph (a) of § 1.47-1 shall apply to the acquiring corporation with respect to such section 38 property. For purposes of recomputing qualified investment with respect to such property its actual useful life shall be the period beginning with the date on which it was placed in service by the transferor corporation and ending with the date of the disposition by, or cessation with respect to, the acquiring corporation.
(2) Examples. This paragraph may be illustrated by the following examples:
(ii) Under subparagraph (1) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the January 15, 1967, transfer to Y Corporation.
(ii) Under subparagraph (1) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the January 15, 1967, transfer to Y Corporation. However, paragraph (a) of § 1.47 applies to the February 2, 1968, sale of the property by Y Corporation. The actual useful life of the property is six years and one month (that is, the period beginning on January 1, 1962, and ending on February 2, 1968).
(f) Mere change in form of conducting a trade or business—(1) General rule. (i) Notwithstanding the provisions of § 1.47-2, relating to “disposition” and “cessation”, paragraph (a) of § 1.47-1 shall not apply to section 38 property which is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the estimated useful life which was taken into account in computing the taxpayer’s qualified investment by reason of a mere change in the form of conducting the trade or business in which such section 38 property is used provided that the conditions set forth in subdivision (ii) of this subparagraph are satisfied.
(ii) The conditions referred to in subdivision (i) of this subparagraph are as follows:
(a) The section 38 property described in subdivision (i) of this subparagraph is retained as section 38 property in the same trade or business,
(b) The transferor (or in a case where the transferor is a partnership, estate, trust, or electing small business corporation, the partner, beneficiary, or shareholder) of such section 38 property retains a substantial interest in such trade or business,
(c) Substantially all the assets (whether or not section 38 property) necessary to operate such trade or business are transferred to the transferee to whom such section 38 property is transferred, and
(d) The basis of such section 38 property in the hands of the transferee is determined in whole or in part by reference to the basis of such section 38 property in the hands of the transferor. This subparagraph shall not apply to the transfer of section 38 property if paragraph (e) of this section, relating to transactions to which section 381 applies, applies with respect to such transfer.
(2) Substantial interest. For purposes of this paragraph, a transferor (or in a case where the transferor is a partnership, estate, trust, or electing small business corporation, the partner, beneficiary, or shareholder) shall be considered as having retained a substantial interest in the trade or business only if, after the change in form, his interest in such trade or business—
(i) Is substantial in relation to the total interest of all persons, or
(ii) Is equal to or greater than his interest prior to the change in form.
(3) Property held for the production of income. Subparagraph (1)(i) of this paragraph applies to section 38 property held for the production of income (within the meaning of section 167(a)(2)) as well as to section 38 property used in a trade or business.
(4) Leased property. In a case where a lessor of new section 38 property made a valid election, under § 1.48-4, to treat the lessee as having purchased such property for purposes of the credit allowed by section 38, in determining whether subparagraph (1)(i) of this paragraph applies to an assignment of the lease and transfer of possession of such property, the condition contained in subparagraph (1)(ii)(d) of this paragraph is not applicable.
(5) Disposition or cessation. (i) If section 38 property described in subparagraph (1)(i) of this paragraph is disposed of by the transferee, or otherwise ceases to be section 38 property with respect to the transferee, before the close of the estimated useful life which was taken into account in computing the qualified investment of the transferor (or in a case where the transferor is a partnership, estate, trust, or electing small business corporation, the qualified investment of the partners, beneficiaries, or shareholders) then under paragraph (a) of § 1.47-1 such property ceases to be section 38 property with respect to the transferor (or such partners, beneficiaries, or shareholders), and a recapture determination shall be made with respect to such property. For purposes of recomputing qualified investment with respect to such property, the actual useful life shall be the period beginning with the date on which it was placed in service by the transferor and ending with the date of the disposition by, or cessation with respect to, the transferee.
(ii) If in any taxable year the transferor (or in a case where the transferor is a partnership, estate, trust, or electing small business corporation, the partner, beneficiary, or shareholder) of the section 38 property described in subparagraph (1)(i) of this paragraph does not retain a substantial interest in the trade or business directly or indirectly (through ownership in other entities provided that such other entities’ bases in such interest are determined in whole or in part by reference to the basis of such interest in the hands of the transferor) then, under paragraph (a) of § 1.47-1, such property ceases to be section 38 property with respect to the transferor and he (or the partner, beneficiary, or shareholder) shall make a recapture determination. For purposes of recomputing qualified investment with respect to property described in this subdivision, its actual useful life shall be the period beginning with the date on which it was placed in service by the transferor and ending with the first date on which the transferor (or the partner, beneficiary, or shareholder) does not retain a substantial interest in the trade or business. Any taxpayer who seeks to establish his interest in a trade or business under the rule of this subdivision shall maintain adequate records to demonstrate his indirect interest in such trade or business after any such transfer or transfers.
(iii) In making a recapture determination under this subparagraph there shall be taken into account any prior recapture determinations with respect to the transferor in connection with the same property.
(iv) Notwithstanding subparagraph (1) of this paragraph and subdivision (ii) of this subparagraph in the case of a mere change in the form of a trade or business, if the interest of a taxpayer in the trade or business is reduced but such taxpayer has retained a substantial interest in such trade or business, paragraph (a)(2) of § 1.47-4 (relating to electing small business corporations), paragraph (a)(2) of § 1.47-5 (relating to estates or trusts) or paragraph (a)(2) of § 1.47-6 (relating to partnerships) shall apply, as the case may be.
(6) Examples. This paragraph may be illustrated by the following examples in each of which it is assumed that the transfer satisfies the conditions of subparagraphs (1)(ii) (a), (c), and (d) of this paragraph.
(ii) Under subparagraph (1)(i) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the March 15, 1963, transfer to X Corporation.
(ii) Under subparagraph (1)(i) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the March 15, 1963, transfer to X Corporation. However, under subparagraph (5)(i) of this paragraph, paragraph (a) of § 1.47-1 applies to the February 2, 1964, sale of the item of section 38 property by X Corporation to Y Corporation. The actual useful life of the property is two years and one month (that is, the period beginning on January 1, 1962, and ending on February 2, 1964). The recomputed qualified investment with respect to such property is zero ($12,000 basis multiplied by zero applicable percentage) and A’s recomputed credit earned for the taxable year 1962 is zero. The income tax imposed by chapter 1 of the Code on A for 1964 is increased by the $840 decrease in his credit earned for the taxable year 1962 (that is, $840 credit earned minus zero recomputed credit earned).
(ii) Under subparagraph (1)(i) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the March 15, 1963 transfer by the ABC Partnership to X Corporation.
(ii) Under subparagraph (1)(i) of this paragraph, with respect to all of the partners (including partner A) except partner B, paragraph (a) of § 1.47-1 does not apply to the March 15, 1963, transfer by the ABC Partnership to X Corporation. Paragraph (a) of § 1.47-1 applies with respect to partner B’s $2,000 share of the item of section 38 property. See paragraph (a)(1) of § 1.47-6.
(ii) Under subparagraph (1)(i) of this paragraph, paragraph (a) of § 1.47-1 does not apply to the February 10, 1965, transfer to Partnership XY.
(g) Sale-and-leaseback transactions—(1) In general. Notwithstanding the provisions of § 1.47-2, relating to “disposition” and “cessation”, paragraph (a) of § 1.47-1 shall not apply where section 38 property is disposed of and as part of the same transaction is leased back to the vendor even though gain or loss is recognized to the vendor-lessee and the property ceases to be subject to depreciation in his hands. If paragraph (a) of § 1.47-1 applies with respect to such property subsequent to the transaction, the actual useful life shall begin with the date on which such property was first placed in service by the vendor-lessee as owner.
(2) Special rule for progress expenditure property. The sale and leaseback (or agreement or contract to leaseback) of progress expenditure property (including any contract rights to the property), in general, will be treated as a cessation described in section 47(a)(3)(A) with respect to the seller-lessee. However, a sale and leaseback (or agreement or contract to leaseback) will not be treated as a cessation to the extent qualified investment passed through to the lessee under section 48(d) in the year the property is placed in service equals or exceeds qualified progress expenditures for the property taken into account by the lessee. If a sale-leaseback transaction is treated as a cessation, qualified investment must be reduced and the credit recomputed, beginning with the most recent credit year (i.e., the most recent year property is taken into account in computing qualified investment under § 1.46-3 or 1.46-5). The amount of the reduction is the amount, if any, by which qualified progress expenditures taken into account by the lessee in all prior years exceeds qualified investment passed through to the lessee under section 48(d). This paragraph (g)(2) does not apply to any progress expenditure property that has been placed in service by a vendor-lessee (as described in paragraph (g)(1) of this section) prior to a sale-leaseback of that property in a transaction described in paragraph (g)(1) of this section.
(h) Certain property replaced after April 18, 1969—(1) In general. (i) If section 38 property is disposed of and property which is, for purposes of section 1033 and the regulations thereunder, similar or related in service or use to the property disposed of and which would be section 38 property but for the application of section 49 is placed in service to replace the property disposed of, the increase in income tax and adjustment of investment credit carryovers and carrybacks resulting from the recomputation under paragraph (a) of § 1.47-1 shall be reduced (but not below zero) by the credit that would be allowed for the qualified investment of the replacement property (determined as if such property were section 38 property). The preceding sentence shall not apply unless the replacement takes place within 6 months after the disposition. If property otherwise qualifies as replacement property, it is immaterial that it is placed in service (for example, to undergo testing) before the replaced property is disposed of. The assignment by the taxpayer in his return of an estimated useful life to the replacement property in computing its qualified investment will be considered a representation by the taxpayer that he expects to retain the replacement property for its entire estimated useful life. If such property is disposed of before the end of such life, then the circumstances surrounding the replacement will be examined to determine whether the taxpayer’s representation was in good faith and, if appropriate, the qualified investment of the replacement property will be recomputed for the year of replacement using the actual useful life of such property.
(ii) The provisions of subdivision (i) of this subparagraph may be illustrated by the following example:
(2) Leased property. Property disposed of may be replaced with property leased from another, provided (i) an election with respect to the newly leased property could be made under section 48(d) but for section 49, and (ii) the lessee obtains the lessor’s written statement that he will not claim such property as replacement property under this paragraph. The statement of the lessor shall contain the information specified in subdivisions (i) through (vii) of § 1.48-4(f)(1) and the statement (or a copy thereof) shall be retained in the records of the lessor and the lessee for a period of at least 3 years after the property is transferred to the lessee.
§ 1.47-4 Electing small business corporation.
(a) In general—(1) Disposition or cessation in hands of corporation. If an electing small business corporation (as defined in section 1371(b)) or a former electing small business corporation disposes of any section 38 property (or if any section 38 property otherwise ceases to be section 38 property in the hands of the corporation) before the close of the estimated useful life which was taken into account in computing qualified investment with respect to such property, a recapture determination shall be made with respect to each shareholder who is treated, under § 1.48-5, as a taxpayer with respect to such property. Each such recapture determination shall be made with respect to the pro rata share of the basis (or cost) of such property taken into account by such shareholder in computing his qualified investment. For purposes of each such recapture determination the actual useful life of such property shall be the period beginning with the date on which it was placed in service by the electing small business corporation and ending with the date of the disposition or cessation. In making a recapture determination under this subparagraph there shall be taken into account any prior recapture determinations made with respect to the shareholder in connection with the same property. For definition of “recapture determination” see paragraph (a)(1) of § 1.47-1.
(2) Disposition of shareholder’s interest. (i) If—
(a) The basis (or cost) of section 38 property is apportioned, under § 1.48-5, to a shareholder of an electing small business corporation who takes such basis (or cost) into account in computing his qualified investment, and
(b) After the end of the shareholder’s taxable year in which such apportionment was taken into account and before the close of the estimated useful life of the property, such shareholder’s proportionate stock interest in such corporation is reduced (for example, by a sale or redemption, or by the issuance of additional shares) below the percentage specified in subdivision (ii) of this subparagraph,
(ii) The percentage referred to in subdivision (i)(b) of this subparagraph is 66
(iii) In determining a shareholder’s proportionate stock interest in a former electing small business corporation for purposes of this subparagraph, the shareholder shall be considered to own stock in such corporation which he owns directly or indirectly (through ownership in other entities provided such other entities’ bases in such stock are determined in whole or in part by reference to the basis of such stock in the hands of the transferor). For example, if A, who owns all of the 100 shares of the outstanding stock of corporation X, a corporation which was formerly an electing small business corporation, transfers on November 1, 1966, 70 shares of X stock to corporation Y in exchange for 90 percent of the stock of Y in a transaction to which section 351 applies, then, for purposes of subdivision (i) of this subparagraph, A shall be considered to own 93 percent of the stock of X, 30 percent directly and 63 percent indirectly (i.e., 90 percent of 70). Any taxpayer who seeks to establish his interest in the stock of a former electing small business corporation under the rule of this subdivision shall maintain adequate records to demonstrate his indirect interest in the corporation after any such transfer or transfers.
(b) Election of a small business corporation under section 1372—(1) General rule. If a corporation makes a valid election under section 1372 to be an electing small business corporation (as defined in section 1371(b)), then on the last day of the taxable year immediately preceding the first taxable year for which such election is effective, any section 38 property the basis (or cost) of which was taken into account in computing the corporation’s qualified investment in taxable years prior to the first taxable year for which the election is effective (and which has not been disposed of or otherwise ceased to be section 38 property with respect to the corporation prior to such last day) shall be considered as having ceased to be section 38 property with respect to such corporation and § 1.47-1 shall apply. However, if the corporation and each of the persons who are shareholders of the corporation on the first day of the first taxable year for which the election under section 1372 is to be effective, or on the date of such election, whichever is later, execute the agreement specified in subparagraph (2) of this paragraph, § 1.47-1 shall not apply to any such section 38 property by reason of the election by the corporation under section 1372.
(2) Agreement of shareholders and corporation. (i) The agreement referred to in subparagraph (1) of this paragraph shall be signed by the shareholders and the corporation, and shall recite that, in the event the section 38 property described in subparagraph (1) of this paragraph is later disposed of by, or ceases to be section 38 property with respect to, the corporation during a taxable year of the corporation for which the election under section 1372 is effective, each such signer agrees (a) to notify the district director of such disposition or cessation, and (b) to be jointly and severally liable to pay to the district director an amount equal to the increase in tax provided by section 47. The amount of such increase shall be determined as if such property had ceased to be section 38 property as of the last day of the taxable year immediately preceding the first taxable year for which the election under section 1372 is effective, except that the actual useful life (within the meaning of paragraph (a) of § 1.47-1) of the property shall be considered to have ended on the date of the actual disposition by, or cessation in the hands of, the electing small business corporation.
(ii) The agreement shall set forth the name, address, and taxpayer account number of each party and the internal revenue district in which each such party files his or its income tax return for the taxable year which includes the last day of the corporation’s taxable year immediately preceding the first taxable year for which the election under section 1372 is effective. The agreement may be signed on behalf of the corporation by any person who is duly authorized. The agreement shall be filed with the district director with whom the corporation files its income tax return for its taxable year immediately preceding the first taxable year for which the election under section 1372 is effective and shall be filed on or before the due date (including extensions of time) of such return. However, if the due date (including extensions of time) of such income tax return is on or before September 1, 1967, the agreement may be filed on or before December 31, 1967. For purposes of the two preceding sentences, the district director may, if good cause is shown, permit the agreement to be filed on a later date.
(c) Examples. This section may be illustrated by the following examples in each of which it is assumed that X Corporation, an electing small business corporation which makes its returns on the basis of the calendar year, acquired and placed in service on June 1, 1962, three items of section 38 property. The basis and estimated useful life of each item of section 38 property are as follows:
Asset No. | Basis | Estimated useful life (Years) |
---|---|---|
1 | $30,000 | 4 |
2 | 30,000 | 6 |
3 | 30,000 | 8 |
Useful life category | |||
---|---|---|---|
4 to 6 years | 6 to 8 years | 8 years or more | |
Total bases | $30,000 | $30,000 | $30,000 |
Shareholder A (10/20) | 15,000 | 15,000 | 15,000 |
Shareholder B (10/20) | 15,000 | 15,000 | 15,000 |
Basis | Applicable percentage | Qualified investment |
---|---|---|
$15,000 | 33 | $5,000 |
$15,000 | 66 | 10,000 |
$15,000 | 100 | 15,000 |
30,000 |
(ii) The actual useful life of asset No. 3 is three years and six months. The recomputed qualified investment with respect to each shareholder’s share of the basis of asset No. 3 is zero ($15,000 share of basis multiplied by zero applicable percentage) and for the taxable year 1962 each shareholder’s recomputed credit earned is $1,050 (7 percent of $15,000). The income tax imposed by chapter 1 of the Code on each of the shareholders for the taxable year 1965 is increased by the $1,050 decrease in his credit earned for the taxable year 1962 (that is, $2,100 original credit earned minus $1,050 recomputed credit earned).
(ii) Under paragraph (a)(2) of this section, on December 3, 1964, 50 percent of the share of the basis of each of the three items of section 38 property ceases to be section 38 property with respect to shareholder A since immediately after the December 3, 1964, sale A’s proportionate stock interest in X Corporation is reduced to 50 percent of the proportionate stock interest in X Corporation which he held on December 31, 1962. The actual useful life of the share of the bases of the section 38 properties which cease to be section 38 property with respect to A is two years and six months (that is, the period beginning with June 1, 1962, and ending with December 3, 1964). A’s recomputed qualified investment with respect to such properties is $15,000, computed as follows:
Basis | Applicable percentage | Recomputed qualified investment |
---|---|---|
$7,500 | 33 | $2,500 |
$7,500 | 66 | 5,000 |
$7,500 | 100 | 7,500 |
15,000 |
(iv) The actual useful life of asset No. 3 which was sold on January 2, 1966, is three years and seven months. The recomputed qualified investment with respect to B’s share of the basis of asset No. 3 is zero ($15,000 share of basis multiplied by zero applicable percentage) and for the taxable year 1962, B’s recomputed credit earned is $1,050 (7 percent of $15,000). The income tax imposed by chapter 1 of the Code on shareholder B for the taxable year 1966 is increased by the $1,050 decrease in his credit earned for the taxable year 1962 ($2,100 original credit earned minus $1,050 recomputed credit earned). The sale of asset No. 3 on January 2, 1966, by X Corporation has no effect on A.
(d) Termination or revocation of an election under section 1372. Section 38 property shall not be considered to be disposed of or to have ceased to be section 38 property solely by reason of a termination or revocation of a corporation’s election under section 1372.
§ 1.47-5 Estates and trusts.
(a) In general—(1) Disposition or cessation in hands of estate or trust. If an estate or trust disposes of any section 38 property (or if any section 38 property otherwise ceases to be section 38 property in the hands of the estate or trust) before the close of the estimated useful life which was taken into account in computing qualified investment with respect to such property, a recapture determination shall be made with respect to the estate or trust, and each beneficiary who is treated, under § 1.48-6, as a taxpayer with respect to such property. Each such recapture determination shall be made with respect to the share of the basis (or cost) of such property taken into account by such estate or trust and such beneficiary in computing its or his each such recapture determination the actual useful life of such property shall be the period beginning with the date on which it was placed in service by the estate or trust and ending with the date of the disposition or cessation. In making a recapture determination under this subparagraph with respect to a taxpayer there shall be taken into account any prior recapture determinations made with respect to such taxpayer in connection with the same property. For definition of “recapture determination” see paragraph (a)(1) of § 1.47-1.
(2) Disposition of interest. (i) If—
(a) The basis (or cost) of section 38 property is apportioned, under § 1.48-6, to an estate or trust which, or to a beneficiary of an estate or trust who, takes such basis (or cost) into account in computing his qualified investment, and
(b) After the date on which such section 38 property was placed in service by the estate or trust and before the close of the estimated useful life of the property, such estate’s, trust’s, or such beneficiary’s proportionate interest in the income of the estate or trust is reduced (for example, by a sale, or by the terms of the estate or trust instrument) below the percentage specified in subdivision (ii) of this subparagraph, then, on the date of such reduction, such section 38 property ceases to be section 38 property with respect to such estate, trust, or beneficiary to the extent of the actual reduction in such estate’s, trust’s, or beneficiary’s proportionate interest in the income of the estate or trust. (For example, if $100 of the basis of section 38 property was apportioned to a beneficiary and if his proportionate interest in the income of the estate or trust is reduced from 60 percent to 30 percent (that is, 50 percent of his original interest), then such property shall be treated as having ceased to be section 38 property to the extent of $50). Accordingly, a recapture determination shall be made with respect to such estate, trust, or beneficiary. For purposes of such recapture determination the actual useful life of such property shall be the period beginning with the date on which it was placed in service by the estate or trust and ending with the date on which it is treated as having ceased to be section 38 property with respect to the estate, trust, or beneficiary. In making a recapture determination under this subparagraph there shall be taken into account any prior recapture determination made with respect to the estate, trust, or beneficiary in connection with the same property.
(ii) The percentage referred to in subdivision (i)(b) of this subparagraph is 66
(iii) In determining a beneficiary’s proportionate interest in the income of an estate or trust for purposes of this subparagraph, the beneficiary shall be considered to own any interest in such an estate or trust which he owns directly or indirectly (through ownership in other entities provided such other entities’ bases in such interest are determined in whole or in part by reference to the basis of such interest in the hands of the beneficiary). For example, if A, whose proportionate interest in the income of trust X is 30 percent, transfers all of such interest to corporation Y in exchange for all of the stock of Y in a transaction to which section 351 applies, then, for purposes of subdivision (i) of this subparagraph, A shall be considered to own a 30-percent interest in trust X. Any taxpayer who seeks to establish his interest in an estate or trust under the rule of this subdivision shall maintain adequate records to demonstrate his indirect interest in the estate or trust after any such transfer or transfers.
(b) Examples. Paragraph (a) of this section may be illustrated by the following examples in each of which it is assumed that XYZ Trust, which makes its returns on the basis of the calendar year, acquired and placed in service on June 1, 1962, three items of section 38 property. The basis and estimated useful life of each item of section 38 property are as follows:
Asset No. | Basis | Estimated useful life (Years) |
---|---|---|
1 | $30,000 | 4 |
2 | 30,000 | 6 |
3 | 30,000 | 8 |
Useful life category | ||||
---|---|---|---|---|
4 to 6 years | 6 to 8 years | 8 years or more | ||
Total bases | $30,000 | $30,000 | $30,000 | |
($10,000) | 15,000 | 15,000 | 15,000 | |
XYZ Trust | ($20,000) | |||
Beneficiary A | ($10,000) | 15,000 | 15,000 | 15,000 |
($20,000) |
Basis | Applicable percentage | Qualified investment |
---|---|---|
$15,000 | 33 | $5,000 |
$15,000 | 66 | 10,000 |
$15,000 | 100 | 15,000 |
30,000 |
(ii) The actual useful life of asset No. 3 is three years and six months. The recomputed qualified investment with respect to XYZ Trust’s and beneficiary A’s share of the basis of asset No. 3 is zero ($15,000 share of basis multiplied by zero applicable percentage) and for the taxable year 1962, XYZ Trust’s and beneficiary A’s recomputed credit earned is $1,050 (7 percent of $15,000). The income tax imposed by chapter 1 of the Code on XYZ Trust and on beneficiary A for the taxable year 1965 is increased by the $1,050 decrease in his credit earned for the taxable year 1962 (that is, $2,100 original credit earned minus $1,050 recomputed credit earned).
(ii) Under paragraph (a)(2) of this section, on December 3, 1964, 50 percent of the basis of each of the three items of section 38 property ceases to be section 38 property with respect to beneficiary A since immediately after the December 3, 1964, sale A’s proportionate interest in the income of XYZ Trust is reduced to 50 percent of his proportionate interest in the income of XYZ Trust for the taxable year 1962. The actual useful life of the share of the bases of the section 38 properties which cease to be section 38 property with respect to A is two years and six months (that is, the period beginning with June 1, 1962, and ending with December 3, 1964). Beneficiary A’s recomputed qualified investment with respect to such properties is $15,000, computed as follows:
Basis | Applicable percentage | Qualified investment |
---|---|---|
$7,500 | 33 | $2,500 |
$7,500 | 66 | 5,000 |
$7,500 | 100 | 7,500 |
15,000 |
(iv) The actual useful life of asset No. 3 which was sold on January 2, 1966, is three years and seven months. The recomputed qualified investment with respect to XYZ Trust’s share of the basis of asset No. 3 is zero ($15,000 share of basis multiplied by zero applicable percentage) and for the taxable year 1962, XYZ Trust’s recomputed credit earned is $1,050 (7 percent of $15,000). The income tax imposed by chapter 1 of the Code on XYZ Trust for the taxable year 1966 is increased by the $1,050 decrease in its credit earned for the taxable year 1962 ($2,100 original credit earned minus $1,050 recomputed credit earned). The sale of asset No. 3 on January 2, 1966, has no effect on A.
§ 1.47-6 Partnerships.
(a) In general—(1) Disposition or cessation in hands of partnership. If a partnership disposes of any partnership section 38 property (or if any partnership section 38 property otherwise ceases to be section 38 property in the hands of the partnership) before the close of the estimated useful life which was taken into account in computing qualified investment with respect to such property, a recapture determination shall be made with respect to each partner who is treated, under paragraph (f) of § 1.46-3, as a taxpayer with respect to such property. Each such recapture determination shall be made with respect to the share of the basis (or cost) of such property taken into account by such partner in computing his qualified investment. For purposes of each such recapture determination the actual useful life of such property shall be the period beginning with the date on which it was placed in service by the partnership and ending with the date of the disposition or cessation. In making a recapture determination under this subparagraph there shall be taken into account any prior recapture determinations made with respect to the partner in connection with the same property. For definition of “recapture determination” see paragraph (a)(1) of § 1.47-1.
(2) Disposition of partner’s interest. (i) If—
(a) The basis (or cost) of partnership section 38 property is taken into account by a partner in computing his qualified investment, and
(b) After the date on which such partnership section 38 property was placed in service by the partnership and before the close of the estimated useful life of the property, such partner’s proportionate interest in the general profits of the partnership (or in the particular item of property) is reduced (for example, by a sale, by a change in the partnership agreement, or by the admission of a new partner) below the percentage specified in subdivision (ii) of this subparagraph, then, on the date of such reduction such partnership section 38 property ceases to be section 38 property with respect to such partner to the extent of the actual reduction in such partner’s proportionate interest in the general profits of the partnership (or in the particular item of property). (For example, if $100 of the basis of section 38 property was taken into account by a partner and if his proportionate interest in the general profits of the partnership is reduced from 60 percent to 30 percent (that is, 50 percent of his original interest), then such property shall be treated as having ceased to be section 38 property to the extent of $50.) Accordingly, a recapture determination shall be made with respect to such partner. For purposes of such recapture determination the actual useful life of such property shall be the period beginning with the date on which it was placed in service by the partnership and ending with the date on which it is treated as having ceased to be section 38 property with respect to the partner. In making a recapture determination under this subparagraph there shall be taken into account any prior recapture determination made with respect to the partner in connection with the same property.
(ii) The percentage referred to in subdivision (i)(b) of this subparagraph is 66
(iii) In determining a partner’s proportionate interest in the general profits of a partnership for purposes of this subparagraph, the partner shall be considered to own any interest in such a partnership which he owns directly or indirectly (through ownership in other entities provided the other entities’ bases in such interest are determined in whole or in part by reference to the basis of such interest in the hands of the partner). For example, if A, whose proportionate interest in the general profits of partnership X is 20 percent, transfers all of such interest to corporation Y in exchange for all of the stock of Y in a transaction to which section 351 applies, then, for purposes of subdivision (i) of this subparagraph, A shall be considered to own a 20-percent interest in partnership X. Any taxpayer who seeks to establish his interest in a partnership under the rule of this subdivision shall maintain adequate records to demonstrate his indirect interest in the partnership after any such transfer or transfers.
(b) Examples. Paragraph (a) of this section may be illustrated by the following examples in each of which it is assumed that ABC Partnership, which makes its returns on the basis of the calendar year, acquired and placed in service on June 1, 1962, three items of section 38 property. The basis and estimated useful life of each item of section 38 property are as follows:
Asset No. | Basis | Estimated useful life Years |
---|---|---|
1 | $30,000 | 4 |
2 | 30,000 | 6 |
3 | 30,000 | 8 |
Asset No. | Estimated useful life (years) | Basis | Partners share of basis | |
---|---|---|---|---|
A 50 percent | B 50 percent | |||
1 | 4 | $30,000 | $15,000 | $15,000 |
2 | 6 | 30,000 | 15,000 | 15,000 |
3 | 8 | 30,000 | 15,000 | 15,000 |
Partnership asset No. | Share of basis | Applicable percentage | Qualified investment |
---|---|---|---|
1 | $15,000 | 33 | $5,000 |
2 | 15,000 | 66 | 10,000 |
3 | 15,000 | 100 | 15,000 |
30,000 |
(ii) The actual useful life of asset No. 3 is three years and six months. The recomputed qualified investment with respect to each partner’s share of the basis of asset No. 3 is zero ($15,000 shares of basis multiplied by zero applicable percentage) and for the taxable year 1962, each partner’s recomputed credit earned is $1,050 (7 percent of $15,000). The income tax imposed by chapter 1 of the Code on each of the partners for the taxable year 1965 is increased by the $1,050 decrease in his credit earned for the taxable year 1962 (that is, $2,100 original credit earned minus $1,050 recomputed credit earned).
(ii) Under paragraph (a)(2) of this section, on December 3, 1964, 50 percent of the basis of each of the three items of section 38 property ceases to be section 38 property with respect to partner A since immediately after the December 3, 1964, sale A’s proportionate interest in the general profits of ABC Partnership is reduced to 50 percent of his proportionate interest in the general profits of ABC Partnership for 1962. The actual useful life of the share of the basis of each of the section 38 properties which cease to be section 38 property with respect to A is two years and six months (that is, the period beginning with June 1, 1962, and ending with December 3, 1964). Partner A’s recomputed qualified investment with respect to such properties is $15,000, computed as follows:
Partnership asset No. | Share of basis | Applicable percentage | Qualified investment |
---|---|---|---|
1 | $7,500 | 33 | $2,500 |
2 | 7,500 | 66 | 5,000 |
3 | 7,500 | 100 | 7,500 |
15,000 |
(iv) The actual useful life of asset No. 3 which was sold on January 2, 1966, is three years and seven months. The recomputed qualified investment with respect to partner B’s share of the basis of asset No. 3 is zero ($15,000 share of basis multiplied by zero applicable percentage) and for the taxable year 1962, partner B’s recomputed credit earned is $1,050 (7 percent of $15,000). The income tax imposed by chapter 1 of the Code on partner B for the taxable year 1966 is increased by the $1,050 decrease in his credit earned for the taxable year 1962 ($2,100 original credit earned minus $1,050 recomputed credit earned). The sale of asset No. 3 on January 2, 1966, has no effect on A.
§ 1.47-7 Rehabilitation credit allocated over a 5-year period.
(a) In general. For purposes of section 46, for any taxable year during the 5-year period beginning in the taxable year in which a qualified rehabilitated building, as defined in section 47(c)(1) and § 1.48-12(b), is placed in service, the rehabilitation credit for the taxable year is an amount equal to the ratable share for the taxable year, provided the requirements of section 47 are satisfied. Except as provided by section 13402(c)(2) of Public Law 115-97, 131 Stat. 2054 (2017), this section applies with respect to qualified rehabilitation expenditures, as defined in section 47(c)(2) and § 1.48-12(c), paid or incurred after December 31, 2017.
(b) Ratable share. For purposes of paragraph (a) of this section, the term ratable share means, for any taxable year during the 5-year period described in such paragraph, the amount equal to 20 percent of the rehabilitation credit determined with respect to the qualified rehabilitated building, allocated ratably to each year during such period.
(c) Rehabilitation credit determined. The term rehabilitation credit determined means the amount equal to 20 percent of the qualified rehabilitation expenditures, as defined in section 47(c)(2) and § 1.48-12(c), taken into account under section 47(b)(1) for the taxable year in which the qualified rehabilitated building is placed in service. However, if the taxpayer claims the additional first year depreciation for the qualified rehabilitation expenditures pursuant to § 1.168(k)-2(g)(9), the term rehabilitation credit determined means the amount equal to 20 percent of the remaining rehabilitated basis, as defined in § 1.168(k)-2(g)(9)(i)(B), of the qualified rehabilitated building for the taxable year in which such building is placed in service.
(d) Coordination with section 50. For purposes of section 50 and § 1.50-1, the amount of the rehabilitation credit determined is the amount defined in paragraph (c) of this section.
(e) Examples. The provisions of paragraphs (a) through (d) of this section are illustrated by the following examples. Assume that the additional first year depreciation deduction provided by section 168(k) is not allowed or allowable for the qualified rehabilitation expenditures.
(1) Example 1: Rehabilitation Credit Determined and Ratable Share. Between February 1, 2021 and October 1, 2021, X, a calendar year C corporation, incurred qualified rehabilitation expenditures of $200,000 with respect to a qualified rehabilitated building. X placed the building in service on October 15, 2021. X’s rehabilitation credit determined in 2021 under paragraph (c) of this section is $40,000 ($200,000 × 0.20). For purposes of section 46, for each taxable year during the 5-year period beginning in 2021, the ratable share allocated under paragraph (b) of this section for the year is $8,000 ($40,000 × 0.20).
(2) Example 2: Coordination with section 50(c). The facts are the same as in paragraph (e)(1) of this section (Example 1). For purposes of determining the amount of X’s basis adjustment in 2021 under section 50(c), the amount of the rehabilitation credit determined under paragraph (c) of this section is $40,000.
(3) Example 3: Coordination with section 50(a). The facts are the same as in paragraph (e)(1) of this section (Example 1). In 2021 and 2022, X claimed the full amount of the ratable share allowed under section 46, or $8,000 per taxable year. X’s total allowable ratable share for 2023 through 2025 is $24,000 ($8,000 allowable per taxable year). On November 1, 2023, X disposes of the qualified rehabilitated building. Under section 50(a)(1)(B)(iii), because the period of time between when the qualified rehabilitated building was placed in service is more than two, but less than 3 full years, the applicable recapture percentage is 60%. Based on these facts, X has an increase in tax of $9,600 under section 50(a) ($16,000 of credit claimed in 2021 and 2022 × 0.60) and has $3,200 of credits remaining in each of 2023 through 2025, after forgoing $4,800 in credits in each of the years 2023 through 2025 ($8,000 × 0.60).
(4) Example 4: Coordination with section 50(d)(5) and § 1.50-1; C corporation lessee. X, a calendar year C corporation, leases nonresidential real property from Y. The property is a qualified rehabilitated building that is placed in service on October 15, 2021. Under paragraph (c) of this section, the amount of the rehabilitation credit determined is $100,000. Y elects under § 1.48-4 to treat X as having acquired the property. The shortest recovery period that could be available to the property under section 168 is 39 years. Because Y has elected to treat X as having acquired the property, Y does not reduce its basis in the property under section 50(c). Instead, pursuant to section 50(d)(5) and § 1.50-1, X, the lessee of the property, must include ratably in gross income over 39 years an amount equal to the rehabilitation credit determined with respect to such property.
(5) Example 5: Coordination with section 50(d)(5) and § 1.50-1; partnership lessee. A and B, calendar year taxpayers, form a partnership, the AB partnership, that leases nonresidential real property from Y. The property is a qualified rehabilitated building that is placed in service on October 15, 2021. Under paragraph (c) of this section, the amount of the rehabilitation credit determined is $200,000. Y elects under § 1.48-4 to treat the AB partnership as having acquired the property. The shortest recovery period that could be available to the property under section 168 is 39 years. Because Y has elected to treat the AB partnership as having acquired the property, Y does not reduce its basis in the building under section 50(c). Instead, A and B, the ultimate credit claimants, as defined in § 1.50-1(b)(3)(ii), must include the amount of the rehabilitation credit determined under paragraph (c) of this section with respect to A and B ratably in gross income over 39 years, the shortest recovery period available with respect to such property.
(f) Applicability date. This section applies to taxable years beginning on or after September 18, 2020. Taxpayers may choose to apply this section for taxable years beginning before September 18, 2020, provided the taxpayer applies this section in its entirety and in a consistent manner.
§ 1.48-1 Definition of section 38 property.
(a) In general. Property which qualifies for the credit allowed by section 38 is known as “section 38 property”. Except as otherwise provided in this section, the term “section 38 property” means property (1) with respect to which depreciation (or amortization in lieu of depreciation) is allowable to the taxpayer, (2) which has an estimated useful life of 3 years or more (determined as of the time such property is placed in service), and (3) which is (i) tangible personal property, (ii) other tangible property (not including a building and its structural components) but only if such other property is used as an integral part of manufacturing, production, or extraction, or an integral part of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services by a person engaged in a trade or business of furnishing any such service, or is a research or storage facility used in connection with any of the foregoing activities, (iii) an elevator or escalator which satisfies the conditions of section 48(a)(1)(C), or (iv) in the case of a qualified rehabilitated building, that portion of the basis which is attributable to qualified rehabilitation expenditures. The determination of whether property qualifies as section 38 property in the hands of the taxpayer for purposes of the credit allowed by section 38 must be made with respect to the first taxable year in which such property is placed in service by the taxpayer. See paragraph (d) of § 1.46-3. For the meaning of “estimated useful life”, see paragraph (e) of § 1.46-3. In the case of property which is not described in section 50, this paragraph shall be applied by substituting “4 years” for “3 years”.
(b) Depreciation allowable. (1) Property (with the exception of property described in section 48(a)(1)(F) and paragraph (p) of this section) is not section 38 property unless a deduction for depreciation (or amortization in lieu of depreciation) with respect to such property is allowable to the taxpayer for the taxable year. A deduction for depreciation is allowable if the property is of a character subject to the allowance for depreciation under section 167 and the basis (or cost) of the property is recovered through a method of depreciation, including, for example, the unit of production method and the retirement method as well as methods of depreciation which measure the life of the property in terms of years. If property is placed in service (within the meaning of paragraph (d) of § 1.46-3) in a trade or business (or in the production of income), but under the taxpayer’s depreciation practice the period for depreciation with respect to such property begins in a taxable year subsequent to the taxable year in which such property is placed in service, then a deduction for depreciation shall be treated as allowable with respect to such property in the earlier taxable year (or years). Thus, for example, if a machine is placed in service in a trade or business in 1963, but the period for depreciation with respect to such machine begins in 1964, because the taxpayer uses an averaging convention (see § 1.167(a)-10) in computing depreciation, then, for purposes of determining whether the machine qualifies as section 38 property, a deduction for depreciation shall be treated as allowable in 1963.
(2) If, for the taxable year in which property is placed in service, a deduction for depreciation is allowable to the taxpayer only with respect to a part of such property, then only the proportionate part of the property with respect to which such deduction is allowable qualifies as section 38 property for the purpose of determining the amount of credit allowable under section 38. Thus, for example, if property is used 80 percent of the time in a trade or business and is used 20 percent of the time for personal purposes, only 80 percent of the basis (or cost) of such property qualifies as section 38 property. Further, property does not qualify to the extent that a deduction for depreciation thereon is disallowed under section 274 (relating to disallowance of certain entertainment, etc., expenses).
(3) If the cost of property is not recovered through a method of depreciation but through a deduction of the full cost in one taxable year, for purposes of subparagraph (1) of this paragraph a deduction for depreciation with respect to such property is not allowable to the taxpayer. However, if an adjustment with respect to the income tax return for such taxable year requires the cost of such property to be recovered through a method of depreciation, a deduction for depreciation will be considered as allowable to the taxpayer.
(4) If depreciation sustained on property is not an allowable deduction for the taxable year but is added to the basis of property being constructed, reconstructed, or erected by the taxpayer, for purposes of subparagraph (1) of this paragraph a deduction for depreciation shall be treated as allowable for the taxable year with respect to the property on which depreciation is sustained. Thus, if $1,000 of depreciation sustained with respect to property No. 1, which is placed in service in 1964 by taxpayer A, is not allowable to A as a deduction for 1964 but is added to the basis of property being constructed by A (property no. 2), for purposes of subparagraph (1) of this paragraph a deduction for depreciation shall be treated as allowable to A for 1964 with respect to property no. 1. However, the $1,000 amount is not included in the basis of property no. 2 for purposes of determining A’s qualified investment with respect to property no. 2. See paragraph (c)(1) of § 1.46-3.
(c) Definition of tangible personal property. If property is tangible personal property it may qualify as section 38 property irrespective of whether it is used as an integral part of an activity (or constitutes a research or storage facility used in connection with such activity) specified in paragraph (a) of this section. Local law shall not be controlling for purposes of determining whether property is or is not “tangible” or “personal”. Thus, the fact that under local law property is held to be personal property or tangible property shall not be controlling. Conversely, property may be personal property for purposes of the investment credit even though under local law the property is considered to be a fixture and therefore real property. For purposes of this section, the term “tangible personal property” means any tangible property except land and improvements thereto, such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures). Thus, buildings, swimming pools, paved parking areas, wharves and docks, bridges, and fences are not tangible personal property. Tangible personal property includes all property (other than structural components) which is contained in or attached to a building. Thus, such property as production machinery, printing presses, transportation and office equipment, refrigerators, grocery counters, testing equipment, display racks and shelves, and neon and other signs, which is contained in or attached to a building constitutes tangible personal property for purposes of the credit allowed by section 38. Further, all property which is in the nature of machinery (other than structural components of a building or other inherently permanent structure) shall be considered tangible personal property even though located outside a building. Thus, for example, a gasoline pump, hydraulic car lift, or automatic vending machine, although annexed to the ground, shall be considered tangible personal property.
(d) Other tangible property—(1) In general. In addition to tangible personal property, any other tangible property (but not including a building and its structural components) used as an integral part of manufacturing, production, or extraction, or as an integral part of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services by a person engaged in a trade or business of furnishing any such service, or which constitutes a research or storage facility used in connection with any of the foregoing activities, may qualify as section 38 property.
(2) Manufacturing, production, and extraction. For purposes of the credit allowed by section 38, the terms “manufacturing”, “production”, and “extraction” include the construction, reconstruction, or making of property out of scrap, salvage, or junk material, as well as from new or raw material, by processing, manipulating, refining, or changing the form of an article, or by combining or assembling two or more articles, and include the cultivation of the soil, the raising of livestock, and the mining of minerals. Thus, section 38 property would include, for example, property used as an integral part of the extracting, processing, or refining of metallic and nonmetallic minerals, including oil, gas, rock, marble, or slate; the construction of roads, bridges, or housing; the processing of meat, fish or other foodstuffs; the cultivation of orchards, gardens, or nurseries; the operation of sawmills, the production of lumber, lumber products or other building materials; the fabrication or treatment of textiles, paper, leather goods, or glass; and the rebuilding, as distinguished from the mere repairing, of machinery.
(3) Transportation and communications businesses. Examples of transportation businesses include railroads, airlines, bus companies, shipping or trucking companies, and oil pipeline companies. Examples of communications businesses include telephone or telegraph companies and radio or television broadcasting companies.
(4) Integral part. In order to qualify for the credit, property (other than tangible personal property and research or storage facilities used in connection with any of the activities specified in subparagraph (1) of this paragraph) must be used as an integral part of one or more of the activities specified in subparagraph (1) of this paragraph. Property such as pavements, parking areas, inherently permanent advertising displays or inherently permanent outdoor lighting facilities, or swimming pools, although used in the operation of a business, ordinarily is not used as an integral part of any of such specified activities. Property is used as an integral part of one of the specified activities if it is used directly in the activity and is essential to the completeness of the activity. Thus, for example, in determining whether property is used as an integral part of manufacturing, all properties used by the taxpayer in acquiring or transporting raw materials or supplies to the point where the actual processing commences (such as docks, railroad tracks and bridges), or in processing raw materials into the taxpayer’s final product, would be considered as property used as an integral part of manufacturing. Specific examples of property which normally would be used as an integral part of one of the specified activities are blast furnaces, oil and gas pipelines, railroad tracks and signals, telephone poles, broadcasting towers, oil derricks, and fences used to confine livestock. Property shall be considered used as an integral part of one of the specified activities if so used either by the owner of the property or by the lessee of the property.
(5) Research or storage facilities. (i) If property (other than a building and its structural components) constitutes a research or storage facility and if it is used in connection with an activity specified in subparagraph (1) of this paragraph, such property may qualify as section 38 property even though it is not used as an integral part of such activity. Examples of research facilities include wind tunnels and test stands. Examples of storage facilities include oil and gas storage tanks and grain storage bins. Although a research or storage facility must be used in connection with, for example, a manufacturing process, the taxpayer-owner of such facility need not be engaged in the manufacturing process.
(ii) In the case of property described in section 50, property will constitute a storage facility only if the facility is used principally for the bulk storage of fungible commodities. Bulk storage means the storage of a commodity in a large mass prior to its consumption or utilization. Thus, if a facility is used to store oranges that have been sorted and boxed, it is not used for bulk storage.
(e) Definition of building and structural components. (1) Generally, buildings and structural components thereof do not qualify as section 38 property. See, however, section 48(a)(1)(E) and (g), and § 1.48-11 (relating to investment credit for qualified rehabilitated building). The term “building” generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores. Such term includes any such structure constructed by, or for, a lessee even if such structure must be removed, or ownership of such structure reverts to the lessor, at the termination of the lease. Such term does not include (i) a structure which is essentially an item of machinery or equipment, or (ii) a structure which houses property used as an integral part of an activity specified in section 48(a)(1)(B)(i) if the use of the structure is so closely related to the use of such property that the structure clearly can be expected to be replaced when the property it initially houses is replaced. Factors which indicate that a structure is closely related to the use of the property it houses include the fact that the structure is specifically designed to provide for the stress and other demands of such property and the fact that the structure could not be economically used for other purposes. Thus, the term “building” does not include such structures as oil and gas storage tanks, grain storage bins, silos, fractionating towers, blast furnaces, basic oxygen furnaces, coke ovens, brick kilns, and coal tipples.
(2) The term “structural components” includes such parts of a building as walls, partitions, floors, and ceilings, as well as any permanent coverings therefor such as paneling or tiling; windows and doors; all components (whether in, on, or adjacent to the building) of a central air conditioning or heating system, including motors, compressors, pipes and ducts; plumbing and plumbing fixtures, such as sinks and bathtubs; electric wiring and lighting fixtures; chimneys; stairs, escalators, and elevators, including all components thereof; sprinkler systems; fire escapes; and other components relating to the operation or maintenance of a building. However, the term “structural components” does not include machinery the sole justification for the installation of which is the fact that such machinery is required to meet temperature or humidity requirements which are essential for the operation of other machinery or the processing of materials or foodstuffs. Machinery may meet the “sole justification” test provided by the preceding sentence even though it incidentally provides for the comfort of employees, or serves, to an insubstantial degree, areas where such temperature or humidity requirements are not essential. For example, an air conditioning and humidification system installed in a textile plant in order to maintain the temperature or humidity within a narrow optimum range which is critical in processing particular types of yarn or cloth is not included within the term “structural components”. For special rules with respect to an elevator or escalator, the construction, reconstruction, or erection of which is completed by the taxpayer after June 30, 1963, or which is acquired after June 30, 1963, and the original use of which commences with the taxpayer and commences after such date, see section 48(a)(1)(C) and paragraph (m) of this section.
(f) Intangible property. Intangible property, such as patents, copyrights, and subscription lists, does not qualify as section 38 property. The cost of intangible property, in the case of a patent or copyright, includes all costs of purchasing or producing the item patented or copyrighted. Thus, in the case of a motion picture or television film or tape, the cost of the intangible property includes manuscript and screenplay costs, the cost of wardrobe and set design, the salaries of cameramen, actors, directors, etc., and all other costs properly includible in the basis of such film or tape. In the case of a book, the cost of the intangible property includes all costs of producing the original copyrighted manuscript, including the cost of illustration, research, and clerical and stenographic help. However, if tangible depreciable property is used in the production of such intangible property, see paragraph (b)(4) of this section.
(g) Property used outside the United States—(1) General rule. (i) Except as provided in subparagraph (2) of this paragraph, the term “section 38 property” does not include property which is used predominantly outside the United States (as defined in section 7701(a)(9)) during the taxable year. The determination of whether property is used predominantly outside the United States during the taxable year shall be made by comparing the period of time in such year during which the property is physically located outside the United States with the period of time in such year during which the property is physically located within the United States. If the property is physically located outside the United States during more than 50 percent of the taxable year, such property shall be considered used predominantly outside the United States during that year. If property is placed in service after the first day of the taxable year, the determination of whether such property is physically located outside the United States during more than 50 percent of the taxable year shall be made with respect to the period beginning on the date on which the property is placed in service and ending on the last day of such taxable year.
(ii) Since the determination of whether a credit is allowable to the taxpayer with respect to any property may be made only with respect to the taxable year in which the property is placed in service by the taxpayer, property used predominantly outside the United States during the taxable year in which it is placed in service cannot qualify as section 38 property with respect to such taxpayer, regardless of the fact that the property is permanently returned to the United States in a later year. Furthermore, if property is used predominantly in the United States in the year in which it is placed in service by the taxpayer, and a credit under section 38 is allowed with respect to such property, but such property is thereafter in any one year used predominantly outside the United States, such property ceases to be section 38 property with respect to the taxpayer and is subject to the application of section 47.
(iii) This subparagraph applies whether property is used predominantly outside the United States by the owner of the property, or by the lessee of the property. If property is leased and if the lessor makes a valid election under § 1.48-4 to treat the lessee as having purchased such property for purposes of the credit allowed by section 38, the determination of whether such property is physically located outside the United States during more than 50 percent of the taxable year shall be made with respect to the taxable year of the lessee; however, if the lessor does not make such an election, such determination shall be made with respect to the taxable year of the lessor.
(2) Exceptions. The provisions of subparagraph (1) of this paragraph do not apply to—
(i) Any aircraft which is registered by the Administrator of the Federal Aviation Agency, and which (a) is operated, whether on a scheduled or nonscheduled basis, to and from the United States, or (b) is placed in service by the taxpayer during a taxable year ending after March 9, 1967, and is operated under contract with the United States: Provided, That use of the aircraft under the contract constitutes its principal use outside the United States during the taxable year. The term “to and from the United States” is not intended to exclude an aircraft which makes flights from one point in a foreign country to another such point, as long as such aircraft returns to the United States with some degree of frequency;
(ii) Rolling stock, of a domestic railroad corporation subject to part I of the Interstate Commerce Act, which is used within and without the United States. For purposes of this subparagraph, the term “rolling stock” means locomotives, freight and passenger train cars, floating equipment, and miscellaneous transportation equipment on wheels, the expenditures for which are chargeable (or, in the case of leased property, would be chargeable) to the equipment investment accounts in the uniform system of accounts for railroad companies prescribed by the Interstate Commerce Commission;
(iii) Any vessel documented under the laws of the United States which is operated in the foreign or domestic commerce of the United States. A vessel is documented under the laws of the United States if it is registered, enrolled, or licensed under the laws of the United States by the Commandant, U.S. Coast Guard. Vessels operated in the foreign or domestic commerce of the United States include those documented for use in foreign trade, coastwise trade, or fisheries;
(iv) Any motor vehicle of a United States person (as defined in section 7701(a)(30)) which is operated to and from the United States with some degree of frequency;
(v) Any container of a United States person which is used in the transportation of property to and from the United States;
(vi) Any property (other than a vessel or an aircraft) of a U.S. person which is used for the purpose of exploring for, developing, removing, or transporting resources from the outer Continental Shelf (within the meaning of section 2 of the Outer Continental Shelf Lands Act, as amended and supplemented; 43 U.S.C. 1331). Thus for example, offshore drilling equipment may be section 38 property;
(vii) Any property placed in service after December 31, 1965 which (a) is owned by a domestic corporation (other than a corporation entitled to the benefits of section 931 or 934(b)) or by a United States citizen (other than a citizen entitled to the benefits of section 931, 932, 933, or 934(c)), and (b) is used predominantly in a possession of the United States during the taxable year by such a corporation or such a citizen, or by a corporation created or organized in, or under the law of, a possession of the United States. Thus, property placed in service after December 31, 1965, which is owned by a domestic corporation not entitled to the benefits of section 931 or 934(b), which is leased to a corporation organized under the laws of a U.S. possession, and which is used by such lessee predominantly in a possession of the United States may qualify as section 38 property. However, property which is owned by a corporation not entitled to the benefits of section 931 or 934(b) but which is leased to a domestic corporation entitled to such benefits would not qualify as section 38 property. The determination of whether property is used predominantly in a possession of the United States during the taxable year shall be made under principles similar to those described in subparagraph (1) of this paragraph. For example, if a machine is placed in service in a possession of the United States on July 1, 1966, by a calendar year taxpayer and if it is physically located in such a possession during more than 50 percent of the period beginning on July 1, 1966 and ending on December 31, 1966, then such machine shall be considered used predominantly in a possession of the United States during the taxable year 1966;
(viii) Any communications satellite (as defined in section 103(3) of the Communications Satellite Act of 1962, 47 U.S.C., sec. 702(3)), or any interest therein, of a U.S. person;
(ix) Any cable which is property described in section 50, or any interest therein, of a domestic corporation engaged in furnishing telephone service to which section 46(c)(3)(B)(iii) applies (or of a wholly owned domestic subsidiary of such corporation), if such cable is part of a submarine cable system which constitutes part of a communications link exclusively between the United States and one or more foreign countries; and
(x) Any property described in section 50 (other than a vessel or an aircraft) of a U.S. person which is used in international or territorial waters for the purpose of exploring for, developing, removing, or transporting resources from ocean waters or deposits under such waters.
(h) Property used for lodging—(1) In general. (i) Except as provided in subparagraph (2) of this paragraph, the term “section 38 property” does not include property which is used predominantly to furnish lodging or is used predominantly in connection with the furnishing of lodging during the taxable year. Property used in the living quarters of a lodging facility, including beds and other furniture, refrigerators, ranges, and other equipment, shall be considered as used predominantly to furnish lodging. The term “lodging facility” includes an apartment house, hotel, motel, dormitory, or any other facility (or part of a facility) where sleeping accommodations are provided and let, except that such term does not include a facility used primarily as a means of transportation (such as an aircraft, vessel, or a railroad car) or used primarily to provide medical or convalescent services, even though sleeping accommodations are provided.
(ii) Property which is used predominantly in the operation of a lodging facility or in serving tenants shall be considered used in connection with the furnishing of lodging, whether furnished by the owner of the lodging facility or another person. Thus, for example, lobby furniture, office equipment, and laundry and swimming pool facilities used in the operation of an apartment house or in serving tenants would be considered used predominantly in connection with the furnishing of lodging. However, property which is used in furnishing, to the management of a lodging facility or its tenants, electrical energy, water, sewage disposal services, gas, telephone service, or other similar services shall not be treated as property used in connection with the furnishing of lodging. Thus, such items as gas and electric meters, telephone poles and lines, telephone station and switchboard equipment, and water and gas mains, furnished by a public utility would not be considered as property used in connection with the furnishing of lodging.
(iii) Notwithstanding any other provision of this paragraph (h), in the case of a qualified rehabilitated building (within the meaning of section 48(g)(1) and § 1.48-12(b)), expenditures for property resulting in basis described in section 48(a)(1)(E) shall not be treated as section 38 property to the extent that such property is attributable to a portion of the building that is used for lodging or in connection with lodging. For example, if expenditures are incurred to rehabilitate a five story qualified rehabilitated building, three floors of which are used for apartments and two floors of which are used as commercial office space, the portion of the basis of the building attributable to qualified rehabilitated expenditures attributable to the commercial part of the building shall not be considered to be expenditures for property, or in connection with property, used predominantly for lodging. Allocation of expenditures between the two portions of the building are to be made using the principles contained in § 1.48-12(C)(10)(ii).
(2) Exceptions—(i) Nonlodging commercial facility. A nonlodging commercial facility which is available to persons not using the lodging facility on the same basis as it is available to the tenants of the lodging facility shall not be treated as property which is used predominantly to furnish lodging or predominantly in connection with the furnishing of lodging. Examples of non-lodging commercial facilities include restaurants, drug stores, grocery stores, and vending machines located in a lodging facility.
(ii) Property used by a hotel or motel. Property used by a hotel, motel, inn, or other similar establishment, in connection with the trade or business of furnishing lodging shall not be considered as property which is used predominantly to furnish lodging or predominantly in connection with the furnishing of lodging, provided that the predominant portion of the living accommodations in the hotel, motel, etc., is used by transients during the taxable year. For purposes of the preceding sentence, the term “predominant portion” means “more than one-half”. Thus, if more than one-half of the living quarters of a hotel, motel, inn, or other similar establishment is used during the taxable year to accommodate tenants on a transient basis, none of the property used by such hotel, motel, etc., in the trade or business of furnishing lodging shall be considered as property which is used predominantly to furnish lodging or predominantly in connection with the furnishing of lodging. Accommodations shall be considered used on a transient basis if the rental period is normally less than 30 days.
(iii) Coin-operated machines. In the case of property which is described in section 50, coin-operated vending machines and coin-operated washing machines and dryers shall not be considered as property which is used predominantly to furnish lodging or predominantly in connection with the furnishing of lodging.
(iv) Certified historic structures. For purposes of this paragraph (h), regardless of the actual use of a certified historic structure, that portion of the basis of such certified historic structure which is attributable to qualified rehabilitation expenditures (as defined in § 1.48-12(c)) shall not be considered as property which is either used predominantly to furnish lodging or predominantly in connection with the furnishing of lodging. Accordingly, such portion of the basis may qualify as section 38 property. (For the definition of “certified historic structure,” see section 48(g)(3) and § 1.48-12(d).)
(i) [Reserved]
(j) Property used by certain tax-exempt organizations. The term “section 38 property” does not include property used by an organization (other than a cooperative described in section 521) which is exempt from the tax imposed by chapter 1 of the Code unless such property is used predominantly in an unrelated trade or business the income of which is subject to tax under section 511. If such property is debt-financed property as defined in section 514(b), the basis or cost of such property for purposes of computing qualified investment under section 46(c) shall include only that percentage of the basis or cost which is the same percentage as is used under section 514(a), for the year the property is placed in service, in computing the amount of gross income to be taken into account during such taxable year with respect to such property. The term “property used by an organization” means (1) property owned by the organization (whether or not leased to another person), and (2) property leased to the organization. Thus, for example, a data processing or copying machine which is leased to an organization exempt from tax would be considered as property used by such organization. Property (unless used predominantly in an unrelated trade or business) leased by another person to an organization exempt from tax or leased by such an organization to another person is not section 38 property to either the lessor or the lessee, and in either case the lessor may not elect under § 1.48-4 to treat the lessee of such property as having purchased such property for purposes of the credit allowed by section 38. This paragraph shall not apply to property leased on a casual or short-term basis to an organization exempt from tax.
(k) Property used by governmental units. The term “section 38 property” does not include property used by the United States, any State (including the District of Columbia) or political subdivision thereof, any international organization (as defined in section 7701(a)(18)) other than the International Telecommunications Satellite Consortium or any successor organization, or any agency or instrumentality of the United States, of any State or political subdivision thereof, or of any such international organization. The term “property used by the United States, etc.” means (1) property owned by any such governmental unit (whether or not leased to another person), and (2) property leased to any such governmental unit. Thus, for example, a data processing or copying machine which is leased to any such governmental unit would be considered as property used by such governmental unit. Property leased by another person to any such governmental unit or leased by such governmental unit to another person is not section 38 property to either the lessor or the lessee, and in either case the lessor may not elect under § 1.48-4 to treat the lessee of such property as having purchased such property for purposes of the credit allowed by section 38. This paragraph shall not apply to property leased on a casual or short-term basis to any such governmental unit.
(l) [Reserved]
(m) Elevators and escalators—(1) In general. Under section 48(a)(1)(C), an elevator or escalator qualifies as section 38 property if—
(i) The construction, reconstruction, or erection of the elevator or escalator is completed by the taxpayer after June 30, 1963, or
(ii) The elevator or escalator is acquired after June 30, 1963, and the original use of such elevator or escalator commences with the taxpayer and commences after such date.
(2) Definition of elevators and escalators. For purposes of this section the term “elevator” means a cage or platform and its hoisting machinery for conveying persons or freight to or from different levels and functionally related equipment which is essential to its operation. The term includes, for example, guide rails and cables, motors and controllers, control panels and landing buttons, and elevator gates and doors, which are essential to the operation of the elevator. The term “elevator” does not, however, include a structure which is considered a building for purposes of the investment credit. The term “escalator” means a moving staircase and functionally related equipment which is essential to its operation. For purposes of determining qualified investment under section 46(c) and § 1.46-3, the basis of an elevator or escalator does not include the cost of any structural alterations to the building, such as the cost of constructing a shaft or of making alterations to the floor, walls, or ceiling, even though such alterations may be necessary in order to install or modernize the elevator or escalator.
(3) Examples. The provisions of this paragraph may be illustrated by the following examples:
(n) Amortized property. Any property with respect to which an election under 167(k), 169, 184, 187, or 188 applies shall not be treated as section 38 property. In the case of any property to which section 169 applies, the preceding sentence shall apply only to so much of the adjusted basis of the property as (after the application of section 169(f)) constitutes the amortizable basis for purposes of section 169. This paragraph shall not apply to property with respect to which an election under section 167(k), 184, 187, or 188 applies unless such property is described in section 50.
(o) [Reserved]
(p) Qualified timber property. (1) Qualified timber property (within the meaning of section 194(c)(1)) shall be treated as section 38 property to the extent of the portion of the basis of such property which is the amortizable basis (as defined in § 1.194-3(b)) acquired during the taxable year and taken into account under section 194 (after applying the limitation of section 194(b)(1)). Such amortizable basis shall qualify as section 38 property whether or not an election is made under section 194. However, any portion of such amortizable basis which is attributable to property which otherwise qualifies as section 38 property shall not be treated as section 38 property under section 48(a)(1)(F) and this paragraph. For example, amortizable basis attributable to depreciation on equipment would not qualify as section 38 property under this paragraph if such equipment qualifies as section 38 property under sections 48(a)(1) (A) or (B). In determining the portion of amortizable basis which qualifies as section 38 property under this paragraph, the reduction in amortizable basis to account for depreciation sustained with respect to property used in the reforestation process (which otherwise qualifies as section 38 property) shall be applied before the $10,000 limitation on eligible costs under section 194(b)(1). For example, if in a taxable year a taxpayer incurs qualifying reforestation costs resulting in $12,000 of amortizable basis with respect to property for which an election is in effect, and $2,000 of these costs are attributable to depreciation of the taxpayer’s equipment, such $12,000 would first be reduced by the $2,000 of depreciation, and the $10,000 limitation under section 194(b)(1) would be applied following such reduction.
(2) If a taxpayer makes an election to amortize reforestation expenditures under section 194, and allocates the $10,000 limitation among more than one property under § 1.194-2(b)(2), then such allocation shall apply for purposes of determining the amortizable basis that qualifies as section 38 property under paragraph (p)(1) of this section. If no election is made under section 194, the taxpayer may select the manner in which the $10,000 limitation is to be allocated among the qualified timber properties.
§ 1.48-2 New section 38 property.
(a) In general. Section 48(b) defines “new section 38 property” as section 38 property—
(1) The construction, reconstruction, or erection of which is completed by the taxpayer after December 31, 1961, or
(2) Which is acquired by the taxpayer after December 31, 1961, provided that the original use of such property commences with the taxpayer and commences after such date.
(b) Special rules for determining date of acquisition, original use, and basis attributable to construction, reconstruction, or erection. For purposes of paragraph (a) of this section, the principles set forth in paragraphs (a) (1) and (2) of § 1.167(c)-1 shall be applied. Thus, for example, the following rules are applicable:
(1) Property is considered as constructed, reconstructed, or erected by the taxpayer if the work is done for him in accordance with his specifications.
(2) The portion of the basis of property attributable to construction, reconstruction, or erection after December 31, 1961, consists of all costs of construction, reconstruction, or erection allocable to the period after December 31, 1961, including the cost or other basis of materials entering into such work (but not including, in the case of reconstruction of property, the adjusted basis of the reconstructed property as of the time such reconstruction is commenced).
(3) It is not necessary that materials entering into construction, reconstruction, or erection be acquired after December 31, 1961, or that they be new in use.
(4) If construction or erection by the taxpayer began after December 31, 1961, the entire cost or other basis of such construction or erection may be taken into account as the basis of new section 38 property.
(5) Construction, reconstruction, or erection by the taxpayer begins when physical work is started on such construction, reconstruction, or erection.
(6) Property shall be deemed to be acquired when reduced to physical possession, or control.
(7) The term “original use” means the first use to which the property is put, whether or not such use corresponds to the use of such property by the taxpayer. For example, a reconditioned or rebuilt machine acquired by the taxpayer will not be treated as being put to original use by the taxpayer. The question of whether property is reconditioned or rebuilt property is a question of fact. Property will not be treated as reconditioned or rebuilt merely because it contains some used parts.
(c) Examples. This section may be illustrated by the following examples:
(d) Special rule for qualified rehabilitated buildings. Notwithstanding the rules in paragraphs (a) through (c) of this section, that portion of the basis of a qualified rehabilitated building attributable to qualified rehabilitation expenditures is treated as new section 38 property. See section 48(a)(1)(E) and (g), and § 1.48-11.
§ 1.48-3 Used section 38 property.
(a) In general. (1) Section 48(c) provides that “used section 38 property” means section 38 property acquired by purchase after December 31, 1961, which is not “new section 38 property.” See §§ 1.48-1 and 1.48-2, respectively, for definitions of section 38 property and new section 38 property. In determining whether property is acquired by purchase, the provisions of paragraph (c)(1) of § 1.179-3 shall apply, except that (i) “1961” shall be substituted for “1957”, and (ii) the definition of “component member” of a controlled group of corporations in paragraph (d)(4) of this section shall be substituted for the definition of such term in paragraph (e) of § 1.179-3.
(2)(i) Property shall not qualify as used section 38 property if, after its acquisition by the taxpayer, it is used by (a) a person who used such property before such acquisition, or (b) a person who bears a relationship described in section 179(d)(2) (A) or (B) to a person who used such property before such acquisition. Thus, for example, if property is used by a person and is later sold by him under a sale and lease-back arrangement, such property in the hands of the purchaser-lessor is not used section 38 property because the property, after its acquisition, is being used by the same person who used it before its acquisition. Similarly, where a lessee has been leasing property and subsequently purchases it (whether or not the lease contains an option to purchase), such property is not used section 38 property with respect to the purchaser because the property is being used by the same person who used it before its acquisition. In addition, if property owned by a lessor is sold subject to the lease, or is sold upon the termination of the lease, the property will not qualify as used section 38 property with respect to the purchaser if, after the purchase, the property is used by a person who used the property as a lessee before the purchase.
(ii) For purposes of applying subdivision (i) of this subparagraph, property shall not be considered as used by a person before its acquisition if such property was used only on a casual basis by such person.
(iii) In determining whether a person bears a relationship described in section 179(d)(2) (A) or (B) to a person who used property before its acquisition by the taxpayer, the provisions of paragraphs (c)(1) (i) and (ii) of § 1.179-3 shall apply, except that the definition of “component member” of a controlled group of corporations in paragraph (d)(4) of this section shall be substituted for the definition of such term in paragraph (e) of § 1.179-3.
(3) The provisions of this paragraph may be illustrated by the following examples:
(b) Cost. (1) The cost of used section 38 property is equal to the basis of such property, but does not include so much of such basis as is determined by reference to the adjusted basis of other property (whether or not section 38 property) held at any time by the taxpayer acquiring such used section 38 property.
(2) If property (whether or not section 38 property) is disposed of by the taxpayer (other than by reason of its destruction or damage by fire, storm, shipwreck, or other casualty, or its theft) and used section 38 property similar or related in service or use is acquired as a replacement therefor in a transaction in which the basis of the replacement property is not determined by reference to the adjusted basis of the property replaced, then the cost of the used section 38 property so acquired shall be its basis reduced by the adjusted basis of the property replaced. The preceding sentence shall apply only if the taxpayer acquires (or enters into a contract to acquire) the replacement property within a period of 60 days before or after the date of the disposition.
(3) Notwithstanding subparagraphs (1) and (2) of this paragraph, the cost of used section 38 property shall not be reduced with respect to the adjusted basis of any property disposed of if, by reason of section 47, such disposition resulted in an increase of tax or a reduction of investment credit carrybacks or carryovers described in section 46(b).
(4) The provisions of this paragraph may be illustrated by the following examples:
(c) Dollar limitation—(1) In general. Section 48(c)(2) provides that the aggregate cost of used section 38 property which may be taken into account for any taxable year in computing qualified investment under section 46(c)(1)(B) shall not exceed $50,000. If the total cost of used section 38 property exceeds $50,000, there must be selected, in the manner provided in subparagraph (4) of this paragraph, the particular items of used section 38 property the cost of which is to be taken into account in computing qualified investment. The cost of used section 38 property that may be taken into account by a person in applying the $50,000 limitation for any taxable year includes not only the cost of used section 38 property placed in service by such person during such taxable year, but also the cost of used section 38 property apportioned to such person. For purposes of this section, the cost of used section 38 property apportioned to any person means the cost of such property apportioned to him by a trust, estate, or electing small business corporation (as defined in section 1371(b)), and his share of the cost of partnership used section 38 property, with respect to the taxable year of such trust, estate, corporation or partnership ending with or within such person’s taxable year. Thus, if an individual places in service during his taxable year used section 38 property with a cost of $25,000, if the cost of used section 38 property apportioned to him by an electing small business corporation for such year is $30,000, and if his share for such year of the cost of used section 38 property placed in service by a partnership is $20,000, he may select from the used section 38 property with a total cost of $75,000 the particular used section 38 property the cost of which he wishes to take into account. No part of the excess of $25,000 ($75,000 cost minus $50,000 annual limitation) may be taken into account in any other taxable year. For determining the amount of the cost to be apportioned by an electing small business corporation, see paragraph (a)(2) of § 1.48-5; in the case of estates and trusts, see paragraph (a)(2) of § 1.48-6. See paragraph (e) of this section for application of $50,000 limitation in the case of affiliated groups.
(2) Married individuals filing separate returns. In the case of a husband or wife who files a separate return, the aggregate cost of used section 38 property which may be taken into account for the taxable year to which such return relates cannot exceed $25,000. The preceding sentence shall not apply, however, unless the taxpayer’s spouse places in service (or is apportioned the cost of) used section 38 property for the taxable year of such spouse which ends with or within the taxpayer’s taxable year. Thus, if a husband and wife who file separate returns on a calendar year basis both place in service used section 38 property during the taxable year, the maximum cost of used section 38 property which may be taken into account by each is $25,000. However, in such case, if only one spouse places in service (or is apportioned the cost of) used section 38 property during the taxable year, such spouse may take into account a maximum of $50,000 for such year. The determination of whether an individual is married shall be made under the principles of section 143 and the regulations thereunder.
(3) Partnerships. In the case of a partnership, the aggregate cost of used section 38 property placed in service by the partnership (or apportioned to the partnership) which may be taken into account by the partners with respect to any taxable year of the partnership may not exceed $50,000. If such aggregate cost exceeds $50,000, the partnership must make a selection in the manner provided in subparagraph (4) of this paragraph. The $50,000 limitation applies to each partner, as well as to the partnership.
(4) Selection of $50,000 cost. (i) If the sum of (a) the cost of used section 38 property placed in service during the taxable year by any person, (b) such person’s share of the cost of partnership used section 38 property placed in service during the taxable year of a partnership ending with or within such person’s taxable year, and (c) the cost of used section 38 property apportioned to such person for such taxable year by an electing small business corporation, estate, or trust, exceeds $50,000, such person must make a selection for such taxable year in the manner provided in subdivision (ii) of this subparagraph.
(ii) For purposes of computing qualified investment (or, in the case of a partnership, electing small business corporation, estate, or trust, for purposes of selecting used section 38 property the cost of which may be taken into account by the partners, shareholders, or estate or trust and its beneficiaries) any person to whom subdivision (i) of this subparagraph applies must select a total cost of $50,000 from (a) the cost of specific used section 38 property placed in service by such person, (b) such person’s share of the cost of specific used section 38 property placed in service by a partnership and (c) the cost of used section 38 property apportioned to such person by an electing small business corporation, estate, or trust. When a particular property is selected, the entire cost (or entire share of cost of a particular property in the case of partnership property) of such property must be taken into account unless, as a result of the selection of such particular property, the $50,000 limitation is exceeded. Likewise, in the case of an apportionment from an electing small business corporation, estate, or trust, when the cost in a particular useful life category is selected, the entire cost in such category must be taken into account unless, as a result of the selection of such cost, the $50,000 limitation is exceeded. Thus, if a person places in service during the taxable year three items of used section 38 property, each with a cost of $20,000, he must select the entire cost of two of the items and only $10,000 of the cost of the third item; he may not select a portion of the cost of each of the three items. The selection by any person shall be made by taking the cost of used section 38 property into account in computing qualified investment (or in selecting the used section 38 property the cost of which may be taken into account by the partners, etc.), and if such property was placed in service by such person, he must maintain records which permit specific identification of any item of used section 38 property selected.
(5) Examples. The provisions of this paragraph may be illustrated by the following examples:
Property | Estimated useful life (years) | Cost |
---|---|---|
Partnership XYZ | ||
Property No. 1 | 9 | $10,000 |
Property No. 2 | 7 | 50,000 |
Property No. 3 | 7 | 50,000 |
Property No. 4 | 5 | 30,000 |
Partner X | ||
Property No. 5 | 6 | 30,000 |
Partner Y | ||
Property No. 6 | 10 | 60,000 |
Partner Z | ||
Property No. 7 | 4 | 36,000 |
Property No. | Estimated useful life (years) | Selected cost | Partner’s share of cost | ||
---|---|---|---|---|---|
X (50%) | Y (30%) | Z (20%) | |||
1 | 9 | $10,000 | $5,000 | $3,000 | $2,000 |
2 | 7 | 40,000 | 20,000 | 12,000 | 8,000 |
Total | 50,000 | 25,000 | 15,000 | 10,000 |
(iii) Qualified investment of partner X. X’s total qualified investment in used section 38 property for 1963 is $35,000, computed as follows:
Property No. | Estimated useful life (years) | Selected cost | Applicable percentage | Qualified investment |
---|---|---|---|---|
1 | 9 | $5,000 | 100 | $5,000 |
2 | 7 | 15,000 | 66 | 10,000 |
5 | 6 | 30,000 | 66 | 20,000 |
Total | 50,000 | 35,000 |
(v) Qualified investment of partner Z. Z’s total qualified investment in used section 38 property for 1963 is $19,333, computed as follows:
Property No. | Estimated useful life (years) | Selected cost | Applicable percentage | Qualified investment |
---|---|---|---|---|
1 | 9 | $2,000 | 100 | $2,000 |
2 | 7 | 8,000 | 66 | 5,333 |
7 | 4 | 36,000 | 33 | 12,000 |
Total | 46,000 | 19,333 |
(d) Dollar limitation for component members of a controlled group—(1) In general. (i) Section 48(c)(2)(C) provides that the $50,000 limitation on the cost of used section 38 property which may be taken into account for any taxable year shall, in the case of component members of a controlled group (as defined in subparagraph (4) of this paragraph) on a particular December 31, be reduced for each such member by apportioning the $50,000 amount among such component members for their taxable years that include such December 31 in accordance with their respective amounts of used section 38 property which may be taken into account, that is, in accordance with the total cost of used section 38 property placed in service by each such member during its taxable year (without regard to the $50,000 limitation or the applicable percentages to be applied in computing qualified investment).
(ii) Except as otherwise provided in this paragraph, the $50,000 amount shall be apportioned among those corporations which are component members of the controlled group on a December 31. For the taxable year of each such member which includes such December 31, the cost of used section 38 property taken into account in computing qualified investment under section 46(c)(1)(B) shall not exceed the amount which bears the same ratio to $50,000 as the cost of used section 38 property placed in service by such member for such taxable year bears to the total cost of used section 38 property placed in service by all component members of the controlled group for their taxable years which include such December 31.
(iii) If a component member of the group makes its income tax return on the basis of a 52-53-week taxable year, the principles of section 441(f)(2)(A)(ii) and § 1.441-2 apply in determining the last day of such a taxable year.
(2) Statement by the “filing member”. For purposes of this paragraph, the term “filing member” with respect to a particular December 31 means the member (or members) of a controlled group which has, among those members of the group which are apportioned part of the $50,000 amount for their taxable years which include such December 31, the taxable year including such December 31 which ends on the earliest date. The filing member of the group shall attach to its income tax return a statement containing the name, address, and employer identification number of each component member of the controlled group on such December 31 and a schedule showing the computation of the apportionment of the $50,000 amount among the component members of the group. Each such other member shall retain as part of its records a copy of the statement containing the apportionment schedule. Except as otherwise provided in subparagraph (3)(ii) of this paragraph, each member which is apportioned part of the $50,000 amount shall take such apportioned amount into account in filing its return for its taxable year which includes such December 31.
(3) Estimate of used section 38 property to be placed in service. (i) For purposes of subparagraphs (1) and (2) of this paragraph, if on the date (including extensions of time) for filing the income tax return of the filing member of the group with respect to a particular December 31, the total cost of used section 38 property actually placed in service by any component member of the group during such member’s taxable year that includes such December 31 is not known, then such member shall estimate such cost. The estimate shall be made on the basis of the facts and circumstances known as of the time of the estimate. Any such estimate shall also be used in determining the total cost of used section 38 property placed in service by all component members for their taxable years including such December 31.
(ii) If an estimate is used by any component member of a controlled group pursuant to subdivision (i) of this subparagraph, each member may later file an original or amended return in which the apportionment of the $50,000 amount is based upon the cost of used section 38 property actually placed in service by all component members of the group during their taxable year which include such December 31. Such amended apportionment shall be made only if each component member of the group whose limitation would be changed files an original or amended return which reflects the amended apportionment based upon the cost of the used section 38 property actually placed in service by component members of the group. In such case, the new statement reflecting the amended apportionment shall be attached to the amended return of the filing member of the group, and a copy of such statement shall be retained by each such member pursuant to the requirements of subparagraph (2) of this paragraph.
(4) Definitions of controlled group of corporations and component member of controlled group. For purposes of this section, the terms “controlled group of corporations” and “component member” of a controlled group of corporations shall have the same meaning assigned to those terms in section 1563 (a) and (b), except that the phrase “more than 50 percent” shall be substituted for the phrase “at least 80 percent” each place it appears in section 1563(a)(1). For purposes of applying § 1.1563-1(b)(2)(ii)(c), an electing small business corporation shall be treated as an excluded member whether or not it is subject to the tax imposed by section 1378.
(5) Members of controlled group filing a consolidated return. For the purpose of apportioning the $50,000 amount in the case of component members of a controlled group which join in filing a consolidated return, all such members shall be treated as though they were a single component member of the controlled group. Thus, in determining the limitation on the cost of used section 38 property which may be taken into account by the group filing the consolidated return, the apportionment provided in subparagraph (1)(ii) of this paragraph shall be made by using the aggregate cost of such property placed in service by all members of the group filing the consolidated return. If all component members of the controlled group join in filing a consolidated return, the group may select the items to be taken into account to the extent of an aggregate cost of $50,000; if some component members of the controlled group do not join in filing the consolidated return, then the members of the group which join in filing the consolidated return may select the items to be taken into account to the extent of the amount apportioned to such members under subparagraph (1)(ii) of this paragraph.
(6) Examples. This paragraph may be illustrated by the following examples:
(ii) The cost of used section 38 property taken into account by N for its taxable year ending March 31, 1971, may not exceed $20,000, that is, an amount which bears the same ratio to $50,000 as the cost of used section 38 property placed in service by N for its taxable year ($100,000) bears to the total cost of used section 38 property placed in service by all component members of the controlled group (M, N, and O) for their taxable years which include December 31, 1970 ($250,000). Similarly, the cost of used section 38 property taken into account by O for its taxable year ending April 30, 1971, may not exceed $30,000.
(ii) S, the “filing member” of the group, must file an apportionment schedule under which it may take into account as the cost of used section 38 property an amount not in excess of $20,000 ($100,000/$250,000 × $50,000). If T actually places in service during its taxable year used section 38 property costing more or less than $150,000, its income tax return for its taxable year ending June 30, 1972, may reflect the amended apportionment of the $50,000 limitation based upon the cost of used section 38 property actually placed in service by the group, provided that S attaches a new apportionment schedule to an amended return to reflect the amended apportionment. For example, if T places in service used section 38 property costing $200,000, the cost of used section 38 property taken into account by S and T for their respective taxable years could not exceed $16,667 ($100,000/$300,000 × $50,000) and $33,333 ($200,000/$300,000 × $50,000), respectively, under an amended apportionment.
§ 1.48-4 Election of lessor of new section 38 property to treat lessee as purchaser.
(a) In general—(1) Lessee treated as purchaser. Under section 48(d), a lessor of property may elect to treat the lessee of such property as having purchased such property (or, in the case of short-term lease property described in subparagraph (2) of this paragraph, a portion of such property) for purposes of the credit allowed by section 38 if the following conditions are satisfied:
(i) The property must be “section 38 property” in the hands of the lessor; that is, it must be property with respect to which depreciation (or amortization in lieu of depreciation) is allowable to the lessor, it must have a useful life of 3 years (4 years in the case of property which is not described in section 50) or more in his hands, and in every other respect it must meet the requirements of § 1.48-1. Thus, for example, property leased by a municipality to a taxpayer for use in what is commonly known as an “industrial park” is not eligible for the election since, under paragraph (k) of § 1.48-1, property used by a governmental unit is not section 38 property. In addition, property used by the lessee predominantly outside the United States is not eligible for the election since, under paragraph (g) of § 1.48-1, such property is not section 38 property. For purposes of this subdivision, if the lessor is an estate or trust, depreciation (or amortization in lieu of depreciation) will be considered allowable to the estate or trust even if it is apportioned to the beneficiaries or other persons.
(ii) The property must be “new section 38 property” (within the meaning of § 1.48-2) in the hands of the lessor, and the original use of such property must commence with the lessor. See paragraph (b) of this section for the application of the rules relating to “original use” in the case of leased property.
(iii) The property would constitute “new