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									                                                                   Internal Revenue Service, Treasury                                                              § 1.451–1
                                                                   three-year test period (taxable years 2007                income when all the events have oc-
                                                                   through 2009) is greater than its safe harbor             curred which fix the right to receive
                                                                   uncollectible amount for the three-year test              such income and the amount thereof
                                                                   period ($295,000), under paragraph (e)(3)(ii)(B)
                                                                   of this section, the $5,000 excess of K’s cumu-
                                                                                                                             can be determined with reasonable ac-
                                                                   lative uncollectible amount over K’s safe                 curacy. Therefore, under such a meth-
                                                                   harbor uncollectible amount for the three-                od of accounting if, in the case of com-
                                                                   year test period must be recaptured into in-              pensation for services, no determina-
                                                                   come in 2009 in accordance with paragraph                 tion can be made as to the right to
                                                                   (e)(3)(ii)(B) of this section. Since K’s cumu-            such compensation or the amount
                                                                   lative uncollectible amount for the three-                thereof until the services are com-
                                                                   year test period ($300,000) is less than 110% of
                                                                   its    safe   harbor    uncollectible    amount
                                                                                                                             pleted, the amount of compensation is
                                                                   ($295,000×110%=$324,500),     under    paragraph          ordinarily income for the taxable year
                                                                   (e)(3)(ii)(B) of this section, K may continue             in which the determination can be
                                                                   to use its alternative nonaccrual-experience              made. Under the cash receipts and dis-
                                                                   method, subject to the three-year self-test               bursements method of accounting, such
                                                                   requirement.                                              an amount is includible in gross in-
                                                                     Example 12. Subsequent worthlessness of year-           come when actually or constructively
                                                                   end receivable. The facts are the same as in
                                                                   Example 4, except that one of the accounts
                                                                                                                             received. Where an amount of income
                                                                   receivable outstanding at the end of 2002 was             is properly accrued on the basis of a
                                                                   for $8,000, and in 2003, under section 166, the           reasonable estimate and the exact
                                                                   entire amount of this receivable becomes                  amount is subsequently determined,
                                                                   wholly worthless. Because F does not accrue               the difference, if any, shall be taken
                                                                   as income $1,573 of this account receivable               into account for the taxable year in
                                                                   ($8,000×.1967) under the nonaccrual-experi-               which such determination is made. To
                                                                   ence method in 2002, under paragraph (d)(2)
                                                                                                                             the extent that income is attributable
                                                                   of this section F may not deduct this portion
                                                                   of the account receivable as a bad debt de-               to the recovery of bad debts for ac-
                                                                   duction under section 166 in 2003. F may de-              counts charged off in prior years, it is
                                                                   duct the remaining balance of the receivable              includible in the year of recovery in ac-
                                                                   in 2003 as a bad debt deduction under section             cordance with the taxpayer’s method of
                                                                   166 ($8,000¥$1,574=$6,426).                               accounting, regardless of the date when
                                                                     Example 13. Subsequent collection of year-end           the amounts were charged off. For
                                                                   receivable. The facts are the same as in Exam-
                                                                                                                             treatment of bad debts and bad debt re-
                                                                   ple 4. In 2007, F collects in full an account re-
                                                                   ceivable of $1,700 that was outstanding at the            coveries, see sections 166 and 111 and
                                                                   end of 2006. Under paragraph (d)(5) of this               the regulations thereunder. For rules
                                                                   section, F must recognize additional gross                relating to the treatment of amounts
                                                                   income in 2007 equal to the portion of this re-           received in crop shares, see section 61
                                                                   ceivable that F excluded from gross income                and the regulations thereunder. For
                                                                   in the prior taxable year ($1,700×.1967=$334).            the year in which a partner must in-
                                                                   That amount ($334) is a recovery under para-              clude his distributive share of partner-
                                                                   graph (d)(5) of this section.
                                                                                                                             ship income, see section 706(a) and
                                                                     (h) Effective date. This section is ap-                 paragraph (a) of § 1.706–1. If a taxpayer
                                                                   plicable for taxable years ending on or                   ascertains that an item should have
                                                                   after August 31, 2006.                                    been included in gross income in a
                                                                   [T.D. 9285, 71 FR 52437, Sept. 6, 2006]                   prior taxable year, he should, if within
                                                                                                                             the period of limitation, file an amend-
                                                                      TAXABLE YEAR FOR WHICH ITEMS OF                        ed return and pay any additional tax
                                                                          GROSS INCOME INCLUDED                              due. Similarly, if a taxpayer ascertains
                                                                                                                             that an item was improperly included
                                                                   § 1.451–1 General rule for taxable year                   in gross income in a prior taxable year,
                                                                        of inclusion.                                        he should, if within the period of limi-
                                                                      (a) General rule. Gains, profits, and                  tation, file claim for credit or refund of
                                                                   income are to be included in gross in-                    any overpayment of tax arising there-
                                                                   come for the taxable year in which                        from.
                                                                   they are actually or constructively re-                     (b) Special rule in case of death. (1) A
                                                                   ceived by the taxpayer unless includ-                     taxpayer’s taxable year ends on the
                                                                   ible for a different year in accordance                   date of his death. See section 443(a)(2)
                                                                   with the taxpayer’s method of account-                    and paragraph (a)(2) of § 1.443–1. In com-
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                                                                   ing. Under an accrual method of ac-                       puting taxable income for such year,
                                                                   counting, income is includible in gross                   there shall be included only amounts

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                                                                   § 1.451–2                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   properly includible under the method                        (f) Timing of income from notional prin-
                                                                   of accounting used by the taxpayer.                       cipal contracts. For the timing of in-
                                                                   However, if the taxpayer used an ac-                      come with respect to notional principal
                                                                   crual method of accounting, amounts                       contracts, see § 1.446–3.
                                                                   accrued only by reason of his death                         (g) Timing of income from section 467
                                                                   shall not be included in computing tax-                   rental agreements. For the timing of in-
                                                                   able income for such year. If the tax-                    come with respect to section 467 rental
                                                                   payer uses no regular accounting meth-                    agreements, see section 467 and the
                                                                   od, only amounts actually or construc-                    regulations thereunder.
                                                                   tively received during such year shall                    [T.D. 6500, 25 FR 11709, Nov. 26, 1960, as
                                                                   be included. (For rules relating to the                   amended by T.D. 7001, 34 FR 997, Jan. 23, 1969;
                                                                   inclusion of partnership income in the                    T.D. 7154, 36 FR 24996, Dec. 28, 1971; 43 FR
                                                                   return of a decedent partner, see sub-                    59357, Dec. 20, 1978; T.D. 8491, 58 FR 53135, Oct.
                                                                   chapter K, chapter 1 of the Code, and                     14, 1993; T.D. 8820, 64 FR 26851, May 18, 1999]
                                                                   the regulations thereunder.)
                                                                      (2) If the decedent owned an install-                  § 1.451–2 Constructive receipt of in-
                                                                   ment obligation the income from                                come.
                                                                   which was taxable to him under section                       (a) General rule. Income although not
                                                                   453, no income is required to be re-                      actually reduced to a taxpayer’s pos-
                                                                   ported in the return of the decedent by                   session is constructively received by
                                                                   reason of the transmission at death of                    him in the taxable year during which it
                                                                   such obligation. See section 453(d)(3).                   is credited to his account, set apart for
                                                                   For the treatment of installment obli-                    him, or otherwise made available so
                                                                   gations acquired by the decedent’s es-                    that he may draw upon it at any time,
                                                                   tate or by any person by bequest, de-                     or so that he could have drawn upon it
                                                                   vise, or inheritance from the decedent,                   during the taxable year if notice of in-
                                                                   see section 691(a)(4) and the regulations                 tention to withdraw had been given.
                                                                   thereunder.                                               However, income is not constructively
                                                                      (c) Special rule for employee tips. Tips               received if the taxpayer’s control of its
                                                                   reported by an employee to his em-                        receipt is subject to substantial limita-
                                                                   ployer in a written statement fur-                        tions or restrictions. Thus, if a cor-
                                                                   nished to the employer pursuant to                        poration credits its employees with
                                                                   section 6053(a) shall be included in                      bonus stock, but the stock is not avail-
                                                                   gross income of the employee for the                      able to such employees until some fu-
                                                                   taxable year in which the written                         ture date, the mere crediting on the
                                                                   statement is furnished the employer.                      books of the corporation does not con-
                                                                   For provisions relating to the report-                    stitute receipt. In the case of interest,
                                                                   ing of tips by an employee to his em-                     dividends, or other earnings (whether
                                                                   ployer, see section 6053 and § 31.6053–1 of               or not credited) payable in respect of
                                                                   this chapter (Employment Tax Regula-                      any deposit or account in a bank,
                                                                   tions).                                                   building and loan association, savings
                                                                      (d) Special rule for ratable inclusion of              and loan association, or similar insti-
                                                                   original issue discount. For ratable in-                  tution, the following are not substan-
                                                                   clusion of original issue discount in re-                 tial limitations or restrictions on the
                                                                   spect of certain corporate obligations                    taxpayer’s control over the receipt of
                                                                   issued after May 27, 1969, see section                    such earnings:
                                                                   1232(a)(3).                                                  (1) A requirement that the deposit or
                                                                      (e) Special rule for inclusion of quali-               account, and the earnings thereon,
                                                                   fied tax refund effected by allocation. For               must be withdrawn in multiples of even
                                                                   rules relating to the inclusion in in-                    amounts;
                                                                   come of an amount paid by a taxpayer                         (2) The fact that the taxpayer would,
                                                                   in respect of his liability for a qualified               by withdrawing the earnings during
                                                                   State individual income tax and allo-                     the taxable year, receive earnings that
                                                                   cated or reallocated in such a manner                     are not substantially less in compari-
                                                                   as to apply it toward the taxpayer’s li-                  son with the earnings for the cor-
                                                                   ability for the Federal income tax, see                   responding period to which the tax-
                                                                   paragraph (f)(1) of § 301.6361–1 of this                  payer would be entitled had he left the
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                                                                   chapter (Regulations on Procedure and                     account on deposit until a later date
                                                                   Administration).                                          (for example, if an amount equal to

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                                                                   Internal Revenue Service, Treasury                                                              § 1.451–4

                                                                   three months’ interest must be for-                       payment of the interest during such
                                                                   feited upon withdrawal or redemption                      year. Dividends on corporate stock are
                                                                   before maturity of a one year or less                     constructively        received      when
                                                                   certificate of deposit, time deposit,                     unqualifiedly made subject to the de-
                                                                   bonus plan, or other deposit arrange-                     mand of the shareholder. However, if a
                                                                   ment then the earnings payable on pre-                    dividend is declared payable on Decem-
                                                                   mature withdrawal or redemption                           ber 31 and the corporation followed its
                                                                   would be substantially less when com-                     usual practice of paying the dividends
                                                                   pared with the earnings available at                      by checks mailed so that the share-
                                                                   maturity);                                                holders would not receive them until
                                                                     (3) A requirement that the earnings                     January of the following year, such
                                                                   may be withdrawn only upon a with-                        dividends are not considered to have
                                                                   drawal of all or part of the deposit or                   been constructively received in Decem-
                                                                   account. However, the mere fact that                      ber. Generally, the amount of dividends
                                                                   such institutions may pay earnings on                     or interest credited on savings bank de-
                                                                   withdrawals, total or partial, made                       posits or to shareholders of organiza-
                                                                   during the last three business days of                    tions such as building and loan associa-
                                                                   any calendar month ending a regular                       tions or cooperative banks is income to
                                                                   quarterly or semiannual earnings pe-                      the depositors or shareholders for the
                                                                   riod at the applicable rate calculated                    taxable year when credited. However, if
                                                                   to the end of such calendar month shall                   any portion of such dividends or inter-
                                                                   not constitute constructive receipt of                    est is not subject to withdrawal at the
                                                                   income by any depositor or account                        time credited, such portion is not con-
                                                                   holder in any such institution who has                    structively received and does not con-
                                                                   not made a withdrawal during such pe-                     stitute income to the depositor or
                                                                   riod;                                                     shareholder until the taxable year in
                                                                     (4) A requirement that a notice of in-                  which the portion first may be with-
                                                                   tention to withdraw must be given in                      drawn. Accordingly, if, under a bonus
                                                                   advance of the withdrawal. In any case                    or forfeiture plan, a portion of the divi-
                                                                   when the rate of earnings payable in                      dends or interest is accumulated and
                                                                   respect of such a deposit or account de-                  may not be withdrawn until the matu-
                                                                   pends on the amount of notice of inten-                   rity of the plan, the crediting of such
                                                                   tion to withdraw that is given, earn-                     portion to the account of the share-
                                                                   ings at the maximum rate are con-                         holder or depositor does not constitute
                                                                   structively received during the taxable                   constructive receipt. In this case, such
                                                                   year regardless of how long the deposit                   credited portion is income to the de-
                                                                   or account was held during the year or                    positor or shareholder in the year in
                                                                   whether, in fact, any notice of inten-                    which the plan matures. However, in
                                                                   tion to withdraw is given during the                      the case of certain deposits made after
                                                                   year. However, if in the taxable year of                  December 31, 1970, in banks, domestic
                                                                   withdrawal the depositor or account                       building and loan associations, and
                                                                   holder receives a lower rate of earnings                  similar financial institutions, the rat-
                                                                   because he failed to give the required                    able inclusion rules of section 1232(a)(3)
                                                                   notice of intention to withdraw, he                       apply. See § 1.1232–3A. Accrued interest
                                                                   shall be allowed an ordinary loss in                      on unwithdrawn insurance policy divi-
                                                                   such taxable year in an amount equal                      dends is gross income to the taxpayer
                                                                   to the difference between the amount                      for the first taxable year during which
                                                                   of earnings previously included in gross                  such interest may be withdrawn by
                                                                   income and the amount of earnings ac-                     him.
                                                                   tually received. See section 165 and the                  [T.D. 6723, 29 FR 5342, Apr. 21, 1964; as amend-
                                                                   regulations thereunder.                                   ed by T.D. 7154, 36 FR 24997, Dec. 28, 1971;
                                                                     (b) Examples of constructive receipt.                   T.D. 7663, 44 FR 76782, Dec. 28, 1979]
                                                                   Amounts payable with respect to inter-
                                                                   est coupons which have matured and                        § 1.451–4 Accounting for redemption of
                                                                   are payable but which have not been                            trading stamps and coupons.
                                                                   cashed are constructively received in                        (a) In general—(1) Subtraction from re-
                                                                   the taxable year during which the cou-                    ceipts. If an accrual method taxpayer
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                                                                   pons mature, unless it can be shown                       issues trading stamps or premium cou-
                                                                   that there are no funds available for                     pons with sales, or an accrual method

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                                                                   § 1.451–4                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   taxpayer is engaged in the business of                    the number of trading stamps or cou-
                                                                   selling trading stamps or premium cou-                    pons outstanding as of the end of such
                                                                   pons, and such stamps or coupons are                      year that it is reasonably estimated
                                                                   redeemable by such taxpayer in mer-                       will ultimately be presented for re-
                                                                   chandise, cash, or other property, the                    demption. Such estimate shall be de-
                                                                   taxpayer should, in computing the in-                     termined in accordance with the rules
                                                                   come from such sales, subtract from                       contained in paragraph (c) of this sec-
                                                                   gross receipts with respect to sales of                   tion.
                                                                   such stamps or coupons (or from gross                       (iii) For purposes of this section, the
                                                                   receipts with respect to sales with                       estimated average cost of redeeming
                                                                   which trading stamps or coupons are                       each trading stamp or coupon shall be
                                                                   issued) an amount equal to—                               computed by including only the costs
                                                                     (i) The cost to the taxpayer of mer-
                                                                                                                             to the taxpayer of acquiring the mer-
                                                                   chandise, cash, and other property used
                                                                                                                             chandise, cash, or other property need-
                                                                   for redemptions in the taxable year,
                                                                                                                             ed to redeem such stamps or coupons.
                                                                     (ii) Plus the net addition to the pro-
                                                                                                                             The term ‘‘the costs to the taxpayer of
                                                                   vision for future redemptions during
                                                                   the taxable year (or less the net sub-                    acquiring the merchandise, cash, or
                                                                   traction from the provision for future                    other property needed to redeem such
                                                                   redemptions during the taxable year).                     stamps or coupons’’ includes only the
                                                                     (2) Trading stamp companies. For pur-                   price charged by the seller (less trade
                                                                   poses of this section, a taxpayer will be                 or other discounts, except strictly cash
                                                                   considered as being in the business of                    discounts approximating a fair interest
                                                                   selling trading stamps or premium cou-                    rate, which may be deducted or not at
                                                                   pons if—                                                  the option of the taxpayer provided a
                                                                     (i) The trading stamps or premium                       consistent course is followed) plus
                                                                   coupons sold by him are issued by pur-                    transportation or other necessary
                                                                   chasers to promote the sale of their                      charges in acquiring possession of the
                                                                   merchandise or services,                                  goods. Items such as the costs of adver-
                                                                     (ii) The principal activity of the                      tising, catalogs, operating redemption
                                                                   trade or business is the sale of such                     centers, transporting merchandise or
                                                                   stamps or coupons,                                        other property from a central ware-
                                                                     (iii) Such stamps or coupons are re-                    house to a branch warehouse (or from a
                                                                   deemable by the taxpayer for a period                     warehouse to a redemption center), and
                                                                   of at least 1 year from the date of sale,                 storing the merchandise or other prop-
                                                                   and                                                       erty used to redeem stamps or coupons
                                                                     (iv) Based on his overall experience,                   should not be included in costs of re-
                                                                   it is estimated that not more than two-                   deeming stamps or premium coupons,
                                                                   thirds of the stamps or coupons sold                      but rather should be accounted for in
                                                                   which it is estimated, pursuant to                        accordance with the provisions of sec-
                                                                   paragraph (c) of this section, will be ul-                tions 162 and 263.
                                                                   timately redeemed, will be redeemed
                                                                                                                               (2) Changes in provision for future re-
                                                                   within 6 months of the date of sale.
                                                                                                                             demptions. For purposes of this section,
                                                                     (b) Computation of the net addition to
                                                                                                                             a ‘‘net addition to’’ or ‘‘net subtraction
                                                                   or subtraction from the provision for fu-
                                                                                                                             from’’ the provision for future redemp-
                                                                   ture redemptions—(1) Determination of
                                                                                                                             tions for a taxable year is computed as
                                                                   the provision for future redemptions. (i)
                                                                   The provision for future redemptions                      follows:
                                                                   as of the end of a taxable year is com-                     (i) Carry over the provision for future
                                                                   puted by multiplying ‘‘estimated fu-                      redemptions (if any) as of the end of
                                                                   ture redemptions’’ (as defined in sub-                    the preceding taxable year,
                                                                   division (ii) of this subparagraph) by                      (ii) Compute the provision for future
                                                                   the estimated average cost of redeem-                     redemptions as of the end of the tax-
                                                                   ing each trading stamp or coupon                          able year in accordance with subpara-
                                                                   (computed in accordance with subdivi-                     graph (1) of this paragraph, and
                                                                   sion (iii) of this subparagraph).                           (iii) If the amount referred to in sub-
                                                                     (ii) For purposes of this section, the                  division (ii) of this subparagraph ex-
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                                                                   term ‘‘estimated future redemptions’’                     ceeds the amount referred to in sub-
                                                                   as of the end of a taxable year means                     division (i) of this subparagraph, such

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                                                                   Internal Revenue Service, Treasury                                                                                                                                     § 1.451–4

                                                                   excess is the net addition to the provi-                                                       Minus provision for future redemptions
                                                                   sion for future redemptions for the tax-                                                         on Dec. 31, 1971 ...............................                18,000
                                                                   able year. On the other hand, if the                                                           Addition to provision for future redemp-
                                                                   amount referred to in such subdivision                                                           tions ....................................................         6,080
                                                                   (i) exceeds the amount referred to in
                                                                   such subdivision (ii), such excess is the                                                               Total cost of redemptions .............................                 27,150
                                                                   net subtraction from the provision for                                                         1972 Gross income from sales of
                                                                   future redemptions for the taxable                                                               stamps ................................................       ..............   22,850
                                                                   year.
                                                                                                                                                                    (c) Estimated future redemptions—(1) In
                                                                      (3) Example. The provisions of this
                                                                                                                                                                  general. A taxpayer may use any meth-
                                                                   paragraph and paragraph (a)(1) of this
                                                                                                                                                                  od of determining the estimated future
                                                                   section may be illustrated by the fol-
                                                                                                                                                                  redemptions as of the end of a year so
                                                                   lowing example:
                                                                                                                                                                  long as—
                                                                     Example. (a) X Company, a calendar year                                                        (i) Such method results in a reason-
                                                                   accrual method taxpayer, is engaged in the                                                     ably accurate estimate of the stamps
                                                                   business of selling trading stamps to mer-                                                     or coupons outstanding at the end of
                                                                   chants. In 1971, its first year of operation, X
                                                                   sells 10 million stamps at $5 per 1,000; it re-
                                                                                                                                                                  such year that will ultimately be pre-
                                                                   deems 3 million stamps for merchandise and                                                     sented for redemption,
                                                                   cash of an average value of $3 per 1,000                                                         (ii) Such method is used consistently,
                                                                   stamps. At the end of 1971 it is estimated                                                     and
                                                                   (pursuant to paragraph (c) of this section)                                                      (iii) Such taxpayer complies with the
                                                                   that a total of 9 million stamps of the 10 mil-                                                requirements of this paragraph and
                                                                   lion stamps issued in 1971 will eventually be
                                                                                                                                                                  paragraphs (d) and (e) of this section.
                                                                   presented for redemption. At this time it is
                                                                   estimated that the average cost of redeem-                                                       (2) Utilization of prior redemption expe-
                                                                   ing stamps (as described in subparagraph                                                       rience. Normally, the estimated future
                                                                   (1)(iii) of this paragraph) would continue to                                                  redemptions of a taxpayer shall be de-
                                                                   be $3 per 1,000 stamps. Under these cir-                                                       termined on the basis of such tax-
                                                                   cumstances, X computes its gross income                                                        payer’s prior redemption experience.
                                                                   from sales of trading stamps as follows:                                                       However, if the taxpayer does not have
                                                                   Gross receipts from sales (10 million                                                          sufficient redemption experience to
                                                                     stamps at $5 per 1,000) .....................              ..............    $50,000
                                                                   Less:                                                                                          make a reasonable determination of
                                                                       Cost of actual redemptions (3 mil-                                                         his ‘‘estimated future redemptions,’’ or
                                                                         lion stamps at $3 per 1,000) .......                      $9,000        ..............   if because of a change in his mode of
                                                                       Provision for future redemptions on
                                                                         December 31, 1971 (9 million
                                                                                                                                                                  operation or other relevant factors the
                                                                         stamps ¥ 3 million stamps × $3                                                           determination cannot reasonably be
                                                                         per 1,000) ....................................           18,000        ..............   made completely on the basis of the
                                                                                                                                                                  taxpayer’s own experience, the experi-
                                                                                                                                                    27,000
                                                                                                                                                                  ences of similarly situated taxpayers
                                                                   1971 gross income from sales of                                                                may be used to establish an experience
                                                                     stamps ................................................                        23,000        factor.
                                                                     (b) In 1972, X also sells 10 million stamps at                                                 (3) One method of determining estimated
                                                                   $5 per 1,000 stamps. During 1972 X redeems 7                                                   future redemptions. One permissible
                                                                   million stamps at an average cost of $3.01 per                                                 method of determining the estimated
                                                                   1,000 stamps. At the end of 1972 it is deter-                                                  future redemptions as of the end of the
                                                                   mined that the estimated future redemptions
                                                                                                                                                                  current taxable year is as follows:
                                                                   (within the meaning of subparagraph (1)(ii)
                                                                   of this paragraph) is 8 million. It is further                                                   (i) Estimate for each preceding tax-
                                                                   determined that the estimated average cost                                                     able year and the current taxable year
                                                                   of redeeming stamps would continue to be                                                       the number of trading stamps or cou-
                                                                   $3.01 per 1,000 stamps. X thus computes its                                                    pons issued for each such year which
                                                                   gross income from sales of trading stamps                                                      will ultimately be presented for re-
                                                                   for 1972 as follows:                                                                           demption.
                                                                   Gross receipts from sales (10 million stamps at $5                                               (ii) Determine the sum of the esti-
                                                                     per 1,000) .............................................................     $50,000
                                                                   Less:                                                                                          mates under subdivision (i) of this sub-
                                                                       Cost of actual redemptions (7 mil-                                                         paragraph for each taxable year prior
                                                                         lion stamps at $3.01 per 1,000) .. $21,070                                               to and including the current taxable
                                                                   Plus:
                                                                                                                                                                  year.
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                                                                       Provision for future redemptions on
                                                                         Dec. 31, 1972 (8 million stamps                                                            (iii) The difference between the sum
                                                                         at $3.01 per 1,000) .....................                24,080                          determined under subdivision (ii) of

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                                                                   § 1.451–4                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   this subparagraph and the total num-                      sampling technique, the appropriate-
                                                                   ber of trading stamps or coupons which                    ness of the method (including the ap-
                                                                   have already been presented for re-                       propriateness of the sampling tech-
                                                                   demption is the estimated future re-                      nique, if any) and the accuracy and re-
                                                                   demptions as of the end of the current                    liability of the results obtained must,
                                                                   taxable year.                                             if requested, be demonstrated to the
                                                                      (4) Determination of an ‘‘estimated re-                satisfaction of the district director.
                                                                   demption percentage.’’ For purposes of                      (ii) No inference shall be drawn from
                                                                   applying subparagraph (3)(i) of this                      subdivision (i) of this subparagraph
                                                                   paragraph, one permissible method of                      that the use of any method to which
                                                                   estimating the number of trading                          such subdivision applies is less accept-
                                                                   stamps or coupons issued for a taxable                    able than the method described in sub-
                                                                   year that will ultimately be presented                    paragraph (5)(i) of this paragraph.
                                                                   for redemption is to multiply such                        Therefore, certain probability sam-
                                                                   number of stamps issued for such year                     pling techniques used in determining
                                                                   by an ‘‘estimated redemption percent-                     estimated future redemptions may re-
                                                                   age.’’ For purposes of this section the                   sult in reasonably accurate and reli-
                                                                   term ‘‘estimated redemption percent-                      able estimates. Such a sampling tech-
                                                                   age’’ for a taxable year means a frac-                    nique will be considered appropriate if
                                                                   tion, the numerator of which is the                       the sample is—
                                                                   number of trading stamps or coupons                         (a) Taken in accordance with sound
                                                                   issued during a taxable year that it is                   statistical sampling principles,
                                                                   reasonably estimated will ultimately                        (b) In accordance with such prin-
                                                                   be redeemed, and the denominator of                       ciples, sufficiently broad to produce a
                                                                   which is the number of trading stamps                     reasonably accurate result, and
                                                                   or coupons issued during such year.                         (c) Taken with sufficient frequency
                                                                   Consequently, the product of such per-                    as to produce a reasonably accurate re-
                                                                   centage and the number of stamps                          sult.
                                                                   issued for such year equals the number
                                                                   of trading stamps or coupons issued for                   In addition, if the sampling technique
                                                                   such year that it is estimated will ulti-                 is appropriate, the results obtained
                                                                   mately be redeemed.                                       therefrom in determining estimated fu-
                                                                      (5) Five-year rule. (i) One permissible                ture redemptions will be considered ac-
                                                                   method of determining the ‘‘estimated                     curate and reliable if the evaluation of
                                                                   redemption percentage’’ for a taxable                     such results is consistent with sound
                                                                   year is to—                                               statistical    principles.   Ordinarily,
                                                                      (a) Determine the percentage which                     samplings and recomputations of the
                                                                   the total number of stamps or coupons                     estimated future redemptions will be
                                                                   redeemed in the taxable year and the 4                    required annually. However, the facts
                                                                   preceding taxable years is of the total                   and circumstances in a particular case
                                                                   number of stamps or coupons issued or                     may justify such a recomputation
                                                                   sold in such 5 years; and                                 being taken less frequently than annu-
                                                                      (b) Multiply such percentage by an                     ally. In addition, the Commissioner
                                                                   appropriate growth factor as deter-                       may prescribe procedures indicating
                                                                   mined pursuant to guidelines published                    that samples made to update the re-
                                                                   by the Commissioner.                                      sults of a sample of stamps redeemed in
                                                                      (ii) If a taxpayer uses the method de-                 a prior year need not be the same size
                                                                   scribed in subdivision (i) of this sub-                   as the sample of such prior year.
                                                                   paragraph for a taxable year, it will                       (d) Consistency with financial report-
                                                                   normally be presumed that such tax-                       ing—(1) Estimated future redemptions.
                                                                   payer’s ‘‘estimated redemption per-                       For taxable years beginning after Au-
                                                                   centage’’ is reasonably accurate.                         gust 22, 1972, the estimated future re-
                                                                      (6) Other methods of determining esti-                 demptions must be no greater than the
                                                                   mated future redemptions. (i) If a tax-                   estimate that the taxpayer uses for
                                                                   payer uses a method of determining his                    purposes of all reports (including con-
                                                                   ‘‘estimated future redemptions’’ (other                   solidated financial statements) to
                                                                   than a method which applies the 5-year                    shareholders, partners, beneficiaries,
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                                                                   rule as described in subparagraph (5)(i)                  other proprietors, and for credit pur-
                                                                   of this paragraph) such as a probability                  poses.

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                                                                   Internal Revenue Service, Treasury                                                              § 1.451–5

                                                                      (2) Average cost of redeeming stamps.                  which is received in a taxable year by
                                                                   For taxable years beginning after Au-                     a taxpayer using an accrual method of
                                                                   gust 22, 1972, the estimated average                      accounting for purchases and sales or a
                                                                   cost of redeeming each stamp or cou-                      long-term contract method of account-
                                                                   pon must be no greater than the aver-                     ing (described in § 1.451–3), pursuant to,
                                                                   age cost of redeeming each stamp or                       and to be applied against, an agree-
                                                                   coupon (computed in accordance with                       ment:
                                                                   paragraph (b)(1)(iii) of this section)                       (i) For the sale or other disposition
                                                                   that the taxpayer uses for purposes of                    in a future taxable year of goods held
                                                                   all reports (including consolidated fi-                   by the taxpayer primarily for sale to
                                                                   nancial statements) to shareholders,                      customers in the ordinary course of his
                                                                   partners, beneficiaries, other propri-                    trade or business, or
                                                                   etors, and for credit purposes.                              (ii) For the building, installing, con-
                                                                      (e) Information to be furnished with re-               structing or manufacturing by the tax-
                                                                   turn—(1) In general. For taxable years                    payer of items where the agreement is
                                                                   beginning after August 22, 1972, a tax-                   not completed within such taxable
                                                                   payer described in paragraph (a) of this                  year.
                                                                   section who uses a method of deter-
                                                                                                                                (2) For purposes of subparagraph (1)
                                                                   mining the ‘‘estimated future redemp-
                                                                                                                             of this paragraph:
                                                                   tions’’ other than that described in
                                                                   paragraph (c)(5)(i) of this section shall                    (i) The term ‘‘agreement’’ includes
                                                                   file a statement with his return show-                    (a) a gift certificate that can be re-
                                                                   ing such information as is necessary to                   deemed for goods, and (b) an agreement
                                                                   establish the correctness of the amount                   which obligates a taxpayer to perform
                                                                   subtracted from gross receipts in the                     activities described in subparagraph
                                                                   taxable year.                                             (1)(i) or (ii) of this paragraph and which
                                                                      (2) Taxpayers using the 5-year rule. If a              also contains an obligation to perform
                                                                   taxpayer uses the method of deter-                        services that are to be performed as an
                                                                   mining estimated future redemptions                       integral part of such activities; and
                                                                   described in paragraph (c)(5)(i) of this                     (ii) Amounts due and payable are
                                                                   section, he shall file a statement with                   considered ‘‘received’’.
                                                                   his return showing, with respect to the                      (3) If a taypayer (described in sub-
                                                                   taxable year and the 4 preceding tax-                     paragraph (1) of this paragraph) re-
                                                                   able years—                                               ceives an amount pursuant to, and to
                                                                      (i) The total number of stamps or                      be applied against, an agreement that
                                                                   coupons issued or sold during each                        not only obligates the taxpayer to per-
                                                                   year, and                                                 form the activities described in sub-
                                                                      (ii) The total number of stamps or                     paragraph (1) (i) and (ii) of this para-
                                                                   coupons redeemed in each such year.                       graph, but also obligates the taxpayer
                                                                      (3) Trading stamp companies. In addi-                  to perform services that are not to be
                                                                   tion to the information required by                       performed as an integral part of such
                                                                   subparagraph (1) or (2) of this para-                     activities, such amount will be treated
                                                                   graph, a taxpayer engaged in the trade                    as an ‘‘advance payment’’ (as defined in
                                                                   or business of selling trading stamps or                  subparagraph (1) of this paragraph)
                                                                   premium coupons shall include with                        only to the extent such amount is
                                                                   the statement described in subpara-                       properly allocable to the obligation to
                                                                   graph (1) or (2) of this paragraph such                   perform the activities described in sub-
                                                                   information as may be necessary to                        paragraph (1) (i) and (ii) of this para-
                                                                   satisfy the requirements of paragraph                     graph. The portion of the amount not
                                                                   (a)(2)(iv) of this section.                               so allocable will not be considered an
                                                                   [T.D. 7201, 37 FR 16911, Aug. 23, 1972, as                ‘‘advance payment’’ to which this sec-
                                                                   amended by T.D. 7201, 37 FR 18617, Sept. 14,              tion applies. If, however, the amount
                                                                   1972]                                                     not so allocable is less than 5 percent
                                                                                                                             of the total contract price, such
                                                                   § 1.451–5 Advance payments for goods                      amount will be treated as so allocable
                                                                        and long-term contracts.                             except that such treatment cannot re-
                                                                      (a) Advance payment defined. (1) For                   sult in delaying the time at which the
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                                                                   purposes of this section, the term ‘‘ad-                  taxpayer would otherwise accrue the
                                                                   vance payment’’ means any amount                          amounts attributable to the activities

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                                                                   § 1.451–5                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   described in subparagraph (1) (i) and                     graph (1)(ii)(b) of this paragraph. T must in-
                                                                   (ii) of this paragraph.                                   clude the remaining $12,000 of the gross con-
                                                                      (b) Taxable year of inclusion—(1) In                   tract price in its gross income in 1975 for tax
                                                                   general. Advance payments must be in-                     purposes.
                                                                   cluded in income either—                                    (3) Long-term contracts. In the case of
                                                                      (i) In the taxable year of receipt; or                 a taxpayer accounting for advance pay-
                                                                      (ii) Except as provided in paragraph                   ments for tax purposes pursuant to a
                                                                   (c) of this section.                                      long-term contract method of account-
                                                                      (a) In the taxable year in which prop-                 ing under § 1.460–4, or of a taxpayer ac-
                                                                   erly accruable under the taxpayer’s                       counting for advance payments with
                                                                   method of accounting for tax purposes
                                                                                                                             respect to a long-term contract pursu-
                                                                   if such method results in including ad-
                                                                                                                             ant to an accrual method of accounting
                                                                   vance payments in gross receipts no
                                                                                                                             referred to in the succeeding sentence,
                                                                   later than the time such advance pay-
                                                                   ments are included in gross receipts for                  advance payments shall be included in
                                                                   purposes of all of his reports (including                 income in the taxable year in which
                                                                   consolidated financial statements) to                     properly included in gross receipts pur-
                                                                   shareholders, partners, beneficiaries,                    suant to such method of accounting
                                                                   other proprietors, and for credit pur-                    (without regard to the financial report-
                                                                   poses, or                                                 ing requirement contained in subpara-
                                                                      (b) If the taxpayer’s method of ac-                    graph (1)(ii) (a) or (b) of this para-
                                                                   counting for purposes of such reports                     graph). An accrual method of account-
                                                                   results in advance payments (or any                       ing to which the preceding sentence ap-
                                                                   portion of such payments) being in-                       plies shall consist of any method of ac-
                                                                   cluded in gross receipts earlier than for                 counting under which the income is ac-
                                                                   tax purposes, in the taxable year in                      crued when, and costs are accumulated
                                                                   which includible in gross receipts pur-                   until, the subject matter of the con-
                                                                   suant to his method of accounting for                     tract (or, if the subject matter of the
                                                                   purposes of such reports.                                 contract consists of more than one
                                                                      (2) Examples. This paragraph may be                    item, an item) is shipped, delivered, or
                                                                   illustrated by the following examples:                    accepted.
                                                                     Example 1. S, a retailer who uses for tax                 (4) Installment method. The financial
                                                                   purposes and for purposes of the reports re-              reporting requirement of subparagraph
                                                                   ferred to in subparagraph (1)(ii)(a) of this              (1)(ii) (a) or (b) of this paragraph shall
                                                                   paragraph, an accrual method of accounting                not be construed to prevent the use of
                                                                   under which it accounts for its sales of goods            the installment method under section
                                                                   when the goods are shipped, receives advance
                                                                   payments for such goods. Such advance pay-
                                                                                                                             453. See § 1.446–1(c)(1)(ii).
                                                                   ments must be included in gross receipts for                (c) Exception for inventoriable goods.
                                                                   tax purposes either in the taxable year the               (1)(i) If a taxpayer receives an advance
                                                                   payments are received or in the taxable year              payment in a taxable year with respect
                                                                   such goods are shipped (except as provided in             to an agreement for the sale of goods
                                                                   paragraph (c) of this section).                           properly includible in his inventory, or
                                                                     Example 2. T, a manufacturer of household
                                                                   furniture, is a calendar year taxpayer who
                                                                                                                             with respect to an agreement (such as
                                                                   uses an accrual method of accounting pursu-               a gift certificate) which can be satis-
                                                                   ant to which income is accrued when fur-                  fied with goods or a type of goods that
                                                                   niture is shipped for purposes of its financial           cannot be identified in such taxable
                                                                   reports (referred to in subparagraph (1)(ii)(a)           year, and on the last day of such tax-
                                                                   of this paragraph) and an accrual method of               able year the taxpayer—
                                                                   accounting pursuant to which the income is
                                                                                                                               (a) Is accounting for advance pay-
                                                                   accrued when furniture is delivered and ac-
                                                                   cepted for tax purposes. See § 1.446–1(c)(1)(ii).         ments pursuant to a method described
                                                                   In 1974, T receives an advance payment of                 in paragraph (b)(1)(ii) of this section
                                                                   $8,000 from X with respect to an order of fur-            for tax purposes,
                                                                   niture to be manufactured for X for a total                 (b) Has received ‘‘substantial advance
                                                                   price of $20,000. The furniture is shipped to X           payments’’ (as defined in subparagraph
                                                                   in December 1974, but it is not delivered to
                                                                                                                             (3) of this paragraph) with respect to
                                                                   and accepted by X until January 1975. As a
                                                                                                                             such agreement, and
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                                                                   result of this contract, T must include the
                                                                   entire advance payment in its gross income                  (c) Has on hand (or available to him
                                                                   for tax purposes in 1974 pursuant to subpara-             in such year through his normal source

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                                                                   Internal Revenue Service, Treasury                                                                                                  § 1.451–5

                                                                   of supply) goods of substantially simi-                     (3) For purposes of subparagraph (1)
                                                                   lar kind and in sufficient quantity to                    of this paragraph, a taxpayer will be
                                                                   satisfy the agreement in such year,                       considered to have received ‘‘substan-
                                                                   then all advance payments received                        tial advance payments’’ with respect to
                                                                   with respect to such agreement by the                     an agreement by the last day of a tax-
                                                                   last day of the second taxable year fol-                  able year if the advance payments re-
                                                                   lowing the year in which such substan-                    ceived with respect to such agreement
                                                                   tial advance payments are received,                       during such taxable year plus the ad-
                                                                   and not previously included in income                     vance payments received prior to such
                                                                   in accordance with the taxpayer’s ac-                     taxable year pursuant to such agree-
                                                                   crual method of accounting, must be                       ment, equal or exceed the total costs
                                                                   included in income in such second tax-                    and expenditures reasonably estimated
                                                                   able year.                                                as includible in inventory with respect
                                                                     (ii) If advance payments are required                   to such agreement. Advance payments
                                                                   to be included in income in a taxable                     received in a taxable year with respect
                                                                   year solely by reason of subdivision (i)                  to an agreement (such as a gift certifi-
                                                                   of this subparagraph, the taxpayer                        cate) under which the goods or type of
                                                                   must take into account in such taxable                    goods to be sold are not identifiable in
                                                                   year the costs and expenditures in-                       such year shall be treated as ‘‘substan-
                                                                   cluded in inventory at the end of such                    tial advance payments’’ when received.
                                                                   year with respect to such goods (or                         (4) The application of this paragraph
                                                                   substantially similar goods) on hand                      is illustrated by the following example:
                                                                   or, if no such goods are on hand by the
                                                                                                                               Example. In 1971, X, a calendar year accrual
                                                                   last day of such second taxable year,
                                                                                                                             method taxpayer, enters into a contract for
                                                                   the estimated cost of goods necessary                     the sale of goods (properly includible in X’s
                                                                   to satisfy the agreement.                                 inventory) with a total contract price of
                                                                     (iii) Subdivision (ii) of this subpara-                 $100. X estimates that his total inventoriable
                                                                   graph does not apply if the goods or                      costs and expenditures for the goods will be
                                                                   type of goods with respect to which the                   $50. X receives the following advance pay-
                                                                   advance payment is received are not                       ments with respect to the contract:
                                                                   identifiable in the year the advance                      1971   .......................................................................   $35
                                                                   payments are required to be included                      1972   .......................................................................    20
                                                                   in income by reason of subdivision (i)                    1973   .......................................................................    15
                                                                                                                             1974   .......................................................................    10
                                                                   of this subparagraph (for example,                        1975   .......................................................................    10
                                                                   where an amount is received for a gift                    1976   .......................................................................    10
                                                                   certificate).
                                                                     (2) If subparagraph (1)(i) of this para-                  The goods are delivered pursuant to the
                                                                   graph is applicable to advance pay-                       customer’s request in 1977. X’s closing inven-
                                                                                                                             tory for 1972 of the type of goods involved in
                                                                   ments received with respect to an
                                                                                                                             the contract is sufficient to satisfy the con-
                                                                   agreement, any advance payments re-                       tract. Since advance payments received by
                                                                   ceived with respect to such agreement                     the end of 1972 exceed the inventoriable costs
                                                                   subsequent to such second taxable year                    X estimates that he will incur, such pay-
                                                                   must be included in gross income in                       ments constitute ‘‘substantial advance pay-
                                                                   the taxable year of receipt. To the ex-                   ments’’. Accordingly, all payments received
                                                                   tent estimated costs of goods are taken                   by the end of 1974, the end of the second tax-
                                                                   into account in a taxable year pursu-                     able year following the taxable year during
                                                                                                                             which ‘‘substantial advance payments’’ are
                                                                   ant to subparagraph (1)(ii) of this para-
                                                                                                                             received, are includible in gross income for
                                                                   graph, such costs may not again be                        1974. Therefore, for taxable year 1974 X must
                                                                   taken into account in another year. In                    include $80 in his gross income. X must in-
                                                                   addition, any variances between the                       clude in his cost of goods sold for 1974 the
                                                                   costs or estimated costs taken into ac-                   cost of such goods (or similar goods) on hand
                                                                   count pursuant to subparagraph (1)(ii)                    or, if no such goods are on hand, the esti-
                                                                   of this paragraph and the costs actu-                     mated inventoriable costs necessary to sat-
                                                                   ally incurred in fulfilling the tax-                      isfy the contract. Since no further deferral is
                                                                                                                             allowable for such contract, X must include
                                                                   payer’s obligations under the agree-
                                                                                                                             in his gross income for the remaining years
                                                                   ment must be taken into account as an                     of the contract, the advance payment re-
                                                                   adjustment to the cost of goods sold in
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                                                                                                                             ceived each year. Any variance between esti-
                                                                   the year the taxpayer completes his ob-                   mated costs and the costs actually incurred
                                                                   ligations under such agreement.                           in fulfilling the contract is to be taken into

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                                                                   § 1.451–6                                                               26 CFR Ch. I (4–1–12 Edition)
                                                                   account in 1977, when the goods are deliv-                be included in his gross income for
                                                                   ered. See paragraph (c)(2) of this section.               such taxable year.
                                                                      (d) Information schedule. If a taxpayer                   (g) Special rule for certain transactions
                                                                   accounts for advance payments pursu-                      concerning natural resources. A trans-
                                                                   ant to paragraph (b)(1)(ii) of this sec-                  action which is treated as creating a
                                                                   tion, he must attach to his income tax                    mortgage loan pursuant to section 636
                                                                   return for each taxable year to which                     and the regulations thereunder rather
                                                                   such provision applies an annual infor-                   than as a sale shall not be considered a
                                                                   mation schedule reflecting the total                      ‘‘sale or other disposition’’ within the
                                                                   amount of advance payments received                       meaning of paragraph (a)(1) of this sec-
                                                                   in the taxable year, the total amount                     tion. Consequently, any payment re-
                                                                   of advance payments received in prior                     ceived pursuant to such a transaction,
                                                                   taxable years which has not been in-                      which payment would otherwise qual-
                                                                   cluded in gross income before the cur-                    ify as an ‘‘advance payment’’, will not
                                                                   rent taxable year, and the total                          be treated as an ‘‘advance payment’’
                                                                   amount of such payments received in                       for purposes of this section.
                                                                   prior taxable years which has been in-
                                                                                                                             [T.D. 7103, 36 FR 5495, Mar. 24, 1971, as amend-
                                                                   cluded in gross income for the current                    ed by T.D. 7397, 41 FR 2641, Jan. 19, 1976; T.D.
                                                                   taxable year.                                             8067, 51 FR 393, Jan. 6, 1986; T.D. 8929, 66 FR
                                                                      (e) Adoption of method. (1) For taxable                2224, Jan. 11, 2001]
                                                                   years ending on or after December 31,
                                                                   1969, and before January 1, 1971, a tax-                  § 1.451–6 Election to include crop in-
                                                                   payer (even if he has already filed an                         surance proceeds in gross income
                                                                   income tax return for a taxable year                           in the taxable year following the
                                                                   ending within such period) may secure                          taxable year of destruction or dam-
                                                                                                                                  age.
                                                                   the consent of the Commissioner to
                                                                   change his method of accounting for                         (a) In general. (1) For taxable years
                                                                   such year to a method prescribed in                       ending after December 30, 1969, a tax-
                                                                   paragraph (b)(1)(ii) of this section in                   payer reporting gross income on the
                                                                   the manner prescribed in section 446                      cash receipts and disbursements meth-
                                                                   and the regulations thereunder, if an                     od of accounting may elect to include
                                                                   application to secure such consent is                     insurance proceeds received as a result
                                                                   filed on Form 3115 within 180 days after                  of the destruction of, or damage to,
                                                                   March 23, 1971.                                           crops in gross income for the taxable
                                                                      (2) A taxpayer who is already report-                  year following the taxable year of the
                                                                   ing his income in accordance with a                       destruction or damage, if the taxpayer
                                                                   method       prescribed    in     paragraph               establishes that, under the taxpayer’s
                                                                   (b)(1)(ii)(a) of this section need not se-                normal business practice, the income
                                                                   cure the consent of the Commissioner                      from those crops would have been in-
                                                                   to continue to utilize this method.                       cluded in gross income for any taxable
                                                                   However, such a taxpayer, for all tax-                    year following the taxable year of the
                                                                   able years ending after March 23, 1971,                   destruction or damage. However, if the
                                                                   must comply with the requirements of                      taxpayer receives the insurance pro-
                                                                   paragraphs (b)(1)(ii)(a) (including the                   ceeds in the taxable year following the
                                                                   financial reporting requirement) and                      taxable year of the destruction or dam-
                                                                   (d) (relating to an annual information                    age, the taxpayer shall include the pro-
                                                                   schedule) of this section.                                ceeds in gross income for the taxable
                                                                      (f) Cessation of taxpayer’s liability. If a            year of receipt without having to make
                                                                   taxpayer has adopted a method pre-                        an election under section 451(d) and
                                                                   scribed in paragraph (b)(1)(ii) of this                   this section. For the purposes of this
                                                                   section, and if in a taxable year the                     section only, federal payments received
                                                                   taxpayer dies, ceases to exist in a                       as a result of destruction or damage to
                                                                   transaction other than one to which                       crops caused by drought, flood, or any
                                                                   section 381(a) applies, or his liability                  other natural disaster, or the inability
                                                                   under the agreement otherwise ends,                       to plant crops because of such a nat-
                                                                   then so much of the advance payment                       ural disaster, shall be treated as insur-
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                                                                   as was not includible in his gross in-                    ance proceeds received as a result of
                                                                   come in preceding taxable years shall                     destruction or damage to crops. The

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                                                                   Internal Revenue Service, Treasury                                                              § 1.451–7

                                                                   preceding sentence shall apply to pay-                      (vi) The name(s) of the insurance car-
                                                                   ments that are received by the tax-                       rier or carriers from whom payments
                                                                   payer after December 31, 1973.                            were received.
                                                                     (2) In the case of a taxpayer who re-                     (2) Scope of election. Once made, an
                                                                   ceives insurance proceeds as a result of                  election under section 451(d) is binding
                                                                   the destruction of, or damage to, two                     for the taxable year for which made un-
                                                                   or more specific crops, if such proceeds                  less the district director consents to a
                                                                   may, under section 451(d) and this sec-                   revocation of such election. Requests
                                                                   tion, be included in gross income for                     for consent to revoke an election under
                                                                   the taxable year following the taxable                    section 451(d) shall be made by means
                                                                   year of such destruction or damage,                       of a letter to the district director for
                                                                   and if such taxpayer makes an election                    the district in which the taxpayer is re-
                                                                   under section 451(d) and this section                     quired to file his return, setting forth
                                                                   with respect to any portion of such                       the taxpayer’s name, address, and iden-
                                                                   proceeds, then such election will be                      tification number, the year for which it
                                                                   deemed to cover all of such proceeds                      is desired to revoke the election, and
                                                                   which are attributable to crops rep-                      the reasons therefor.
                                                                   resenting a single trade or business                      [T.D. 7097, 36 FR 5215, Mar. 18, 1971, as amend-
                                                                   under section 446(d). A separate elec-                    ed by T.D. 7526, 42 FR 64624, Dec. 27, 1977;
                                                                   tion must be made with respect to in-                     T.D. 8429, 57 FR 38595, Aug. 26, 1992]
                                                                   surance proceeds attributable to each
                                                                   crop which represents a separate trade                    § 1.451–7 Election relating to livestock
                                                                   or business under section 446(d).                              sold on account of drought.
                                                                     (b)(1) Time and manner of making elec-                     (a) In general. Section 451(e) provides
                                                                   tion. The election to include in gross                    that for taxable years beginning after
                                                                   income insurance proceeds received as                     December 31, 1975, a taxpayer whose
                                                                   a result of destruction of, or damage                     principal trade or business is farming
                                                                   to, the taxpayer’s crops in the taxable                   (within the meaning of § 6420 (c)(3)) and
                                                                   year following the taxable year of such                   who reports taxable income on the cash
                                                                   destruction or damage shall be made                       receipts and disbursements method of
                                                                   by means of a statement attached to                       accounting may elect to defer for one
                                                                   the taxpayer’s return (or an amended                      year a certain portion of income. The
                                                                   return) for the taxable year of destruc-                  income which may be deferred is the
                                                                   tion or damage. The statement shall                       amount of gain realized during the tax-
                                                                   include the name and address of the                       able year from the sale or exchange of
                                                                   taxpayer (or his duly authorized rep-                     that number of livestock sold or ex-
                                                                   resentative), and shall set forth the fol-                changed solely on account of a drought
                                                                   lowing information:                                       which caused an area to be designated
                                                                     (i) A declaration that the taxpayer is                  as eligible for assistance by the Fed-
                                                                   making an election under section 451(d)                   eral Government (regardless of whether
                                                                   and this section;                                         the designation is made by the Presi-
                                                                     (ii) Identification of the specific crop                dent or by an agency or department of
                                                                   or crops destroyed or damaged;                            the Federal Government). That number
                                                                     (iii) A declaration that under the tax-                 is equal to the excess of the number of
                                                                   payer’s normal business practice the                      livestock sold or exchanged over the
                                                                   income derived from the crops which                       number which would have been sold or
                                                                   were destroyed or damaged would have                      exchanged had the taxpayer followed
                                                                   been included in this gross income for                    its usual business practices in the ab-
                                                                   a taxable year following the taxable                      sence of such drought. For example, if
                                                                   year of such destruction or damage;                       in the past it has been a taxpayer’s
                                                                     (iv) The cause of destruction or dam-                   practice to sell or exchange annually
                                                                   age of crops and the date or dates on                     400 head of beef cattle but due to quali-
                                                                   which such destruction or damage oc-                      fying drought conditions 550 head were
                                                                   curred;                                                   sold in a given taxable year, only in-
                                                                     (v) The total amount of payments re-                    come from the sale of 150 head may
                                                                   ceived     from     insurance    carriers,                qualify for deferral under this section.
                                                                   itemized with respect to each specific                    The election is not available with re-
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                                                                   crop and with respect to the date each                    spect to livestock described in section
                                                                   payment was received;                                     1231(b)(3) (relating to cattle, horses

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                                                                   § 1.451–7                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   (and other livestock) held by the tax-                    such livestock sold. The resulting
                                                                   payer for 24 months (12 months) and                       quotient shall then be multiplied by
                                                                   used for draft, breeding, dairy, or                       the excess number of such livestock
                                                                   sporting purposes).                                       sold on account of drought.
                                                                      (b) Usual business. The determination                    (2) Example. The provisions of this
                                                                   of the number of animals which a tax-                     paragraph may be illustrated by the
                                                                   payer would have sold if it had followed                  following example:
                                                                   its usual business practice in the ab-
                                                                   sence of drought will be made in light                      Example. A, a calendar year taxpayer, nor-
                                                                   of all facts and circumstances. In the                    mally sells 100 head of beef cattle a year. As
                                                                   case of taxpayers who have not estab-                     the result of drought conditions existing dur-
                                                                                                                             ing 1976, A sells 135 head during that year. A
                                                                   lished a usual business practice, reli-
                                                                                                                             realizes $35,100 of income from the sale of the
                                                                   ance will be placed upon the usual busi-                  135 head. On August 9, 1976, as a result of the
                                                                   ness practice of similarly situated tax-                  drought, the affected area was declared a dis-
                                                                   payers in the same general region as                      aster area thereby eligible for Federal assist-
                                                                   the taxpayer.                                             ance. The amount of income which A may
                                                                      (c) Special rules—(1) Connection with                  defer until 1977, presuming the other provi-
                                                                   drought area. To qualify under section                    sions of this section are met, is determined
                                                                   451(e) and this section, the livestock                    as follows:
                                                                   need not be raised, and the sale or ex-                   $35,100 (total income from sales of beef cat-
                                                                   change need not take place, in a                              tle)/135 (total number of beef cattle
                                                                   drought area. However, the sale or ex-                        sold)×35 (excess number of beef cattle
                                                                   change of the livestock must occur                            sold, i.e. 135¥100)=$9,100 (amount which
                                                                                                                                 A may defer until 1977)
                                                                   solely on account of drought condi-
                                                                   tions, the existence of which affected                      (f) Successive elections. If a taxpayer
                                                                   the water, grazing, or other require-                     makes an election under section 451(e)
                                                                   ments of the livestock so as to neces-                    for successive years, the amount de-
                                                                   sitate their sale or exchange.                            ferred from one year to the next year
                                                                      (2) Sale prior to designation of area as               shall not be deemed to have been re-
                                                                   eligible for Federal assistance. The provi-               ceived from the sale or exchange of
                                                                   sions of this section will apply regard-                  livestock during the later year. In ad-
                                                                   less of whether all or a portion of the                   dition, in determining the taxpayer’s
                                                                   excess number of animals were sold or                     normal business practice for the later
                                                                   exchanged before an area becomes eli-                     year, earlier years for which an elec-
                                                                   gible for Federal assistance, so long as                  tion under section 451(e) was made
                                                                   the drought which caused such disposi-                    shall not be considered.
                                                                   tions also caused the area to be des-
                                                                                                                               (g) Time and manner of making elec-
                                                                   ignated as eligible for Federal assist-
                                                                                                                             tion. The election provided for in this
                                                                   ance.
                                                                      (d) Classifications of livestock with re-              section must be made by the later of (1)
                                                                   spect to which the election may be made.                  the due date for filing the income tax
                                                                   The election to have the provisions of                    return (determined with regard to any
                                                                   section 451(e) apply must be made sepa-                   extensions of time granted the tax-
                                                                   rately for each broad generic classifica-                 payer for filing such return) for the
                                                                   tion of animals (e.g., hogs, sheep, cat-                  taxable year in which the early sale of
                                                                   tle) for which the taxpayer wishes the                    livestock occurs, or (2) (the 90th day
                                                                   provisions to apply. Separate elections                   after the date these regulations are
                                                                   shall not be made solely by reason of                     published as a Treasury decision in the
                                                                   the animals’ age, sex, or breed.                          FEDERAL REGISTER). The election must
                                                                      (e) Computation—(1) Determination of                   be made separately for each taxable
                                                                   amount deferred. The amount of income                     year to which it is to apply. It must be
                                                                   which may be deferred for a classifica-                   made by attaching a statement to the
                                                                   tion of livestock pursuant to this sec-                   return or an amended return for such
                                                                   tion shall be determined in the fol-                      taxable year. The statement shall in-
                                                                   lowing manner. The total amount of                        clude the name and address of the tax-
                                                                   income realized from the sale or ex-                      payer and shall set forth the following
                                                                   change of all livestock in the classi-                    information for each classification of
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                                                                   fication during the taxable year shall                    livestock for which the election is
                                                                   be divided by the total number of all                     made:

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                                                                   Internal Revenue Service, Treasury                                                              § 1.453–3

                                                                     (1) A declaration that the taxpayer is                  sale or other disposition of real prop-
                                                                   making an election under section                          erty or to a casual sale or other casual
                                                                   451(e);                                                   disposition of personal property. In ad-
                                                                     (2) Evidence of the existence of the                    dition, an obligation issued by a cor-
                                                                   drought conditions which forced the                       poration or a government or political
                                                                   early sale or exchange of the livestock                   subdivision thereof—
                                                                   and the date, if known, on which an                          (1) With interest coupons attached
                                                                   area was designated as eligible for as-                   (whether or not the obligation is read-
                                                                   sistance by the Federal Government as                     ily tradable in an established securities
                                                                   a result of the drought conditions.                       market),
                                                                     (3) A statement explaining the rela-                       (2) In registered form (other than an
                                                                   tionship of the drought area to the tax-                  obligation issued in registered form
                                                                   payer’s early sale or exchange of the                     which the taxpayer establishes will not
                                                                   livestock;                                                be readily tradable in an established
                                                                     (4) The total number of animals sold                    securities market), or
                                                                   in each of the three preceding years;                        (3) In any other form designed to
                                                                     (5) The number of animals which                         render such obligation readily tradable
                                                                   would have been sold in the taxable                       in an established securities market
                                                                   year had the taxpayer followed its nor-                   shall not be treated as an evidence of
                                                                   mal business practice in the absence of                   indebtedness of the purchaser in apply-
                                                                   drought;                                                  ing section 453(b) to a sale or other dis-
                                                                     (6) The total number of animals sold,                   position of real property or to a casual
                                                                   and the number sold on account of                         sale or other casual disposition of per-
                                                                   drought, during the taxable year; and                     sonal property. For purposes of this
                                                                     (7) A computation, pursuant to para-                    section, an obligation is to be consid-
                                                                   graph (e) of this section, of the amount                  ered in registered form if it is reg-
                                                                   of income to be deferred for each such                    istered as to principal, interest, or both
                                                                   classification.                                           and if its transfer must be effected by
                                                                     (h) Revocation of election. Once an                     the surrender of the old instrument
                                                                   election under this section is made for                   and either the reissuance by the cor-
                                                                   a taxable year, it may be revoked only                    poration of the old instrument to the
                                                                   with the approval of the Commissioner.                    new holder or the issuance by the cor-
                                                                     (i) Cross reference. For provisions re-                 poration of a new instrument to the
                                                                   lating to the involuntary conversion of                   new holder.
                                                                   livestock sold on account of drought                         (b) Treatment as payment. If under sec-
                                                                   see section 1033(e) and the regulations                   tion 453(b)(3) an obligation is not treat-
                                                                   thereunder.                                               ed as an evidence of indebtedness of the
                                                                   [T.D. 7526, 42 FR 64624, Dec. 27, 1977]                   purchaser, then—
                                                                                                                                (1) For purposes of determining
                                                                   §§ 1.453–1—1.453–2         [Reserved]                     whether the payments received in the
                                                                                                                             taxable year of the sale or disposition
                                                                   § 1.453–3 Purchaser evidences of in-                      exceed 30 percent of the selling price,
                                                                        debtedness payable on demand or                      and
                                                                        readily tradable.                                       (2) For purposes of returning income
                                                                      (a) In general. A bond or other evi-                   on the installment method during the
                                                                   dence of indebtedness (hereinafter in                     taxable year of the sale or disposition
                                                                   this section referred to as an obliga-                    or in a subsequent taxable year, the re-
                                                                   tion) issued by any person and payable                    ceipt by the seller of such obligation
                                                                   on demand shall not be treated as an                      shall be treated as a payment. The
                                                                   evidence of indebtedness of the pur-                      rules stated in this paragraph may be
                                                                   chaser in applying section 453(b) to a                    illustrated by the following examples:
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                                                                   § 1.453–3                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                                              $250, 000 payment (i.e., 250 of
                                                                                                                            o
                                                                                              corporation Y’s registered bonds
                                                                                             each with a principal amount and
                                                                                                fair market value of $1,000)
                                                                                                                                = 25 percent
                                                                                                $1 million selling price (i.e.,
                                                                                                                   r
                                                                                               $250, 000 of corporation Y ’s
                                                                                                   registered bonds plus
                                                                                                promissory note of $750,000)

                                                                      Example 1. On July 1, 1970, A, an individual           $1,000 registered bonds. A must include $7,500
                                                                   on the cash method of accounting reporting                (i.e., 10 percent gross profit percentage times
                                                                   on a calendar year basis, transferred all of              $75,000) in his gross income for calendar year
                                                                   his stock in corporation X (traded on an es-              1971. In addition, A includes the interest pay-
                                                                   tablished securities market and having a fair             ment made by corporation Y on July 1, in his
                                                                   market value of $1 million) to corporation Y              gross income for 1971.
                                                                   in exchange for 250 of corporation Y’s reg-
                                                                   istered bonds (which are traded in an over-                 (c) Payable on demand. Under section
                                                                   the-counter bond market) each with a prin-                453(b)(3), an obligation shall be treated
                                                                   cipal amount and fair market value of $1,000              as payable on demand only if the obli-
                                                                   (with interest payable at the rate of 8 per-              gation is treated as payable on demand
                                                                   cent per year), and Y’s unsecured promissory              under applicable state or local law.
                                                                   note, with a principal amount of $750,000. At               (d) Designed to be readily tradable in
                                                                   the time of such exchange A’s basis in the                an established securities market—(1) In
                                                                   corporation X stock is $900,000. The promis-
                                                                                                                             general. Obligations issued by a cor-
                                                                   sory note is payable at the rate of $75,000 an-
                                                                   nually, due on July 1, of each year following             poration or government or political
                                                                   1970, until the principal balance is paid. The            subdivision thereof will be deemed to
                                                                   note provides for the payment of interest at              be in a form designed to render such
                                                                   the rate of 10 percent per year also payable              obligations readily tradable in an es-
                                                                   on July 1 of each year. Under the rule stated             tablished securities market if—
                                                                   in subparagraph (1) of this paragraph, the 250              (i) Steps necessary to create a mar-
                                                                   registered bonds of corporation Y are treated             ket for them are taken at the time of
                                                                   as a payment for purposes of the 30 percent
                                                                   test described in section 453(b)(2)(A)(ii). The           issuance (or later, if taken pursuant to
                                                                   payment on account of the bonds equals 25                 an expressed or implied agreement or
                                                                   percent of the selling price determined as                understanding which existed at the
                                                                   follows:                                                  time of issuance),
                                                                      Since the payments received in the taxable               (ii) If they are treated as readily
                                                                   year of the sale do not exceed 30 percent of              tradable in an established securities
                                                                   the selling price and the sales price exceeds             market under subparagraph (2) of this
                                                                   $1,000, A may report the income received on
                                                                   the sale of his corporation X stock on the in-
                                                                                                                             paragraph, or
                                                                   stallment method. A elects to report the in-                (iii) If they are convertible obliga-
                                                                   come on the installment method. The gross                 tions to which paragraph (e) of this
                                                                   profit to be realized when the corporation X              section applies.
                                                                   stock is fully paid for is 10 percent of the                (2) Readily tradable in an established
                                                                   total contract price, computed as follows:                securities market. An obligation will be
                                                                   $100,000 gross profit (i.e., $1 million contract          treated as readily tradable in an estab-
                                                                   price less $900,000 basis in corporation X                lished securities market if—
                                                                   stock) over $1 million contract price. How-
                                                                   ever, since subparagraph (2) of this para-
                                                                                                                               (i) The obligation is part of an issue
                                                                   graph also treats the 250 corporation Y reg-              or series of issues which are readily
                                                                   istered bonds as a payment for purposes of                tradable in an established securities
                                                                   reporting income, A must include $25,000                  market, or
                                                                   (i.e., 10 percent times $250,000) in his gross in-          (ii) The corporation issuing the obli-
                                                                   come for calendar year 1970, the taxable year             gation has other obligations of a com-
                                                                   of sale.                                                  parable character which are described
                                                                      Example 2. Assume the same facts as in Ex-             in subdivision (i) of this subparagraph.
                                                                   ample 1. Assume further that on July 1, 1971,
                                                                                                                             For purposes of subdivision (ii) of this
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                                                                   corporation Y makes its first installment
                                                                   payment to A under the terms of the unse-                 subparagraph, the determination as to
                                                                   cured promissory note with 75 more of its                 whether there exist obligations of a

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                                                                   Internal Revenue Service, Treasury                                                              § 1.453–3

                                                                   comparable character depends upon the                     not quoted by any brokers or dealers who
                                                                   particular facts and circumstances.                       deal in corporate bonds, and, furthermore,
                                                                   Factors to be considered in making                        there are no comparable obligations of cor-
                                                                   such determination include, but are                       poration Y (determined with reference to the
                                                                                                                             characteristics set forth in subparagraph (2)
                                                                   not limited to, substantial similarity                    of this paragraph) which are so quoted.
                                                                   with respect to the presence and nature                   Therefore, the bonds are not treated as read-
                                                                   of security for the obligation, the num-                  ily tradable in an established securities mar-
                                                                   ber of obligations issued (or to be                       ket. In addition, under the particular facts
                                                                   issued), the number of holders of such                    and circumstances stated, the bonds will not
                                                                   obligation, the principal amount of the                   be considered to be in a form designed to
                                                                   obligation, and other relevant factors.                   render them readily tradeable in an estab-
                                                                      (3) Readily tradable. For purposes of                  lished securities market. Since the bonds are
                                                                   subparagraph (2)(i) of this paragraph,                    not in registered form, do not have coupons
                                                                                                                             attached, are not in a form designed to
                                                                   an obligation shall be treated as read-                   render them readily tradable in an estab-
                                                                   ily tradable if it is regularly quoted by                 lished securities market, the receipt of such
                                                                   brokers or dealers making a market in                     bonds by the holder is not treated as a pay-
                                                                   such obligation or is part of an issue a                  ment for purposes of section 453(b), notwith-
                                                                   portion of which is in fact traded in an                  standing that they are freely assignable.
                                                                   established securities market.                              Example 2. On April 1, 1972, corporation M
                                                                      (4) Established securities market. For                 purchases in a casual sale of personal prop-
                                                                   purposes of this paragraph, the term                      erty a fleet of trucks from corporation N in
                                                                   established securities market includes                    exchange for corporation M’s negotiable
                                                                   (i) a national securities exchange                        notes, not in registered form and without
                                                                                                                             coupons attached. The corporation M notes
                                                                   which is registered under section 6 of                    are comparable to earlier notes issued by
                                                                   the Securities and Exchange Act of 1934                   corporation M, which notes are quoted in the
                                                                   (15 U.S.C. 78f), (ii) an exchange which is                Eastern Bond section of the National daily
                                                                   exempted from registration under sec-                     quotation sheet, which is an interdealer
                                                                   tion 5 of the Securities Exchange Act                     quotation system. Both issues of notes are
                                                                   of 1935 (15 U.S.C. 78e) because of its lim-               unsecured, held by more than 100 holders,
                                                                   ited volume of transactions, and (iii)                    have a maturity date of more than 5 years,
                                                                   any over-the-counter market. For pur-                     and were issued for a comparable principal
                                                                   poses of this subparagraph, an over-                      amount. On the basis of these similar char-
                                                                                                                             acteristics it appears that the latest notes
                                                                   the-counter market is reflected by the                    will also be readily tradable. Since an inter-
                                                                   existence of an interdealer quotation                     dealer system reflects an over-the-counter
                                                                   system. An interdealer quotation sys-                     market, the earlier notes are treated as read-
                                                                   tem is any system of general circula-                     ily tradable in an established securities mar-
                                                                   tion to brokers and dealers which regu-                   ket. Since the later notes are obligations
                                                                   larly disseminates quotations of obli-                    comparable to the earlier ones, which are
                                                                   gations by identified brokers or deal-                    treated as readily tradable in an established
                                                                   ers, other than a quotation sheet pre-                    securities market, the later notes are also
                                                                   pared and distributed by a broker or                      treated as readily tradable in an established
                                                                                                                             securities market (whether or not such notes
                                                                   dealer in the regular course of his busi-                 are actually traded).
                                                                   ness and containing only quotations of
                                                                   such broker or dealer.                                       (e) Special rule for convertible securi-
                                                                      (5) Examples. The rules stated in this                 ties—(1) General rule. For purposes of
                                                                   paragraph may be illustrated by the                       paragraph (d)(1) of this section, if an
                                                                   following examples:                                       obligation contains a right whereby
                                                                     Example 1. On June 1, 1971, 25 individuals              the holder of such obligation may con-
                                                                   owning equal interests in a tract of land                 vert it directly or indirectly into an-
                                                                   with a fair market value of $1 million sell               other obligation which would be treat-
                                                                   the land to corporation Y. The $1 million                 ed as a payment under paragraph (b) of
                                                                   sales price is represented by 25 bonds issued             this section or may convert it directly
                                                                   by corporation Y each having a face value of              or indirectly into stock which would be
                                                                   $40,000. The bonds are not in registered form             treated as readily tradable or designed
                                                                   and do not have interest coupons attached,
                                                                                                                             to be readily tradable in an established
                                                                   and, in addition, are payable in 120 equal in-
                                                                   stallments each due on the first business day             securities market under paragraph (d)
                                                                                                                             of this section, the convertible obliga-
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                                                                   of each month. In addition, the bonds are ne-
                                                                   gotiable and may be assigned by the holder                tion shall be considered to be in a form
                                                                   to any other person. However, the bonds are               designed to render such obligation

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                                                                   § 1.453–4                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   readily tradable in an established secu-                  contemplate that a conveyance is not
                                                                   rities market unless such obligation is                   to be made at the outset, but only after
                                                                   convertible only at a substantial dis-                    all or a substantial portion of the sell-
                                                                   count. In determining whether the                         ing price has been paid, and (2) sales in
                                                                   stock or obligation, into which an obli-                  which there is an immediate transfer of
                                                                   gation is convertible, is readily                         title, the vendor being protected by a
                                                                   tradable or designed to be readily                        mortgage or other lien as to deferred
                                                                   tradable in an established securities                     payments.
                                                                   market, the rules stated in paragraph                       (b) Classes of sales. Such sales, under
                                                                   (d) of this section shall apply, and for                  either paragraph (a) (1) or (2) of this
                                                                   purposes of such paragraph (d) if such                    section, fall into two classes when con-
                                                                   obligation is convertible into stock                      sidered with respect to the terms of
                                                                   then the term ‘‘stock’’ shall be sub-
                                                                                                                             sale, as follows:
                                                                   stituted for the term ‘‘obligation’’
                                                                   wherever it appears in such paragraph                       (1) Sales of real property which may
                                                                   (d).                                                      be accounted for on the installment
                                                                     (2) Substantial discount rule. Whether                  method, that is, sales of real property
                                                                   an obligation is convertible at a sub-                    in which (i) there are no payments dur-
                                                                   stantial discount depends upon the par-                   ing the taxable year of the sale or (ii)
                                                                   ticular facts and circumstances. A sub-                   the payments in such taxable year (ex-
                                                                   stantial discount shall be considered to                  clusive of evidences of indebtedness of
                                                                   exist if at the time the convertible ob-                  the purchaser) do not exceed 30 percent
                                                                   ligation is issued, the fair market                       of the selling price, or
                                                                   value of the stock or obligation into                       (2) Deferred-payment sales of real
                                                                   which the obligation is convertible is                    property in which the payments re-
                                                                   less than 80 percent of the fair market                   ceived in cash or property other than
                                                                   value of the obligation (determined by                    evidences of indebtedness of the pur-
                                                                   taking into account all relevant fac-                     chaser during the taxable year in
                                                                   tors, including proper discount to re-                    which the sale is made exceed 30 per-
                                                                   flect the fact that the convertible obli-                 cent of the selling price.
                                                                   gation is not readily tradable in an es-                    (c) Determination of ‘‘selling price’’. In
                                                                   tablished securities market and any                       the sale of mortgaged property the
                                                                   additional consideration required to be                   amount of the mortgage, whether the
                                                                   paid by the taxpayer). Also, if a privi-                  property is merely taken subject to the
                                                                   lege to convert an obligation into                        mortgage or whether the mortgage is
                                                                   stock or an obligation which is readily                   assumed by the purchaser, shall, for
                                                                   tradable in an established securities                     the purpose of determining whether a
                                                                   market may not be exercised within a                      sale is on the installment plan, be in-
                                                                   period of 1 year from the date the obli-                  cluded as a part of the ‘‘selling price’’;
                                                                   gation is issued, a substantial discount
                                                                                                                             and for the purpose of determining the
                                                                   shall be considered to exist.
                                                                                                                             payments and the total contract price
                                                                     (f) Effective date. The provisions of
                                                                                                                             as those terms are used in section 453,
                                                                   this section shall apply to sales or
                                                                                                                             and §§ 1.453–1 through 1.453–7, the
                                                                   other dispositions occurring after May
                                                                   27, 1969, which are not made pursuant                     amount of such mortgage shall be in-
                                                                   to a binding written contract entered                     cluded only to the extent that it ex-
                                                                   into on or before such date. No infer-                    ceeds the basis of the property. The
                                                                   ence shall be drawn from this section                     term ‘‘payments’’ does not include
                                                                   as to any question of law concerning                      amounts received by the vendor in the
                                                                   the application of section 453 to sales                   year of sale from the disposition to a
                                                                   or other dispositions occurring on or                     third person of notes given by the
                                                                   before May 27, 1969.                                      vendee as part of the purchase price
                                                                                                                             which are due and payable in subse-
                                                                   [T.D. 7197, 37 FR 13532, July 11, 1972]                   quent years. Commissions and other
                                                                   § 1.453–4 Sale of real property involv-                   selling expenses paid or incurred by the
                                                                        ing deferred periodic payments.                      vendor shall not reduce the amount of
                                                                                                                             the payments, the total contract price,
                                                                      (a) In general. Sales of real property
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                                                                                                                             or the selling price.
                                                                   involving deferred payments include (1)
                                                                   agreements of purchase and sale which                     [T.D. 6500, 25 FR 11715, Nov. 26, 1960]

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                                                                   Internal Revenue Service, Treasury                                                              § 1.453–6

                                                                   § 1.453–5 Sale of real property treated                   charged, or applied, with proper adjust-
                                                                        on installment method.                               ment for any other amounts realized or
                                                                      (a) In general. In any transaction de-                 costs incurred in connection with the
                                                                   scribed in paragraph (b)(1) of § 1.453–4,                 reacquisition.
                                                                   that is, sales of real property in which                    (3) Fair market value of reacquired
                                                                   there are no payments during the year                     property. If the property reacquired is
                                                                   of sale or the payments in that year do                   bid in by the vendor at a foreclosure
                                                                   not exceed 30 percent of the selling                      sale, the fair market value of the prop-
                                                                   price, the vendor may return as income                    erty shall be presumed to be the pur-
                                                                   from each such transaction in any tax-                    chase or bid price thereof in the ab-
                                                                   able year that proportion of the in-                      sence of clear and convincing proof to
                                                                   stallment payments actually received                      the contrary.
                                                                   in that year which the gross profit (as                     (4) Basis of obligations. The basis in
                                                                   described in paragraph (b) of § 1.453–1)                  the hands of the vendor of the obliga-
                                                                   realized or to be realized when the                       tions of the purchaser satisfied, dis-
                                                                   property is paid for bears to the total                   charged, or applied upon the reacquisi-
                                                                   contract price. In any case, the sale of                  tion of the property will be the excess
                                                                   each lot or parcel of a subdivided tract                  of the face value of such obligations
                                                                   must be treated as a separate trans-                      over an amount equal to the income
                                                                   action and gain or loss computed ac-                      which would be returnable were the ob-
                                                                   cordingly. (See paragraph (a) of § 1.61–                  ligations paid in full. For definition of
                                                                   6.)                                                       the basis of an installment obligation,
                                                                      (b) Defaults and repossessions—(1) Ef-                 see section 453(d)(2) and paragraph
                                                                   fective date. This paragraph shall apply                  (b)(2) of § 1.453–9.
                                                                   only with respect to taxable years be-                      (5) Bad debt deduction. No deduction
                                                                   ginning before September 3, 1964, in re-                  for a bad debt shall in any case be
                                                                   spect of which an election has not been                   taken on account of any portion of the
                                                                   properly made to have the provisions of                   obligations of the purchaser which are
                                                                   section 1038 apply. For rules applicable                  treated by the vendor as not having
                                                                   to taxable years beginning after Sep-                     been satisfied, discharged, or applied
                                                                   tember 2, 1964, and for taxable years be-                 upon the reacquisition of the property,
                                                                   ginning after December 31, 1957, to                       unless it is clearly shown that after the
                                                                   which such an election applies, see sec-                  property was reacquired the purchaser
                                                                   tion 1038, and §§ 1.1038–1 through 1.1038–                remained liable for such portion; and in
                                                                   3.                                                        no event shall the amount of the de-
                                                                      (2) Gain or loss on reacquisition of prop-             duction exceed the basis in the hands
                                                                   erty. If the purchaser of real property                   of the vendor of the portion of the obli-
                                                                   on the installment plan defaults in any                   gations with respect to which the pur-
                                                                   of his payments, and the vendor re-                       chaser remained liable after the reac-
                                                                   turning income on the installment                         quisition. See section 166 and the regu-
                                                                   method reacquires the property sold,                      lations thereunder.
                                                                   whether title thereto had been retained                     (6) Basis of reacquired property. If the
                                                                   by the vendor or transferred to the pur-                  property reacquired is subsequently
                                                                   chaser, gain or loss for the year in                      sold, the basis for determining gain or
                                                                   which the reacquisition occurs is to be                   loss is the fair market value of the
                                                                   computed upon any installment obliga-                     property at the date of reacquisition,
                                                                   tions of the purchaser which are satis-                   including the fair market value of any
                                                                   fied or discharged upon the reacquisi-                    fixed improvements placed on the prop-
                                                                   tion or are applied by the vendor to the                  erty by the purchaser.
                                                                   purchase or bid price of the property.                    [T.D. 6500, 25 FR 11716, Nov. 26, 1960, as
                                                                   Such gain or loss is to be measured by                    amended by T.D. 6916, 32 FR 5923, Apr. 13,
                                                                   the difference between the fair market                    1967]
                                                                   value at the date of reacquisition of
                                                                   the property reacquired (including the                    § 1.453–6 Deferred payment sale of real
                                                                   fair market value of any fixed improve-                        property not on installment meth-
                                                                   ments placed on the property by the                            od.
                                                                   purchaser) and the basis in the hands                        (a) Value of obligations. (1) In trans-
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                                                                   of the vendor of the obligations of the                   actions included in paragraph (b)(2) of
                                                                   purchaser which are so satisfied, dis-                    § 1.453–4, that is, sales of real property

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                                                                   § 1.453–6                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   involving deferred payments in which                      hands of the vendor will be the original
                                                                   the payments received during the year                     basis at the time of the sale plus the
                                                                   of sale exceed 30 percent of the selling                  fair market value at the time of repos-
                                                                   price, the obligations of the purchaser                   session of fixed improvements placed
                                                                   received by the vendor are to be consid-                  on the property by the purchaser, ex-
                                                                   ered as an amount realized to the ex-                     cept that, with respect to repossessions
                                                                   tent of their fair market value in                        occurring after September 18, 1958, the
                                                                   ascertaining the profit or loss from the                  basis of the property shall be reduced
                                                                   transaction. Such obligations, how-                       by what would have been a proper ad-
                                                                   ever, are not considered in determining                   justment for exhaustion, wear and
                                                                   whether the payments during the year                      tear, obsolescence, amortization, and
                                                                   of sale exceed 30 percent of the selling                  depletion of the property during the pe-
                                                                   price.                                                    riod the property was in the hands of
                                                                      (2) If the obligations received by the                 the purchaser if the sale had not been
                                                                   vendor have no fair market value, the                     made.
                                                                   payments in cash or other property                          (c) Reacquisition of property where title
                                                                   having a fair market value shall be ap-                   is transferred to purchaser—(1) Gain or
                                                                   plied against and reduce the basis of                     loss on reacquisition. If the vendor in
                                                                   the property sold and, if in excess of
                                                                                                                             sales described in paragraph (a) of this
                                                                   such basis, shall be taxable to the ex-
                                                                                                                             section has previously transferred title
                                                                   tent of the excess. Gain or loss is real-
                                                                                                                             to the purchaser, and the purchaser de-
                                                                   ized when the obligations are disposed
                                                                                                                             faults in any of his payments, and the
                                                                   of or satisfied, the amount thereof
                                                                                                                             vendor accepts a voluntary reconvey-
                                                                   being the difference between the re-
                                                                                                                             ance of the property, in partial or full
                                                                   duced basis as provided in the pre-
                                                                                                                             satisfaction of the unpaid portion of
                                                                   ceding sentence and the amount real-
                                                                   ized therefor. Only in rare and extraor-                  the purchase price, the receipt of the
                                                                   dinary cases does property have no fair                   property so reacquired, to the extent of
                                                                   market value.                                             its fair market value at that time, in-
                                                                      (b) Repossession of property where title               cluding the fair market value of fixed
                                                                   is retained by vendor—(1) Gain or loss on                 improvements placed on the property
                                                                   repossession. If the vendor in sales re-                  by the purchaser, shall be considered as
                                                                   ferred to in paragraph (a) of this sec-                   the receipt of payment on the obliga-
                                                                   tion has retained title to the property                   tions satisfied. If the fair market value
                                                                   and the purchaser defaults in any of his                  of the property is greater than the
                                                                   payments, and the vendor repossesses                      basis of the obligations of the pur-
                                                                   the property, the difference between—                     chaser so satisfied (generally, such
                                                                      (i) The entire amount of the pay-                      basis being the fair market value of
                                                                   ments actually received on the con-                       such obligations previously recognized
                                                                   tract and retained by the vendor plus                     in computing income), the excess con-
                                                                   the fair market value at the time of re-                  stitutes ordinary income. If the value
                                                                   possession of fixed improvements                          of such property is less than the basis
                                                                   placed on the property by the pur-                        of such obligations, the difference may
                                                                   chaser, and                                               be deducted as a bad debt if
                                                                      (ii) The sum of the profits previously                 uncollectible, except that, if the obli-
                                                                   returned as income in connection                          gations satisfied are securities (as de-
                                                                   therewith and an amount representing                      fined in section 165(g)(2)(C)), any gain
                                                                   what would have been a proper adjust-                     or loss resulting from the transaction
                                                                   ment for exhaustion, wear and tear, ob-                   is a capital gain or loss subject to the
                                                                   solescence, amortization, and depletion                   provisions of sections 1201 through 1241.
                                                                   of the property during the period the                       (2) Basis of reacquired property. If the
                                                                   property was in the hands of the pur-                     reacquired property described in sub-
                                                                   chaser had the sale not been made, will                   paragraph (1) of this paragraph is sub-
                                                                   constitute gain or loss, as the case may                  sequently sold, the basis for deter-
                                                                   be, to the vendor for the year in which                   mining gain or loss is the fair market
                                                                   the property is repossessed.                              value of the property at the date of re-
                                                                      (2) Basis of repossessed property. The                 acquisition, including the fair market
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                                                                   basis of the property described in sub-                   value of the fixed improvements placed
                                                                   paragraph (1) of this paragraph in the                    on the property by the purchaser. See

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                                                                   Internal Revenue Service, Treasury                                                                                                  § 1.453–9

                                                                   section 166 and the regulations there-                      Example 1. In 1960 the M Corporation sold a
                                                                   under with respect to property reac-                      piece of unimproved real estate to B for
                                                                   quired by the vendor in a foreclosure                     $20,000. The company acquired the property
                                                                                                                             in 1948 at a cost of $10,000. During 1960 the
                                                                   proceeding.                                               company received $5,000 cash and vendee’s
                                                                      (d) Effective date. Paragraphs (b) and                 notes for the remainder of the selling price,
                                                                   (c) of this section shall apply only with                 or $15,000, payable in subsequent years. In
                                                                   respect to taxable years beginning be-                    1962, before the vendee made any further
                                                                   fore September 3, 1964, in respect of                     payments, the company sold the notes for
                                                                   which an election has not been prop-                      $13,000 in cash. The corporation makes its re-
                                                                                                                             turns on the calendar year basis. The income
                                                                   erly made to have the provisions of sec-
                                                                                                                             to be reported for 1962 is $5,500, computed as
                                                                   tion 1038 apply. For rules applicable to                  follows:
                                                                   taxable years beginning after Sep-                        Proceeds of sale of notes ......................                  ..............   $13,000
                                                                   tember 2, 1964, and for taxable years be-                 Selling price of property .........................                $20,000
                                                                   ginning after December 31, 1957, to                       Cost of property .....................................               10,000
                                                                   which such an election applies, see sec-                        Total profit .......................................          10,000
                                                                   tion 1038, and §§ 1.1038–1 through 1.1038–                      Total contract price .........................                20,000
                                                                   3.
                                                                                                                             Percent of profit, or proportion of each
                                                                   [T.D. 6500, 25 FR 11716, Nov. 26, 1960, as                  payment returnable as income,
                                                                                                                               $10,000 divided by $20,000, 50 per-
                                                                   amended by T.D. 6916, 32 FR 5923, Apr. 13,
                                                                                                                               cent.
                                                                   1967]                                                     Face value of notes ...............................                  15,000
                                                                                                                             Amount of income returnable were the
                                                                   §§ 1.453–7—1.453–8         [Reserved]                       notes satisfied in full, 50 percent of
                                                                                                                               $15,000 ..............................................              7,500
                                                                   § 1.453–9 Gain or loss on disposition of                  Basis of obligation—excess of face
                                                                        installment obligations.                               value of notes over amount of income
                                                                                                                               returnable were the notes satisfied in
                                                                     (a) In general. Subject to the excep-                     full .......................................................        7,500
                                                                   tions contained in section 453(d)(4) and
                                                                   paragraph (c) of this section, the entire                           Taxable income to be reported for 1962 ......                              5,500
                                                                   amount of gain or loss resulting from                       Example 2. Suppose in Example 1 the M
                                                                   any disposition or satisfaction of in-                    Corporation, instead of selling the notes, dis-
                                                                   stallment obligations, computed in ac-                    tributed them in 1962 to its shareholders as a
                                                                   cordance with section 453(d), is recog-                   dividend, and at the time of such distribu-
                                                                   nized in the taxable year of such dis-                    tion, the fair market value of the notes was
                                                                                                                             $14,000. The income to be reported for 1962 is
                                                                   position or satisfaction and shall be                     $6,500, computed as follows:
                                                                   considered as resulting from the sale or                  Fair market value of notes .......................................                 $14,000
                                                                   exchange of the property in respect of                    Basis of obligation—excess of face value of notes
                                                                   which the installment obligation was                        over amount of income returnable were the
                                                                                                                               notes satisfied in full (computed as in Example
                                                                   received by the taxpayer.                                   1) ..........................................................................      7,500
                                                                     (b) Computation of gain or loss. (1) The
                                                                   amount of gain or loss resulting under                          Taxable income to be reported for 1962 ..........                              6,500
                                                                   paragraph (a) of this section is the dif-                    (c) Disposition from which no gain or
                                                                   ference between the basis of the obliga-                  loss is recognized. (1)(i) Under section
                                                                   tion and (i) the amount realized, in the                  453(d)(4)(A), no gain or loss shall be rec-
                                                                   case of satisfaction at other than face                   ognized to a distributing corporation
                                                                   value or in the case of a sale or ex-                     with respect to the distribution made
                                                                   change, or (ii) the fair market value of                  after November 13, 1966, of installment
                                                                   the obligation at the time of disposi-                    obligations if (a) the distribution is
                                                                   tion, if such disposition is other than                   made pursuant to a plan for the com-
                                                                   by sale or exchange.                                      plete liquidation of a subsidiary under
                                                                     (2) The basis of an installment obli-                   section 332, and (b) the basis of the
                                                                   gation shall be the excess of the face                    such obligations in the hands of the
                                                                   value of the obligation over an amount                    distributee is determined under section
                                                                   equal to the income which would be re-                    334(b)(1).
                                                                   turnable were the obligation satisfied                       (ii) Under section 453(d)(4)(B), no gain
                                                                   in full.                                                  or loss shall be recognized to a distrib-
                                                                     (3) The application of subparagraphs
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                                                                                                                             uting corporation with respect to the
                                                                   (1) and (2) of this paragraph may be il-                  distribution of installment obligations
                                                                   lustrated by the following examples:                      if the distribution is made, pursuant to

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                                                                   § 1.453–9                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   a plan for the complete liquidation of a                     (f) Losses. See subchapter P (section
                                                                   corporation which meets the require-                      1201 and following), chapter 1 of the
                                                                   ments of section 337, under conditions                    Code, as to the limitation on capital
                                                                   whereby no gain or loss would have                        losses sustained by corporations and
                                                                   been recognized to the corporation had                    the limitation as to both capital gains
                                                                   such installment obligations been sold                    and capital losses of individuals.
                                                                   or exchanged on the day of the dis-                          (g) Disposition of installment obliga-
                                                                   tribution. The preceding sentence shall                   tions to life insurance companies. (1) Not-
                                                                   not apply to the extent that under sec-                   withstanding the provisions of section
                                                                   tion 453(d)(1) gain to the distributing                   453(d)(4) and paragraph (c) of this sec-
                                                                   corporation would be considered as                        tion or any provision of subtitle A re-
                                                                   gain to which section 341(f)(2), 617(d)(1),               lating to the nonrecognition of gain,
                                                                   1245(a)(1),      1250(a)(1),     1251(c)(1),              the entire amount of any gain realized
                                                                   1252(a)(1), or 1254(a)(1) applies, com-                   on the disposition of an installment ob-
                                                                   puted under the principles of the regu-                   ligation by any person, other than a
                                                                   lations under such provisions. See                        life insurance company (as defined in
                                                                   paragraph (d) of § 1.1245–6, paragraph                    section 801(a) and paragraph (b) of
                                                                   (c)(6) of § 1.1250–1, paragraph (e)(6) of                 § 1.801–3), to a life insurance company
                                                                   § 1.1251–1, paragraph (d)(3) of § 1.1252–1,               or to a partnership of which a life in-
                                                                   and paragraph (d) of § 1.1254–1.
                                                                                                                             surance company is a partner shall be
                                                                      (2) Where the Code provides for ex-                    recognized and treated in accordance
                                                                   ceptions to the recognition of gain or                    with section 453(d)(1) and paragraphs
                                                                   loss in the case of certain dispositions,                 (a) and (b) of this section. If a corpora-
                                                                   no gain or loss shall result under sec-
                                                                                                                             tion which is a life insurance company
                                                                   tion 453(d) in the case of a disposition
                                                                                                                             for the taxable year was a corporation
                                                                   of an installment obligation. Such ex-
                                                                                                                             which was not a life insurance com-
                                                                   ceptions include: Certain transfers to
                                                                                                                             pany for the preceding taxable year,
                                                                   corporations under sections 351 and 361;
                                                                                                                             such corporation shall be treated, for
                                                                   contributions of property to a partner-
                                                                   ship by a partner under section 721; and                  purposes of section 453(d)(1) and this
                                                                   distributions by a partnership to a                       paragraph, as having transferred to a
                                                                   partner under section 731 (except as                      life insurance company, on the last day
                                                                   provided by section 736 and section                       of the preceding taxable year, all in-
                                                                   751).                                                     stallment obligations which it held on
                                                                      (3) Any amount received by a person                    such last day. The gain, if any, realized
                                                                   in payment or settlement of an install-                   by reason of the installment obliga-
                                                                   ment obligation acquired in a trans-                      tions being so transferred shall be rec-
                                                                   action described in subparagraphs (1)                     ognized and treated in accordance with
                                                                   or (2) of this paragraph (other than an                   section 453(d)(1) and paragraphs (a) and
                                                                   amount received by a stockholder with                     (b) of this section. Similarly, a partner-
                                                                   respect to an installment obligation                      ship of which a life insurance company
                                                                   distributed to him pursuant to section                    becomes a partner shall be treated, for
                                                                   337) shall be considered to have the                      purposes of section 453(d)(1) and this
                                                                   character it would have had in the                        paragraph, as having transferred to a
                                                                   hands of the person from whom such                        life insurance company, on the last day
                                                                   installment obligation was acquired.                      of the preceding taxable year of such
                                                                      (d) Carryover of installment method.                   partnership, all installment obliga-
                                                                   For the treatment of income derived                       tions which it holds at the time such
                                                                   from installment obligations received                     life insurance company becomes a part-
                                                                   in transactions to which section 381 (a)                  ner. The gain, if any, realized by reason
                                                                   is applicable, see section 381(c)(8) and                  of the installment obligations being so
                                                                   the regulations thereunder.                               transferred shall be recognized and
                                                                      (e) Installment obligations transmitted                treated in accordance with section
                                                                   at death. Where installment obligations                   453(d)(1) and paragraphs (a) and (b) of
                                                                   are transmitted at death, see section                     this section.
                                                                   691(a)(4) and the regulations thereunder                     (2) The provisions of section 453(d)(5)
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                                                                   for the treatment of amounts consid-                      and subparagraph (1) of this paragraph
                                                                   ered income in respect of a decedent.                     shall not apply to losses sustained in

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                                                                   Internal Revenue Service, Treasury                                                             § 1.453–10

                                                                   connection with the disposition of in-                      Example 4. In 1960, the P Corporation, in a
                                                                   stallment obligations to a life insur-                    reorganization qualifying under section
                                                                   ance company.                                             368(a), transferred certain assets (including
                                                                                                                             installment obligations) to the R Corpora-
                                                                     (3) For the effective date of the provi-                tion, a life insurance company as defined in
                                                                   sions of section 453(d)(5) and this para-                 section 801(a). P realized a loss upon the
                                                                   graph, see paragraph (f) of § 1.453–10.                   transfer of the installment obligations,
                                                                     (4) Application of the provisions of                    which was not recognized under section 361.
                                                                   this paragraph may be illustrated by                      Pursuant to subparagraph (2) of paragraph
                                                                   the following examples:                                   (c) of this section, no loss with respect to the
                                                                                                                             transfer of these obligations will be recog-
                                                                     Example 1. A, an individual, in a trans-                nized to P under section 453(d)(1).
                                                                   action to which section 351 applies, transfers            [T.D. 6500, 25 FR 11718, Nov. 26, 1960, as
                                                                   in 1961 certain assets, including installment             amended by T.D. 6590, 27 FR 1319, Feb. 13,
                                                                   obligations, to a new corporation, X, which               1962; T.D. 7084, 36 FR 267, Jan. 8, 1971; T.D.
                                                                   qualifies as a life insurance company (as de-             7418, 41 FR 18812, May 7, 1976; T.D. 8586, 60 FR
                                                                   fined in section 801(a)) for the year 1961. A             2500, Jan. 10, 1995]
                                                                   makes his return on the calendar year basis.
                                                                   Section 453(d)(5) provides that the non-                  § 1.453–10    Effective date.
                                                                   recognition provisions of section 351 will not
                                                                   apply to the installment obligations trans-                  (a) Except as provided in this section,
                                                                   ferred by A to X Corporation. Therefore, the              the provisions of section 453 and
                                                                   entire amount of any gain realized by A on                §§ 1.453–1 through 1.453–9 shall apply to
                                                                   the transfer of the installment obligations               taxable years beginning after Decem-
                                                                   shall be recognized in 1961, with the amount              ber 31, 1953, and ending after August 16,
                                                                   of any such gain computed in accordance
                                                                   with the provisions of section 453(d)(1) and
                                                                                                                             1954.
                                                                   paragraph (b) of this section.                               (b) The provisions of paragraphs (a)
                                                                     Example 2. The M Corporation did not qual-              (2) and (3), (b), and (c) of § 1.453–8 shall
                                                                   ify as a life insurance company (as defined in            apply to taxable years ending after De-
                                                                   section 801(a)) for the taxable year 1958. On             cember 17, 1958.
                                                                   December 31, 1958, it held $60,000 of install-               (c) Under the provisions of sections
                                                                   ment obligations. The M Corporation quali-                453(b) and 7851(a)(1)(C), section 453(b)(1)
                                                                   fied as a life insurance company for the tax-             and the regulations with respect there-
                                                                   able year 1959. Accordingly, the M Corpora-
                                                                   tion is treated as having transferred to a life
                                                                                                                             to shall also apply—
                                                                   insurance company, on December 31, 1958,                     (1) To a sale or other disposition dur-
                                                                   the $60,000 of installment obligations it held            ing a taxable year beginning before
                                                                   on such date. The gain, if any, realized by M             January 1, 1954, only if the income was
                                                                   by reason of such installment obligations                 returnable (by reason of section 44(b) of
                                                                   being so transferred shall be recognized in               the Internal Revenue Code of 1939) on
                                                                   the taxable year 1958, with the amount of                 the basis and in the manner prescribed
                                                                   any such gain computed in accordance with
                                                                                                                             in section 44(a) of such code.
                                                                   the provisions of section 453(d)(1) and para-
                                                                   graph (b) of this section.                                   (2) To a sale or other disposition dur-
                                                                     Example 3. During its taxable year 1958,                ing a taxable year beginning after De-
                                                                   none of the partners of the N partnership                 cember 31, 1953, and ending before Au-
                                                                   qualified as a life insurance company (as de-             gust 17, 1954, though such taxable year
                                                                   fined in section 801(a)). The N partnership               is subject to the provisions of the In-
                                                                   held $30,000 of installment obligations on De-            ternal Revenue Code of 1939.
                                                                   cember 31, 1958. On July 30, 1959, the O Cor-                (d) Under the provisions of sections
                                                                   poration, a life insurance company (as de-                453(c)(1)(B) and 7851(a)(1)(C) section
                                                                   fined in section 801(a)), became a partner in
                                                                   the partnership. The N partnership held
                                                                                                                             453(c) and the regulations with respect
                                                                   $50,000 of installment obligations on July 30,            thereto shall also apply to taxable
                                                                   1959. Pursuant to section 453(d)(5), the N                years beginning after December 31,
                                                                   partnership is treated as having transferred              1953, and ending before August 17, 1954,
                                                                   to a life insurance company, on December 31,              though such taxable years are subject
                                                                   1958, the $50,000 of installment obligations it           to the provisions of the Internal Rev-
                                                                   held on July 30, 1959. The gain, if any, real-            enue Code of 1939.
                                                                   ized by the N partnership by reason of such
                                                                                                                                (e) The provisions of paragraph (b)(3)
                                                                   installment obligations being so transferred
                                                                   shall be recognized in the taxable year 1958,             of § 1.453–6 shall apply to repossessions
                                                                                                                             occurring after December 18, 1958.
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                                                                   with the amount of any such gain computed
                                                                   in accordance with the provisions of section                 (f) The provisions of section 453(d)(5)
                                                                   453(d)(1) and paragraph (b) of this section.              and paragraph (g) of § 1.453–9 shall

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                                                                   § 1.453–11                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                   apply to taxable years ending after De-                   termined under § 1.1275–1(b)) and the
                                                                   cember 31, 1957, but only as to transfers                 amount of any qualified stated interest
                                                                   or other dispositions of installment ob-                  (as defined in § 1.1273–1(c)) that has ac-
                                                                   ligations occurring after such date.                      crued prior to the distribution but that
                                                                   [T.D. 6500, 25 FR 11718, Nov. 26, 1960, as
                                                                                                                             is not payable until after the distribu-
                                                                   amended by T.D. 6590, 27 FR 1320, Feb. 13,                tion. For purposes of the preceding sen-
                                                                   1962; T.D. 6682, 28 FR 11177, Oct. 18, 1963]              tence, if the qualifying installment ob-
                                                                                                                             ligation is subject to § 1.446–2 (e.g., a
                                                                   § 1.453–11 Installment obligations re-                    debt instrument that has unstated in-
                                                                         ceived from a liquidating corpora-                  terest under section 483), the adjusted
                                                                         tion.                                               issue price of the obligation is deter-
                                                                      (a) In general—(1) Overview. Except as                 mined under § 1.446–2(c) and (d).
                                                                   provided in section 453(h)(1)(C) (relat-                     (B) Variable rate debt instrument. If
                                                                   ing to installment sales of depreciable                   the qualifying installment obligation
                                                                   property to certain closely related per-                  is a variable rate debt instrument (as
                                                                   sons), a qualifying shareholder (as de-                   defined in § 1.1275–5), the shareholder
                                                                   fined in paragraph (b) of this section)                   uses the equivalent fixed rate debt in-
                                                                   who receives a qualifying installment                     strument (within the meaning of
                                                                   obligation (as defined in paragraph (c)                   § 1.1275–5(e)(3)(ii)) constructed for the
                                                                   of this section) in a liquidation that                    qualifying installment obligation as of
                                                                   satisfies section 453(h)(1)(A) treats the                 the date the obligation was issued to
                                                                   receipt of payments in respect of the                     the liquidating corporation to deter-
                                                                   obligation, rather than the receipt of                    mine the accruals of original issue dis-
                                                                   the obligation itself, as a receipt of                    count, if any, and interest on the obli-
                                                                   payment for the shareholder’s stock.                      gation.
                                                                   The shareholder reports the payments                         (3) Liquidating distributions treated as
                                                                   received on the installment method un-                    selling price. All amounts distributed or
                                                                   less the shareholder elects otherwise in                  treated as distributed to a qualifying
                                                                   accordance with § 15a.453–1(d) of this                    shareholder incident to the liquidation,
                                                                   chapter.                                                  including cash, the issue price of quali-
                                                                      (2) Coordination with other provisions—                fying installment obligations as deter-
                                                                   (i) Deemed sale of stock for installment                  mined under paragraph (a)(2)(ii)(A) of
                                                                   obligation. Except as specifically pro-                   this section, and the fair market value
                                                                   vided in section 453(h)(1)(C), a quali-                   of other property (including obliga-
                                                                   fying shareholder treats a qualifying                     tions that are not qualifying install-
                                                                   installment obligation, for all purposes                  ment obligations) are considered as
                                                                   of the Internal Revenue Code, as if the                   having been received by the share-
                                                                   obligation is received by the share-                      holder as the selling price (as defined
                                                                   holder from the person issuing the obli-                  in § 15a.453–1(b)(2)(ii) of this chapter)
                                                                   gation in exchange for the share-                         for the shareholder’s stock in the liqui-
                                                                   holder’s stock in the liquidating cor-                    dating corporation. For the proper
                                                                   poration. For example, if the stock of a                  method of reporting liquidating dis-
                                                                   corporation that is liquidating is trad-                  tributions received in more than one
                                                                   ed on an established securities market,                   taxable year of a shareholder, see para-
                                                                   an installment obligation distributed                     graph (d) of this section. An election
                                                                   to a shareholder of the corporation in                    not to report on the installment meth-
                                                                   exchange for the shareholder’s stock                      od an installment obligation received
                                                                   does not qualify for installment report-                  in the liquidation applies to all dis-
                                                                   ing pursuant to section 453(k)(2).                        tributions received in the liquidation.
                                                                      (ii) Special rules to account for the                     (4) Assumption of corporate liability by
                                                                   qualifying installment obligation—(A)                     shareholders. For purposes of this sec-
                                                                   Issue price. A qualifying installment ob-                 tion, if in the course of a liquidation a
                                                                   ligation is treated by a qualifying                       shareholder assumes secured or unse-
                                                                   shareholder as newly issued on the date                   cured liabilities of the liquidating cor-
                                                                   of the distribution. The issue price of                   poration, or receives property from the
                                                                   the qualifying installment obligation                     corporation subject to such liabilities
                                                                   on that date is equal to the sum of the                   (including any tax liabilities incurred
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                                                                   adjusted issue price of the obligation                    by the corporation on the distribution),
                                                                   on the date of the distribution (as de-                   the amount of the liabilities is added

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                                                                   Internal Revenue Service, Treasury                                                             § 1.453–11

                                                                   to the shareholder’s basis in the stock                     (v) The selling price and contract price of
                                                                   of the liquidating corporation. These                     A’s stock in T is $2,463,188, and the gross
                                                                   additions to basis do not affect the                      profit is $2,363,188 ($2,463,188 selling price less
                                                                                                                             A’s adjusted tax basis of $100,000). A’s gross
                                                                   shareholder’s holding period for the
                                                                                                                             profit ratio is thus 96 percent (gross profit of
                                                                   stock. These liabilities do not reduce                    $2,363,188 divided by total contract price of
                                                                   the amounts received in computing the                     $2,463,188).
                                                                   selling price.                                              (vi) Under §§ 1.446–2(e)(1) and 1.1275–2(a),
                                                                     (5) Examples. The provisions of this                    $98,527 of the $150,000 payment is treated as a
                                                                   paragraph (a) are illustrated by the fol-                 payment of the interest and original issue
                                                                   lowing examples. Except as otherwise                      discount that accrued on the obligation from
                                                                   provided, assume in each example that                     July 31, 1998, to January 31, 1999 ($75,000 of
                                                                   A, an individual who is a calendar-year                   qualified stated interest and $23,527 of origi-
                                                                                                                             nal issue discount). The balance of the pay-
                                                                   taxpayer, owns all of the stock of T                      ment ($51,473) is treated as a payment of
                                                                   corporation. A’s adjusted tax basis in                    principal. A’s gain recognized in 1999 is
                                                                   that stock is $100,000. On February 1,                    $49,414 (96 percent of $51,473).
                                                                   1998, T, an accrual method taxpayer,                        Example 2. (i) T owns Blackacre, unim-
                                                                   adopts a plan of complete liquidation                     proved real property, with an adjusted tax
                                                                   that satisfies section 453(h)(1)(A) and                   basis of $700,000. Blackacre is subject to a
                                                                   immediately sells all of its assets to                    mortgage (underlying mortgage) of $1,100,000.
                                                                   unrelated B corporation in a single                       A is not personally liable on the underlying
                                                                   transaction. The examples are as fol-                     mortgage and the T shares held by A are not
                                                                                                                             encumbered by the underlying mortgage.
                                                                   lows:                                                     The other assets of T consist of $400,000 of
                                                                      Example 1. (i) The stated purchase price for           cash and $600,000 of accounts receivable at-
                                                                   T’s assets is $3,500,000. In consideration for            tributable to sales of inventory in the ordi-
                                                                   the sale, B makes a down payment of $500,000              nary course of business. The unsecured li-
                                                                   and issues a 10-year installment obligation               abilities of T total $900,000.
                                                                   with a stated principal amount of $3,000,000.               (ii) On February 1, 1998, T adopts a plan of
                                                                   The obligation provides for interest pay-                 complete liquidation complying with section
                                                                   ments of $150,000 on January 31 of each year,             453(h)(1)(A), and promptly sells Blackacre to
                                                                   with the total principal amount due at ma-                B for a 4-year mortgage note (bearing ade-
                                                                   turity.                                                   quate stated interest and otherwise meeting
                                                                      (ii) Assume that for purposes of section               all of the requirements of section 453) in the
                                                                   1274, the test rate on February 1, 1998, is 8             face amount of $4 million. Under the agree-
                                                                   percent, compounded semi-annually. Also as-               ment between T and B, T (or its successor) is
                                                                   sume that a semi-annual accrual period is                 to continue to make principal and interest
                                                                   used. Under § 1.1274–2, the issue price of the            payments on the underlying mortgage. Im-
                                                                   obligation on February 1, 1998, is $2,368,450.            mediately thereafter, T completes its liq-
                                                                   Accordingly, the obligation has $631,550 of               uidation by distributing to A its remaining
                                                                   original issue discount ($3,000,000–$2,368,450).          cash of $400,000 (after payment of T’s tax li-
                                                                   Between February 1 and July 31, $19,738 of                abilities), accounts receivable of $600,000, and
                                                                   original issue discount and $75,000 of quali-             the $4 million B note. A assumes T’s $900,000
                                                                   fied stated interest accrue with respect to               of unsecured liabilities and receives the dis-
                                                                   the obligation and are taken into account by              tributed property subject to the obligation
                                                                   T.                                                        to make payments on the $1,100,000 under-
                                                                      (iii) On July 31, 1998, T distributes the in-          lying mortgage. A receives no payments
                                                                   stallment obligation to A in exchange for A’s             from B on the B note during 1998.
                                                                   stock. No other property is ever distributed                (iii) Unless A elects otherwise, the trans-
                                                                   to A. On January 31, 1999, A receives the first           action is reported by A on the installment
                                                                   annual payment of $150,000 from B.                        method. The selling price is $5 million (cash
                                                                      (iv) When the obligation is distributed to A           of $400,000, accounts receivable of $600,000,
                                                                   on July 31, 1998, it is treated as if the obliga-         and the B note of $4 million). The total con-
                                                                   tion is received by A in an installment sale              tract price also is $5 million. A’s adjusted
                                                                   of shares directly to B on that date. Under               tax basis in the T shares, initially $100,000, is
                                                                   § 1.1275–1(b), the adjusted issue price of the            increased by the $900,000 of unsecured T li-
                                                                   obligation on that date is $2,388,188 (original           abilities assumed by A and by the obligation
                                                                   issue price of $2,368,450 plus accrued original           (subject to which A takes the distributed
                                                                   issue discount of $19,738). Accordingly, the              property) to make payments on the $1,100,000
                                                                   issue price of the obligation under paragraph             underlying mortgage on Blackacre, for an
                                                                   (a)(2)(ii)(A) of this section is $2,463,188, the          aggregate adjusted tax basis of $2,100,000. Ac-
                                                                   sum of the adjusted issue price of the obliga-            cordingly, the gross profit is $2,900,000 (sell-
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                                                                   tion on that date ($2,388,188) and the amount             ing price of $5 million less aggregate ad-
                                                                   of accrued but unpaid qualified stated inter-             justed tax basis of $2,100,000). The gross prof-
                                                                   est ($75,000).                                            it ratio is 58 percent (gross profit of $2,900,000

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                                                                   § 1.453–11                                                              26 CFR Ch. I (4–1–12 Edition)
                                                                   divided by the total contract price of $5 mil-            assets of a trade or business sold by the
                                                                   lion). The 1998 payments to A are $1 million              corporation for an installment obliga-
                                                                   ($400,000 cash plus $600,000 receivables) and A
                                                                                                                             tion include depreciable property, cer-
                                                                   recognizes gain in 1998 of $580,000 (58 percent
                                                                   of $1 million).                                           tain marketable securities, accounts
                                                                     (iv) In 1999, A receives payment from B on              receivable, installment obligations, or
                                                                   the B note of $1 million (exclusive of inter-             cash; or that the distribution of assets
                                                                   est). A’s gain recognized in 1999 is $580,000 (58         to the shareholder is or is not taxable
                                                                   percent of $1 million).                                   to the corporation under sections 336
                                                                     (b) Qualifying shareholder. For pur-                    and 453B, does not affect whether in-
                                                                   poses of this section, qualifying share-                  stallment obligations received in ex-
                                                                   holder means a shareholder to which,                      change for those assets are treated as
                                                                   with respect to the liquidating dis-                      qualifying installment obligations by
                                                                   tribution, section 331 applies. For ex-                   the shareholder. However, an obliga-
                                                                   ample, a creditor that receives a dis-                    tion received by the corporation in ex-
                                                                   tribution from a liquidating corpora-                     change for cash, in a transaction unre-
                                                                   tion, in exchange for the creditor’s                      lated to a sale or exchange of noncash
                                                                   claim, is not a qualifying shareholder                    assets by the corporation, is not treat-
                                                                   as a result of that distribution regard-                  ed as a qualifying installment obliga-
                                                                   less of whether the liquidation satisfies                 tion.
                                                                   section 453(h)(1)(A).                                        (3) Installment obligations distributed in
                                                                     (c) Qualifying installment obligation—                  liquidations     described     in     section
                                                                   (1) In general. For purposes of this sec-                 453(h)(1)(E)—(i) In general. In the case
                                                                   tion, qualifying installment obligation                   of a liquidation to which section
                                                                   means an installment obligation (other                    453(h)(1)(E) (relating to certain liqui-
                                                                   than an evidence of indebtedness de-
                                                                                                                             dating subsidiary corporations) applies,
                                                                   scribed in § 15a.453–1(e) of this chapter,
                                                                                                                             a qualifying installment obligation ac-
                                                                   relating to obligations that are payable
                                                                                                                             quired in respect of a sale or exchange
                                                                   on demand or are readily tradable) ac-
                                                                   quired in a sale or exchange of cor-                      by the liquidating subsidiary corpora-
                                                                   porate assets by a liquidating corpora-                   tion will be treated as a qualifying in-
                                                                   tion during the 12-month period begin-                    stallment obligation if distributed by a
                                                                   ning on the date the plan of liquidation                  controlling      corporate      shareholder
                                                                   is adopted. See paragraph (c)(4) of this                  (within the meaning of section 368(c))
                                                                   section for an exception for install-                     to a qualifying shareholder. The pre-
                                                                   ment obligations acquired in respect of                   ceding sentence is applied successively
                                                                   certain sales of inventory. Also see                      to each controlling corporate share-
                                                                   paragraph (c)(5) of this section for an                   holder, if any, above the first control-
                                                                   exception for installment obligations                     ling corporate shareholder.
                                                                   attributable to sales of certain prop-                       (ii) Examples. The provisions of this
                                                                   erty that do not generally qualify for                    paragraph (c)(3) are illustrated by the
                                                                   installment method treatment.                             following examples:
                                                                     (2) Corporate assets. Except as pro-
                                                                                                                               Example 1. (i) A, an individual, owns all of
                                                                   vided in section 453(h)(1)(C), in para-                   the stock of T corporation, a C corporation.
                                                                   graph (c)(4) of this section (relating to                 T has an operating division and three whol-
                                                                   certain sales of inventory), and in para-                 ly-owned subsidiaries, X, Y, and Z. On Feb-
                                                                   graph (c)(5) of this section (relating to                 ruary 1, 1998, T, Y, and Z all adopt plans of
                                                                   certain tax avoidance transactions),                      complete liquidation.
                                                                   the nature of the assets sold by, and                       (ii) On March 1, 1998, the following sales
                                                                   the tax consequences to, the selling                      are made to unrelated purchasers: T sells the
                                                                   corporation do not affect whether an                      assets of its operating division to B for cash
                                                                   installment obligation is a qualifying                    and an installment obligation. T sells the
                                                                   installment obligation. Thus, for exam-                   stock of X to C for an installment obligation.
                                                                   ple, the fact that the fair market value                  Y sells all of its assets to D for an install-
                                                                                                                             ment obligation. Z sells all of its assets to E
                                                                   of an asset is less than the adjusted                     for cash. The B, C, and D installment obliga-
                                                                   basis of that asset in the hands of the                   tions bear adequate stated interest and meet
                                                                   corporation; or that the sale of an                       the requirements of section 453.
                                                                   asset will subject the corporation to
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                                                                                                                               (iii) In June 1998, Y and Z completely liq-
                                                                   depreciation recapture (e.g., under sec-                  uidate, distributing their respective assets
                                                                   tion 1245 or section 1250); or that the                   (the D installment obligation and cash) to T.

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                                                                   Internal Revenue Service, Treasury                                                             § 1.453–11
                                                                   In July 1998, T completely liquidates, distrib-             (iii) Because P held 30 percent of the stock
                                                                   uting to A cash and the installment obliga-               of Q, section 453B(d) is inapplicable to P.
                                                                   tions respectively issued by B, C, and D. The             Under sections 453B(a) and 336, accordingly,
                                                                   liquidation of T is a liquidation to which sec-           Q recognizes gain or loss on the distribution
                                                                   tion 453(h) applies and the liquidations of Y             of the C obligation. P also recognizes gain or
                                                                   and Z into T are liquidations to which sec-               loss on the distribution of the B and C in-
                                                                   tion 332 applies.                                         stallment obligations to A in exchange for
                                                                     (iv) Because T is in control of Y (within               A’s stock. See sections 453B and 336.
                                                                   the meaning of section 368(c)), the D obliga-               (4) Installment obligations attributable
                                                                   tion acquired by Y is treated as acquired by
                                                                                                                             to certain sales of inventory—(i) In gen-
                                                                   T pursuant to section 453(h)(1)(E). A is a
                                                                   qualifying shareholder and the installment
                                                                                                                             eral. An installment obligation ac-
                                                                   obligations issued by B, C, and D are quali-              quired by a corporation in a liquidation
                                                                   fying installment obligations. Unless A                   that satisfies section 453(h)(1)(A) in re-
                                                                   elects otherwise, A reports the transaction               spect of a broken lot of inventory is
                                                                   on the installment method as if the cash and              not a qualifying installment obliga-
                                                                   installment obligations had been received in              tion. If an installment obligation is ac-
                                                                   an installment sale of the stock of T cor-                quired in respect of a broken lot of in-
                                                                   poration. Under section 453B(d), no gain or               ventory and other assets, only the por-
                                                                   loss is recognized by Y on the distribution of
                                                                                                                             tion of the installment obligation ac-
                                                                   the D installment obligation to T. Under sec-
                                                                   tions 453B(a) and 336, T recognizes gain or               quired in respect of the broken lot of
                                                                   loss on the distribution of the B, C, and D in-           inventory is not a qualifying install-
                                                                   stallment obligations to A in exchange for                ment obligation. The portion of the in-
                                                                   A’s stock.                                                stallment obligation attributable to
                                                                     Example 2. (i) A, a cash-method individual              other assets is a qualifying installment
                                                                   taxpayer, owns all of the stock of P corpora-             obligation. For purposes of this sec-
                                                                   tion, a C corporation. P owns 30 percent of               tion, the term broken lot of inventory
                                                                   the stock of Q corporation. The balance of                means inventory property that is sold
                                                                   the Q stock is owned by unrelated individ-                or exchanged other than in bulk to one
                                                                   uals. On February 1, 1998, P adopts a plan of
                                                                                                                             person in one transaction involving
                                                                   complete liquidation and sells all of its prop-
                                                                   erty, other than its Q stock, to B, an unre-              substantially all of the inventory prop-
                                                                   lated purchaser for cash and an installment               erty attributable to a trade or business
                                                                   obligation bearing adequate stated interest.              of the corporation. See paragraph
                                                                   On March 1, 1998, Q adopts a plan of complete             (c)(4)(ii) of this section for rules for de-
                                                                   liquidation and sells all of its property to an           termining what portion of an install-
                                                                   unrelated purchaser, C, for cash and install-             ment obligation is not a qualifying in-
                                                                   ment obligations. Q immediately distributes               stallment obligation and paragraph
                                                                   the cash and installment obligations to its               (c)(4)(iii) of this section for rules deter-
                                                                   shareholders in completion of its liquidation.
                                                                                                                             mining the application of payments on
                                                                   Promptly thereafter, P liquidates, distrib-
                                                                   uting to A cash, the B installment obliga-                an installment obligation only a por-
                                                                   tion, and a C installment obligation that P               tion of which is a qualifying install-
                                                                   received in the liquidation of Q.                         ment obligation.
                                                                     (ii) In the hands of A, the B installment ob-             (ii) Rules for determining nonqualifying
                                                                   ligation is a qualifying installment obliga-              portion of an installment obligation. If a
                                                                   tion. In the hands of P, the C installment ob-            broken lot of inventory is sold to a pur-
                                                                   ligation was a qualifying installment obliga-             chaser together with other corporate
                                                                   tion. However, in the hands of A, the C in-               assets for consideration consisting of
                                                                   stallment obligation is not treated as a                  an installment obligation and either
                                                                   qualifying installment obligation because P
                                                                   owned only 30 percent of the stock of Q. Be-
                                                                                                                             cash, other property, the assumption of
                                                                   cause P did not own the requisite 80 percent              (or taking property subject to) cor-
                                                                   stock interest in Q, P was not a controlling              porate liabilities by the purchaser, or
                                                                   corporate shareholder of Q (within the mean-              some combination thereof, the install-
                                                                   ing of section 368(c)) immediately before the             ment obligation is treated as having
                                                                   liquidation. Therefore, section 453(h)(1)(E)              been acquired in respect of a broken lot
                                                                   does not apply. Thus, in the hands of A, the              of inventory only to the extent that
                                                                   C obligation is considered to be a third-party            the fair market value of the broken lot
                                                                   note (not a purchaser’s evidence of indebted-
                                                                                                                             of inventory exceeds the sum of unse-
                                                                   ness) and is treated as a payment to A in the
                                                                   year of distribution. Accordingly, for 1998, A            cured liabilities assumed by the pur-
                                                                                                                             chaser, secured liabilities which en-
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                                                                   reports as payment the cash and the fair
                                                                   market value of the C obligation distributed              cumber the broken lot of inventory and
                                                                   to A in the liquidation of P.                             are assumed by the purchaser or to

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                                                                   § 1.453–11                                                                        26 CFR Ch. I (4–1–12 Edition)

                                                                   which the broken lot of inventory is                      Thus, the total purchase price G pays is
                                                                   subject, and the sum of the cash and                      $330,000.
                                                                   fair market value of other property re-                     (ii) P immediately completes its liquida-
                                                                                                                             tion, distributing the cash and installment
                                                                   ceived. This rule applies solely for the                  obligations, which otherwise meet the re-
                                                                   purpose of determining the portion of                     quirements of section 453, to A, an individual
                                                                   the installment obligation (if any) that                  cash-method taxpayer who is its sole share-
                                                                   is attributable to the broken lot of in-                  holder. In 1999, G makes a payment to A of
                                                                   ventory.                                                  $100,000 (exclusive of interest) on the $240,000
                                                                      (iii) Application of payments. If, by                  installment obligation.
                                                                                                                               (iii) In the hands of A, the installment ob-
                                                                   reason of the application of paragraph
                                                                                                                             ligations issued by B, C, and D are qualifying
                                                                   (c)(4)(ii) of this section, a portion of an               installment obligations because they were
                                                                   installment obligation is not a quali-                    timely acquired by P in a sale or exchange of
                                                                   fying installment obligation, then for                    its assets. In addition, the installment obli-
                                                                   purposes of determining the amount of                     gation issued by C is a qualifying install-
                                                                   gain to be reported by the shareholder                    ment obligation because it arose from a sale
                                                                   under section 453, payments on the ob-                    to one person in one transaction of substan-
                                                                                                                             tially all of the inventory property of the
                                                                   ligation (other than payments of quali-
                                                                                                                             trade or business engaged in by the Y divi-
                                                                   fied stated interest) shall be applied                    sion.
                                                                   first to the portion of the obligation                      (iv) The installment obligation issued by F
                                                                   that is not a qualifying installment ob-                  is not a qualifying installment obligation be-
                                                                   ligation.                                                 cause it is in respect of a broken lot of inven-
                                                                      (iv) Example. The following example                    tory. A portion of the installment obligation
                                                                   illustrates the provisions of this para-                  issued by G is a qualifying installment obli-
                                                                                                                             gation and a portion is not a qualifying in-
                                                                   graph (c)(4). In this example, assume                     stallment obligation, determined as follows:
                                                                   that all obligations bear adequate stat-                  G purchased part of the inventory property
                                                                   ed interest within the meaning of sec-                    (with a fair market value of $100,000) and all
                                                                   tion 1274(c)(2) and that the fair market                  of the other assets of the Z division by pay-
                                                                   value of each nonqualifying install-                      ing cash ($60,000), issuing an installment ob-
                                                                   ment obligation equals its face                           ligation ($240,000), and assuming liabilities of
                                                                   amount. The example is as follows:                        the Z division ($30,000). The assumed liabil-
                                                                                                                             ities ($30,000) and cash ($60,000) are attributed
                                                                     Example. (i) P corporation has three oper-              first to the inventory property. Therefore,
                                                                   ating divisions, X, Y, and Z, each engaged in             only $10,000 of the $240,000 installment obli-
                                                                   a separate trade or business, and a minor                 gation is attributed to inventory property.
                                                                   amount of investment assets. On July 1, 1998,             Accordingly, in the hands of A, the G install-
                                                                   P adopts a plan of complete liquidation that              ment obligation is a qualifying installment
                                                                   meets the criteria of section 453(h)(1)(A). The           obligation to the extent of $230,000, but is not
                                                                   following sales are promptly made to pur-                 a qualifying installment obligation to the
                                                                   chasers unrelated to P: P sells all of the as-            extent of the $10,000 attributable to the in-
                                                                   sets of the X division (including all of the in-          ventory property.
                                                                   ventory property) to B for $30,000 cash and                 (v) In the 1998 liquidation of P, A receives
                                                                   installment obligations totalling $200,000. P             a liquidating distribution as follows:
                                                                   sells substantially all of the inventory prop-
                                                                                                                                                                                       Qualifying
                                                                   erty of the Y division to C for a $100,000 in-                                                                                         Cash and
                                                                                                                                                                                        install-
                                                                                                                                                     Item                                                   other
                                                                   stallment obligation, and sells all of the                                                                          ment obli-         property
                                                                   other assets of the Y division (excluding cash                                                                       gations
                                                                   but including installment receivables pre-                Cash ..................................................   ................    $190,000
                                                                   viously acquired in the ordinary course of                B note ................................................    $200,000          ................
                                                                   the business of the Y division) to D for a                C note ................................................    $100,000          ................
                                                                   $170,000 installment obligation. P sells 1⁄3 of           D note ................................................    $170,000          ................
                                                                   the inventory property of the Z division to E             F note ................................................   ................    $100,000
                                                                                                                             G note 1 ..............................................    $230,000            $ 10,000
                                                                   for $100,000 cash, 1⁄3 of the inventory property
                                                                   of the Z division to F for a $100,000 install-                         Total ....................................    $700,000           $300,000
                                                                   ment obligation, and all of the other assets                 1 Face    amount $240,000.
                                                                   of the Z division (including the remaining 1⁄3
                                                                   of the inventory property worth $100,000) to                (vi) Assume that A’s adjusted tax basis in
                                                                   G for $60,000 cash, a $240,000 installment obli-          the stock of P is $100,000. Under the install-
                                                                   gation, and the assumption by G of the li-                ment method, A’s selling price and the con-
                                                                   abilities of the Z division. The liabilities as-          tract price are both $1 million, the gross
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                                                                   sumed by G, which are unsecured liabilities               profit is $900,000 (selling price of $1 million
                                                                   and liabilities encumbering the inventory                 less adjusted tax basis of $100,000), and the
                                                                   property acquired by G, aggregate $30,000.                gross profit ratio is 90 percent (gross profit

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                                                                   Internal Revenue Service, Treasury                                                             § 1.453–11
                                                                   of $900,000 divided by the contract price of $1           (relating to certain exceptions to the
                                                                   million). Accordingly, in 1998, A reports gain            definition of dealer dispositions));
                                                                   of $270,000 (90 percent of $300,000 payment in
                                                                   cash and other property). A’s adjusted tax
                                                                                                                               (B) The sale of the property by the
                                                                   basis in each of the qualifying installment               shareholder would result in recapture
                                                                   obligations is an amount equal to 10 percent              income (within the meaning of section
                                                                   of the obligation’s respective face amount.               453(i)(2)), but only if the amount of the
                                                                   A’s adjusted tax basis in the F note, a non-              recapture income is equal to or greater
                                                                   qualifying installment obligation, is $100,000,           than 50 percent of the property’s fair
                                                                   i.e., the fair market value of the note when              market value on the date of the sale by
                                                                   received by A. A’s adjusted tax basis in the
                                                                   G note, a mixed obligation, is $33,000 (10 per-           the corporation;
                                                                   cent of the $230,000 qualifying installment                 (C) The property is stock or securi-
                                                                   obligation portion of the note, plus the                  ties that are traded on an established
                                                                   $10,000 nonqualifying portion of the note).               securities market; or
                                                                     (vii) With respect to the $100,000 payment                (D) The sale of the property by the
                                                                   received from G in 1999, $10,000 is treated as
                                                                   the recovery of the adjusted tax basis of the
                                                                                                                             shareholder would have been under a
                                                                   nonqualifying portion of the G installment                revolving credit plan.
                                                                   obligation and $9,000 (10 percent of $90,000) is            (iii) Safe harbor. Paragraph (c)(5)(i) of
                                                                   treated as the recovery of the adjusted tax               this section will not apply to the liq-
                                                                   basis of the portion of the note that is a                uidation of a corporation if, on the
                                                                   qualifying installment obligation. The re-                date the plan of complete liquidation is
                                                                   maining $81,000 (90 percent of $90,000) is re-
                                                                   ported as gain from the sale of A’s stock. See
                                                                                                                             adopted and thereafter, less than 15
                                                                   paragraph (c)(4)(iii) of this section.                    percent of the fair market value of the
                                                                                                                             corporation’s assets is attributable to
                                                                     (5) Installment obligations attributable                property       described    in paragraph
                                                                   to sales of certain property—(i) In gen-                  (c)(5)(ii) of this section.
                                                                   eral. An installment obligation ac-                         (iv) Example. The provisions of this
                                                                   quired by a liquidating corporation, to
                                                                                                                             paragraph (c)(5) are illustrated by the
                                                                   the extent attributable to the sale of
                                                                                                                             following example:
                                                                   property      described    in    paragraph
                                                                   (c)(5)(ii) of this section, is not a quali-                 Example. Ten percent of the fair market
                                                                   fying obligation if the corporation is                    value of the assets of T is attributable to
                                                                   formed or availed of for a principal                      stock and securities traded on an established
                                                                   purpose of avoiding section 453(b)(2)                     securities market. T owns no other assets de-
                                                                   (relating to dealer dispositions and cer-                 scribed in paragraph (c)(5)(ii) of this section.
                                                                                                                             T, after adopting a plan of complete liquida-
                                                                   tain other dispositions of personal
                                                                                                                             tion, sells all of its stock and securities hold-
                                                                   property), section 453(i) (relating to                    ings to C corporation in exchange for an in-
                                                                   sales of property subject to recapture),                  stallment obligation bearing adequate stated
                                                                   or section 453(k) (relating to disposi-                   interest, sells all of its other assets to B cor-
                                                                   tions under a revolving credit plan and                   poration for cash, and distributes the cash
                                                                   sales of stock or securities traded on                    and installment obligation to its sole share-
                                                                   an established securities market)                         holder, A, in a complete liquidation that sat-
                                                                   through the use of a party bearing a re-                  isfies section 453(h)(1)(A). Because the C in-
                                                                   lationship, either directly or indi-                      stallment obligation arose from a sale of
                                                                   rectly, described in section 267(b) to                    publicly traded stock and securities, T can-
                                                                                                                             not report the gain on the sale under the in-
                                                                   any shareholder of the corporation.
                                                                                                                             stallment method pursuant to section
                                                                     (ii) Covered property. Property is de-                  453(k)(2). In the hands of A, however, the C
                                                                   scribed in this paragraph (c)(5)(ii) if,                  installment obligation is treated as having
                                                                   within 12 months before or after the                      arisen out of a sale of the stock of T corpora-
                                                                   adoption of the plan of liquidation, the                  tion. In addition, the general rule of para-
                                                                   property was owned by any shareholder                     graph (c)(5)(i) of this section does not apply,
                                                                   and—                                                      even if a principal purpose of the liquidation
                                                                     (A) The shareholder regularly sold or                   was the avoidance of section 453(k)(2), be-
                                                                   otherwise disposed of personal property                   cause the fair market value of the publicly
                                                                   of the same type on the installment                       traded stock and securities is less than 15
                                                                                                                             percent of the total fair market value of T’s
                                                                   plan or the property is real property                     assets. Accordingly, section 453(k)(2) does
                                                                   that the shareholder held for sale to                     not apply to A, and A may use the install-
                                                                   customers in the ordinary course of a
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                                                                                                                             ment method to report the gain recognized
                                                                   trade or business (provided the prop-                     on the payments it receives in respect of the
                                                                   erty is not described in section 453(l)(2)                obligation.

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                                                                   § 1.453–12                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                      (d) Liquidating distributions received in              taken into account after the date of
                                                                   more than one taxable year. If a quali-                   sale     but    before   May     7,   1997,
                                                                   fying shareholder receives liquidating                    unrecaptured section 1250 gain had
                                                                   distributions to which this section ap-                   been taken into account before ad-
                                                                   plies in more than one taxable year,                      justed net capital gain.
                                                                   the shareholder must reasonably esti-                        (c) Installment payments received after
                                                                   mate the gain attributable to distribu-                   May 6, 1997, and on or before August 23,
                                                                   tions received in each taxable year. In                   1999. If the amount of unrecaptured
                                                                   allocating basis to calculate the gain                    section 1250 gain in an installment pay-
                                                                   for a taxable year, the shareholder                       ment that is properly taken into ac-
                                                                   must reasonably estimate the antici-                      count after May 6, 1997, and on or be-
                                                                   pated aggregate distributions. For this                   fore August 23, 1999, is less than the
                                                                   purpose, the shareholder must take                        amount that would have been taken
                                                                   into account distributions and other                      into account under this section, the
                                                                   relevant events or information that the                   lesser amount is used to determine the
                                                                   shareholder knows or reasonably could                     amount of unrecaptured section 1250
                                                                   know up to the date on which the fed-                     gain that remains to be taken into ac-
                                                                   eral income tax return for that year is                   count.
                                                                   filed. If the gain for a taxable year is                     (d) Examples. In each example, the
                                                                   properly taken into account on the                        taxpayer, an individual whose taxable
                                                                   basis of a reasonable estimate and the                    year is the calendar year, does not
                                                                   exact amount is subsequently deter-                       elect out of the installment method.
                                                                   mined the difference, if any, must be                     The installment obligation bears ade-
                                                                   taken into account for the taxable year                   quate stated interest, and the property
                                                                   in which the subsequent determination                     sold is real property held in a trade or
                                                                   is made. However, the shareholder may
                                                                                                                             business that qualifies as both section
                                                                   file an amended return for the earlier
                                                                                                                             1231 property and section 1250 property.
                                                                   year in lieu of taking the difference
                                                                                                                             In all taxable years, the taxpayer’s
                                                                   into account for the subsequent tax-
                                                                                                                             marginal tax rate on ordinary income
                                                                   able year.
                                                                                                                             is 28 percent. The following examples
                                                                      (e) Effective date. This section is ap-
                                                                                                                             illustrate the rules of this section:
                                                                   plicable to distributions of qualifying
                                                                   installment obligations made on or                          Example 1. General rule. This example illus-
                                                                   after January 28, 1998.                                   trates the rule of paragraph (a) of this sec-
                                                                                                                             tion as follows:
                                                                   [T.D. 8762, 63 FR 4170, Jan. 28, 1998]
                                                                                                                               (i) In 1999, A sells property for $10,000, to be
                                                                                                                             paid in ten equal annual installments begin-
                                                                   § 1.453–12 Allocation of unrecaptured                     ning on December 1, 1999. A originally pur-
                                                                        section 1250 gain reported on the
                                                                                                                             chased the property for $5000, held the prop-
                                                                        installment method.
                                                                                                                             erty for several years, and took straight-line
                                                                      (a) General rule. Unrecaptured section                 depreciation deductions in the amount of
                                                                   1250 gain, as defined in section 1(h)(7),                 $3000. In each of the years 1999–2008, A has no
                                                                   is reported on the installment method                     other capital or section 1231 gains or losses.
                                                                   if that method otherwise applies under                      (ii) A’s adjusted basis at the time of the
                                                                   section 453 or 453A and the cor-                          sale is $2000. Of A’s $8000 of section 1231 gain
                                                                                                                             on the sale of the property, $3000 is attrib-
                                                                   responding regulations. If gain from an
                                                                                                                             utable to prior straight-line depreciation de-
                                                                   installment sale includes unrecaptured                    ductions and is unrecaptured section 1250
                                                                   section 1250 gain and adjusted net cap-                   gain. The gain on each installment payment
                                                                   ital gain (as defined in section 1(h)(4)),                is $800.
                                                                   the unrecaptured section 1250 gain is                       (iii) As illustrated in the table in this para-
                                                                   taken into account before the adjusted                    graph (iii) of this Example 1., A takes into ac-
                                                                   net capital gain.                                         count the unrecaptured section 1250 gain
                                                                      (b) Installment payments from sales be-                first. Therefore, the gain on A’s first three
                                                                   fore May 7, 1997. The amount of                           payments, received in 1999, 2000, and 2001, is
                                                                                                                             taxed at 25 percent. Of the $800 of gain on the
                                                                   unrecaptured section 1250 gain in an in-
                                                                                                                             fourth payment, received in 2002, $600 is
                                                                   stallment payment that is properly                        taxed at 25 percent and the remaining $200 is
                                                                   taken into account after May 6, 1997,                     taxed at 20 percent. The gain on A’s remain-
                                                                   from a sale before May 7, 1997, is deter-                 ing six installment payments is taxed at 20
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                                                                   mined as if, for all payments properly                    percent. The table is as follows:



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                                                                   Internal Revenue Service, Treasury                                                                                                                                      § 1.453–12

                                                                                                                                                                                                                                    2004–
                                                                                                                                     1999               2000               2001                2002               2003                               Total gain
                                                                                                                                                                                                                                     2008

                                                                   Installment gain .........................................               800                800                800                 800                800              4000               8000
                                                                   Taxed at 25% ............................................                800                800                800                 600      ................   ................           3000
                                                                   Taxed at 20% ............................................      ................   ................   ................              200                800              4000               5000
                                                                   Remaining to be taxed at 25% .................                         2200               1400                 600       ................   ................   ................   ................



                                                                     Example 2. Installment payments from sales                                                     1996, were received before May 7, 1997, and
                                                                   prior to May 7, 1997. This example illustrates                                                   taxed at 28 percent. Under the rule described
                                                                   the rule of paragraph (b) of this section as                                                     in paragraph (b) of this section, A deter-
                                                                   follows:                                                                                         mines the allocation of unrecaptured section
                                                                     (i) The facts are the same as in Example 1                                                     1250 gain for each installment payment after
                                                                   except that A sold the property in 1994, re-                                                     May 6, 1997, by taking unrecaptured section
                                                                   ceived the first of the ten annual installment                                                   1250 gain into account first, treating the gen-
                                                                   payments on December 1, 1994, and had no
                                                                                                                                                                    eral rule of paragraph (a) of this section as
                                                                   other capital or section 1231 gains or losses
                                                                                                                                                                    having applied since the time the property
                                                                   in the years 1994–2003.
                                                                     (ii) As in Example 1, of A’s $8000 of gain on                                                  was sold, in 1994. Consequently, of the $800 of
                                                                   the sale of the property, $3000 was attrib-                                                      gain on the fourth payment, received in 1997,
                                                                   utable to prior straight-line depreciation de-                                                   $600 is taxed at 25 percent and the remaining
                                                                   ductions and is unrecaptured section 1250                                                        $200 is taxed at 20 percent. The gain on A’s
                                                                   gain.                                                                                            remaining six installment payments is taxed
                                                                     (iii) As illustrated in the following table,                                                   at 20 percent. The table is as follows:
                                                                   A’s first three payments, in 1994, 1995, and

                                                                                                                                                                                                                                     1999-              Total
                                                                                                                                     1994               1995               1996                1997               1998               2003               gain

                                                                   Installment gain .........................................               800                800                800                 800                800              4000               8000
                                                                   Taxed at 28% ............................................                800                800                800       ................   ................   ................           2400
                                                                   Taxed at 25% ............................................      ................   ................   ................              600      ................   ................             600
                                                                   Taxed at 20% ............................................      ................   ................   ................              200                800              4000               5000
                                                                   Remaining to be taxed at 25% .................                         2200               1400                 600       ................   ................   ................   ................



                                                                     Example 3. Effect of section 1231(c) recapture.                                                1250 gain, rather than adjusted net capital
                                                                   This example illustrates the rule of para-                                                       gain. Therefore, A has $2200 of unrecaptured
                                                                   graph (a) of this section when there are non-                                                    section 1250 gain remaining to be taken into
                                                                   recaptured net section 1231 losses, as defined                                                   account.
                                                                   in section 1231(c)(2), from prior years as fol-                                                    (iii) In the year 2000, A’s installment gain
                                                                   lows:                                                                                            is taxed at two rates. First, $200 is recap-
                                                                     (i) The facts are the same as in Example 1,                                                    tured as ordinary income under section
                                                                   except that in 1999 A has non-recaptured net                                                     1231(c). Second, the remaining $600 of gain on
                                                                   section 1231 losses from the previous four                                                       A’s year 2000 installment payment is taxed
                                                                   years of $1000.                                                                                  at 25 percent. Because the full $800 of gain re-
                                                                     (ii) As illustrated in the table in paragraph                                                  duces unrecaptured section 1250 gain, A has
                                                                   (iv) of this Example 3, in 1999, all of A’s $800                                                 $1400 of unrecaptured section 1250 gain re-
                                                                   installment gain is recaptured as ordinary                                                       maining to be taken into account.
                                                                   income under section 1231(c). Under the rule                                                       (iv) The gain on A’s installment payment
                                                                   described in paragraph (a) of this section, for                                                  received in 2001 is taxed at 25 percent. Of the
                                                                   purposes of determining the amount of                                                            $800 of gain on the fourth payment, received
                                                                   unrecaptured section 1250 gain remaining to                                                      in 2002, $600 is taxed at 25 percent and the re-
                                                                   be taken into account, the $800 recaptured as                                                    maining $200 is taxed at 20 percent. The gain
                                                                   ordinary income under section 1231(c) is                                                         on A’s remaining six installment payments
                                                                   treated as reducing unrecaptured section                                                         is taxed at 20 percent. The table is as follows:

                                                                                                                                                                                                                                     2004-              Total
                                                                                                                                     1999               2000               2001                2002               2003               2008               gain

                                                                   Installment gain .........................................              800                 800               800                  800                800             4000                8000
                                                                   Taxed at ordinary rates under section
                                                                     1231(c) ..................................................             800                200      ................    ................   ................   ................           1000
                                                                   Taxed at 25% ............................................      ................             600                800                 600      ................   ................           2000
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                                                                   Taxed at 20% ............................................      ................   ................   ................              200                800              4000               5000
                                                                   Remaining non-recaptured net section
                                                                     1231 losses ...........................................                200      ................   ................    ................   ................   ................   ................


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                                                                   § 1.453A–0                                                                                                                 26 CFR Ch. I (4–1–12 Edition)

                                                                                                                                                                                                                                     2004-              Total
                                                                                                                                     1999               2000               2001                2002               2003               2008               gain

                                                                   Remaining to be taxed at 25% .................                        2200                1400                 600       ................   ................   ................   ................



                                                                      Example 4. Effect of a net section 1231 loss.                                                   (iii) In the year 2000, A has $800 of section
                                                                   This example illustrates the application of                                                      1231 installment gain, resulting in a net sec-
                                                                   paragraph (a) of this section when there is a                                                    tion 1231 gain of $800. A also has $200 of non-
                                                                   net section 1231 loss as follows:                                                                recaptured net section 1231 losses. The $800
                                                                      (i) The facts are the same as in Example 1                                                    gain is taxed at two rates. First, $200 is taxed
                                                                   except that A has section 1231 losses of $1000                                                   at ordinary rates under section 1231(c), re-
                                                                   in 1999.                                                                                         capturing the $200 net section 1231 loss sus-
                                                                      (ii) In 1999, A’s section 1231 installment                                                    tained in 1999. Second, the remaining $600 of
                                                                   gain of $800 does not exceed A’s section 1231                                                    gain on A’s year 2000 installment payment is
                                                                   losses of $1000. Therefore, A has a net section                                                  taxed at 25 percent. As in Example 3, the $200
                                                                   1231 loss of $200. As a result, under section                                                    of section 1231(c) gain is treated as reducing
                                                                   1231(a) all of A’s section 1231 gains and losses                                                 unrecaptured section 1250 gain, rather than
                                                                   are treated as ordinary gains and losses. As                                                     adjusted net capital gain. Therefore, A has
                                                                   illustrated in the following table, A’s entire                                                   $1400 of unrecaptured section 1250 gain re-
                                                                   $800 of installment gain is ordinary gain.                                                       maining to be taken into account.
                                                                   Under the rule described in paragraph (a) of                                                       (iv) The gain on A’s installment payment
                                                                   this section, for purposes of determining the                                                    received in 2001 is taxed at 25 percent, reduc-
                                                                   amount of unrecaptured section 1250 gain re-                                                     ing the remaining unrecaptured section 1250
                                                                   maining to be taken into account, A’s $800 of                                                    gain to $600. Of the $800 of gain on the fourth
                                                                   ordinary section 1231 installment gain in 1999                                                   payment, received in 2002, $600 is taxed at 25
                                                                   is treated as reducing unrecaptured section                                                      percent and the remaining $200 is taxed at 20
                                                                   1250 gain. Therefore, A has $2200 of                                                             percent. The gain on A’s remaining six in-
                                                                   unrecaptured section 1250 gain remaining to                                                      stallment payments is taxed at 20 percent.
                                                                   be taken into account.                                                                           The table is as follows:

                                                                                                                                                                                                                                    2004–
                                                                                                                                     1999               2000               2001                2002               2003                               Total gain
                                                                                                                                                                                                                                     2008

                                                                   Installment gain .........................................              800                 800                800                 800                800              4000               8000
                                                                   Ordinary gain under section 1231(a) ........                            800       ................   ................    ................   ................   ................            800
                                                                   Taxed at ordinary rates under section
                                                                     1231(c) ..................................................   ................             200      ................    ................   ................   ................             200
                                                                   Taxed at 25% ............................................      ................             600                800                 600      ................   ................           2000
                                                                   Taxed at 20% ............................................      ................   ................   ................              200                800              4000               5000
                                                                   Net section 1231 loss ...............................                    200      ................   ................    ................   ................   ................   ................
                                                                   Remaining to be taxed at 25% .................                         2200               1400                 600       ................   ................   ................   ................




                                                                     (e) Effective date. This section applies                                                         (e) Installment income of dealers in per-
                                                                   to installment payments properly                                                                 sonal property.
                                                                   taken into account after August 23,                                                                (1) In general.
                                                                                                                                                                      (2) Gross profit and total contract price.
                                                                   1999.                                                                                              (3) Carrying changes not included in total
                                                                   [T.D. 8836, 64 FR 45875, Aug. 23, 1999]                                                          contract price.
                                                                                                                                                                      (f) Other accounting methods.
                                                                   § 1.453A–0               Table of contents.                                                        (g) Records.
                                                                                                                                                                      (h) Effective date.
                                                                     This section lists the paragraphs and
                                                                   subparagraphs contained in §§ 1.453A–1                                                           § 1.453A–2 Treatment of revolving credit plans;
                                                                                                                                                                       taxable years beginning on or before December
                                                                   through 1.453A–3.
                                                                                                                                                                       31, 1986.

                                                                       § 1.453A–1 Installment method of reporting                                                    (a) In general.
                                                                          income by dealers in personal property.                                                    (b) Coordination with traditional install-
                                                                                                                                                                    ment plan.
                                                                     (a) In general.                                                                                 (c) Revolving credit plans.
                                                                     (b) Effect of security.                                                                         (d) Effective date.
                                                                     (c) Definition of dealer, sale, and sale on
                                                                   the installment plan.                                                                            § 1.453A–3 Requirements for adoption of or
                                                                                                                                                                       change to installment method by dealers in
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                                                                     (d) Installment plans.
                                                                     (1) Traditional installment plans.                                                                personal property.
                                                                     (2) Revolving credit plans.                                                                        (a) In general.

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                                                                   Internal Revenue Service, Treasury                                                            § 1.453A–1
                                                                     (b) Time and manner of electing install-                  (c) Definitions of dealer, sale, and sale
                                                                   ment method reporting.                                    on the installment plan. For purposes of
                                                                     (1) Time for election.                                  the regulations under section 453A—
                                                                     (2) Adoption of installation method.
                                                                     (3) Change to installment method.
                                                                                                                               (1) The term ‘‘dealer’’ means a person
                                                                     (4) Deemed elections.                                   who regularly sells or otherwise dis-
                                                                     (c) Consent.                                            poses of personal property on the in-
                                                                     (d) Cut-off method for amounts previously               stallment plan;
                                                                   accrued.                                                    (2) The term ‘‘sale’’ includes sales
                                                                     (e) Effective date.                                     and other dispositions; and
                                                                   [T.D. 8270, 54 FR 46376, Nov. 3, 1989]                      (3) Except as provided in paragraph
                                                                                                                             (d)(2) of this section, the term ‘‘sale on
                                                                   § 1.453A–1 Installment method of re-                      the installment plan’’ means—
                                                                        porting income by dealers on per-                      (i) A sale of personal property by the
                                                                        sonal property.                                      taxpayer under any plan for the sale of
                                                                      (a) In general. A dealer (as defined in                personal property, which plan, by its
                                                                   paragraph (c)(1) of this section) may                     terms and conditions, contemplates
                                                                   elect to return the income from the                       that each sale under the plan will be
                                                                   sale of personal property on the install-                 paid for in two or more payments; or
                                                                   ment method if such sale is a sale on                       (ii) A sale of personal property by the
                                                                   the installment plan (as defined in                       taxpayer under any plan for the sale of
                                                                   paragraphs (c)(3) and (d) of this sec-                    personal property—
                                                                   tion). Under the installment method of                      (A) Which plan, by its terms and con-
                                                                   accounting, a taxpayer may return as                      ditions, contemplates that such sale
                                                                   income from installment sales in any                      will be paid for in two or more pay-
                                                                   taxable year that proportion of the in-                   ments; and
                                                                   stallment payments actually received                        (B) Which sale is in fact paid for in
                                                                   in that year which the gross profit re-                   two or more payments.
                                                                   alized or to be realized when the prop-                     (d) Installment plans—(1) Traditional
                                                                   erty is paid for bears to the total con-                  installment plans. A traditional install-
                                                                   tract price. For this purpose, gross                      ment plan usually has the following
                                                                   profit means sales less cost of goods                     characteristics:
                                                                   sold. See paragraph (d) of this section                     (i) The execution of a separate in-
                                                                   for additional rules relating to the                      stallment contract for each sale or dis-
                                                                   computation of income under the in-                       position of personal property; and
                                                                   stallment method of accounting. In ad-                      (ii) The retention by the dealer of
                                                                   dition, see § 1.453A–2 for rules treating                 some type of security interest in such
                                                                   revolving credit plans as installment                     property.
                                                                   plans for taxable years beginning on or                   Normally, a sale under a traditional in-
                                                                   before December 31, 1986.                                 stallment plan meets the requirements
                                                                      (b) Effect of security. A dealer may                   of paragraph (c)(3)(i) of this section.
                                                                   adopt (but is not required to do so) one                    (2) Revolving credit plans. Sales under
                                                                   of the following four ways of protecting                  a revolving credit plan (within the
                                                                   against loss in case of default by the                    meaning of § 1.453A–2(c)(1))—
                                                                   purchaser:                                                  (i) Are treated, for taxable years be-
                                                                      (1) An agreement that title is to re-                  ginning on or before December 31, 1986,
                                                                   main in the vendor until performance                      as sales on the installment plan to the
                                                                   of the purchaser’s part of the trans-                     extent provided in § 1.453A–2, which
                                                                   action is completed;                                      provides for the application of the re-
                                                                      (2) A form of contract in which title                  quirements of paragraph (c)(3)(ii) of
                                                                   is conveyed to the purchaser imme-                        this section to sales under revolving
                                                                   diately, but subject to a lien for the                    credit plans; and
                                                                   unpaid portion of the selling price;                        (ii) Are not treated as sales on the in-
                                                                      (3) A present transfer of title to the                 stallment plan for taxable years begin-
                                                                   purchaser, who at the same time exe-                      ning after December 31, 1986.
                                                                   cutes a reconveyance in the form of a                       (e) Installment income of dealers in per-
                                                                   chattel mortgage to the vendor; or                        sonal property—(1) In general. The in-
                                                                      (4) A conveyance to a trustee pending                  come from sales on the installment
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                                                                   performance of the contract and sub-                      plan of a dealer may be ascertained by
                                                                   ject to its provisions.                                   treating as income that proportion of

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                                                                   § 1.453A–1                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                   the total payments received in the tax-                   the books of account of the seller but
                                                                   able year from sales on the installment                   are treated as periodic service charges
                                                                   plan (such payments being allocated to                    for customer billing purposes.
                                                                   the year against the sales of which                       Any change in the amount of the car-
                                                                   they apply) which the gross profit real-
                                                                                                                             rying charges or interest in a year sub-
                                                                   ized or to be realized on the total sales
                                                                                                                             sequent to the sale will not affect the
                                                                   on the installment plan made during
                                                                   each year bears to the total contract                     computation of the gross profit for the
                                                                   price of all such sales made during that                  year of sale but will be taken into ac-
                                                                   respective year. However, if the dealer                   count at the time the carrying charges
                                                                   demonstrates to the satisfaction of the                   or interest are adjusted. The applica-
                                                                   district director that income from                        tion of this paragraph (e)(2) to carrying
                                                                   sales on the installment plan is clearly                  charges or interest described in para-
                                                                   reflected, the income from such sales                     graph (e)(2)(ii) of this section may be
                                                                   may be ascertained by treating as in-                     illustrated by the following example:
                                                                   come that proportion of the total pay-                      Example. X Corporation makes sales on the
                                                                   ments received in the taxable year                        traditional installment plan. The customer’s
                                                                   from sales on the installment plan                        order specifies that the total price consists
                                                                   (such payments being allocated to the                     of a cash price plus a ‘‘time price differen-
                                                                   year against the sales of which they                      tial’’ of 11⁄2 percent per month on the out-
                                                                   apply) which either:                                      standing balance in the customer’s account,
                                                                     (i) The gross profit realized or to be                  and the customer is billed in this manner. On
                                                                   realized on the total credit sales made                   its books and for purposes of reporting to
                                                                   during each year bears to the total                       stockholders, X Corporation consistently
                                                                   contract price of all credit sales during                 makes the following entries each month
                                                                   that respective year, or                                  when it records its sales. A debit entry is
                                                                     (ii) The gross profit realized or to be                 make to accounts receivable (for the total
                                                                                                                             price) and balancing credit entries are made
                                                                   realized on all sales made during each
                                                                                                                             to sales (for the established selling price)
                                                                   year bears to the total contract price
                                                                                                                             and to a reserve account for collection ex-
                                                                   of all sales made during that respective                  pense (for the amount of the time price dif-
                                                                   year.                                                     ferential). In computing the gross profit real-
                                                                   A dealer who desires to compute in-                       ized or to be realized on the total sales on
                                                                   come by the installment method shall                      the installment plan, the total selling price
                                                                   maintain accounting records in such a                     and, thus, the total contract price for pur-
                                                                   manner as to enable an accurate com-                      poses of this paragraph (e) would, with re-
                                                                   putation to be made by such method in                     spect to sales made in taxable years begin-
                                                                   accordance with the provisions of this                    ning on or after January 1, 1960, include the
                                                                   section, section 446, and § 1.446–1.                      time price differential.
                                                                     (2) Gross profit and total contract price.                (3) Carrying charges not included in
                                                                   For purposes of paragraph (e)(1) of this                  total contract price. In the case of sales
                                                                   section, in computing the gross profit                    by dealers in personal property made
                                                                   realized or to be realized on the total                   during taxable years beginning after
                                                                   sales on the installment plan, there                      December 31, 1963, the income from
                                                                   shall be included in the total selling                    which is returned on the installment
                                                                   price and, thus, in the total contract                    method, if the carrying charges or in-
                                                                   price of all such sales.                                  terest with respect to such sales is not
                                                                     (i) The amount of carrying charges or
                                                                                                                             included in the total contract price,
                                                                   interest which is determined at the
                                                                                                                             payments received with respect to such
                                                                   time of each sale and is added to the
                                                                   established cash selling price of such                    sales shall be treated as applying first
                                                                   property and is treated as part of the                    against such carrying charges or inter-
                                                                   selling price for customer billing pur-                   est.
                                                                   poses, and                                                  (f) Other accounting methods. If the
                                                                     (ii) In the case of sales made in tax-                  vendor chooses as a matter of con-
                                                                   able years beginning on or after Janu-                    sistent practice to return the income
                                                                   ary 1, 1960, the amount of carrying                       from installment sales on an accrual
                                                                   charges or interest determined with re-                   method (,) such a course is permissible.
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                                                                   spect to such sales which are added                         (g) Records. In adopting the install-
                                                                   contemporaneously with the sale on                        ment method of accounting the seller

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                                                                   Internal Revenue Service, Treasury                                                            § 1.453A–2

                                                                   must maintain such records as are nec-                    elect to report both sales under the re-
                                                                   essary to clearly reflect income in ac-                   volving credit plan and the traditional
                                                                   cordance with this section, section 446                   installment plan on the installment
                                                                   and § 1.446–1.                                            method.
                                                                     (h) Effective date. This section applies                   (c) Revolving credit plans. (1) To the
                                                                   for taxable years beginning after De-                     extent provided in this paragraph (c)
                                                                   cember 31, 1953, and ending after Au-                     sales under a revolving credit plan will
                                                                   gust 16, 1954, but generally does not                     be treated as sales on the installment
                                                                   apply to sales made after December 31,                    plan. The term ‘‘revolving credit plan’’
                                                                   1987, in taxable years ending after such                  includes cycle budget accounts, flexible
                                                                   date. For sales made after December 31,                   budget accounts, continuous budget ac-
                                                                   1987, sales made by a dealer in personal                  counts, and other similar plans or ar-
                                                                   or real property shall not be treated as                  rangements for the sale of personal
                                                                   sales on the installment plan. (How-                      property under which the customer
                                                                   ever, see section 453(l)(2) for exceptions                agrees to pay each billing-month (as
                                                                   to this rule.)                                            defined in paragraph (c)(6)(iii) of this
                                                                   [T.D. 8270, 54 FR 46377, Nov. 3, 1989]
                                                                                                                             section) a part of the outstanding bal-
                                                                                                                             ance of the customer’s account. Sales
                                                                   § 1.453A–2 Treatment        of    revolving               under a revolving credit plan do not
                                                                         credit plans; taxable years begin-                  constitute sales on the installment
                                                                         ning on or before December 31,                      plan merely by reason of the fact that
                                                                         1986.                                               the total debt at the end of a billing-
                                                                      (a) In general. If a dealer sells or oth-              month is paid in installments. The
                                                                   erwise disposes of personal property                      terms and conditions of a revolving
                                                                   under a revolving credit plan—                            credit plan do not contemplate that
                                                                      (1) Such sales will be treated as sales                each sale under the plan will be paid
                                                                   on the installment plan to the extent                     for in two or more payments and thus
                                                                   provided in paragraph (c) of this sec-                    do not meet the requirements of
                                                                   tion;                                                     § 1.453A–1(c)(3)(i). In addition, since
                                                                      (2) Income from sales treated as sales                 under a revolving credit plan payments
                                                                   on the installment plan under para-                       are not generally applied to liquidate
                                                                   graph (c) of this section may be re-                      any particular sale, and since the
                                                                   turned on the installment method; and                     terms and conditions of such plan con-
                                                                      (3) Income returned on the install-                    template that account balances may be
                                                                   ment method is computed in accord-                        paid in full or in installments, it is
                                                                   ance with § 1.453A–1, except that—                        generally impossible to determine that
                                                                      (i) The gross profit on such sales is                  a particular sale under a revolving
                                                                   computed without regard to § 1.453A–                      credit plan is to be or is in fact paid for
                                                                   1(e)(2);                                                  in installments so as to meet the re-
                                                                      (ii) Under the circumstances de-                       quirements of § 1.453A–1 (c)(3)(ii). How-
                                                                   scribed in paragraph (c)(6)(vi) of this                   ever, paragraphs (c) (2) and (3) of this
                                                                   section, the taxpayer may, in com-                        section provides rules under which a
                                                                   puting income for a taxable year, treat                   certain percentage of charges under a
                                                                   all such sales as sales made in such                      revolving credit plan will be treated as
                                                                   taxable year for purposes of applying                     sales on the installment plan. For pur-
                                                                   the gross profit percentage; and                          poses of arriving at this percentage,
                                                                      (iii) The rule contained in § 1.453A–                  these rules, in general, treat as sales
                                                                   1(e)(3) is applied in accordance with                     on the plan those sales under a revolv-
                                                                   paragraph (c)(6)(v) of this section.                      ing installment credit plan:
                                                                      (b) Coordination with traditional in-                     (i) Which are of the type which the
                                                                   stallment plan. A dealer who makes                        terms and conditions of the plan con-
                                                                   sales of personal property under both a                   template will be paid for in two or
                                                                   revolving credit plan and a traditional                   more installments and
                                                                   installment plan (1) may elect to re-                        (ii) Which are charged to accounts on
                                                                   port only sales under the traditional                     which subsequent payments indicate
                                                                   installment plan on the installment                       that such sales are being paid for in
                                                                   method, (2) may elect to report only                      two or more installments.
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                                                                   sales under the revolving credit plan on                     (2)(i) The percentage of charges under
                                                                   the installment method, or (3) may                        a revolving credit plan which will be

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                                                                   § 1.453A–2                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                   treated as sales on the installment                       credit plan as sales on the installment
                                                                   plan shall be computed by making an                       method may apply the percentage ob-
                                                                   actual segregation of charges in a prob-                  tained for the first taxable year ending
                                                                   ability sample of the revolving credit                    on or after such date in determining
                                                                   accounts and by applying the rules                        the percentage of charges under a re-
                                                                   contained in paragraph (c)(3) of this                     volving credit plan for such prior tax-
                                                                   section to determine what percentage                      able year (or years) which will be treat-
                                                                   of charges in the sample is to be treat-                  ed as sales on the installment plan.
                                                                   ed as sales on the installment plan.                      However, in computing the percentage
                                                                   (See paragraph (c)(5) of this section for                 to be applied in determining the per-
                                                                   rules to be used if some of the sales                     centage of charges under a revolving
                                                                   under a revolving credit plan are non-                    credit plan which will be treated as
                                                                   personal property sales (as defined in                    sales on the installment plan for such
                                                                   paragraph (c)(6)(iv) of this section).)                   prior taxable year (or years), the rule
                                                                   Such segregation shall be made of                         stated in § 1.453A–1(e)(3) shall not
                                                                   charges which make up the balances in                     apply. See paragraph (c)(6)(v) of this
                                                                   the sample accounts as of the end of                      section for rules relating to the appli-
                                                                   each customer’s last billing-month                        cation of payments to finance charges
                                                                   ending within the taxable year. (See                      for such prior taxable years.
                                                                   paragraph (c)(6)(v) of this section for                     (3) For the purpose of determining
                                                                   rules to be used in determining which                     the percentage described in paragraph
                                                                   charges make up the balance of an ac-                     (c)(2) of this section, a charge under a
                                                                   count.) However, in making such seg-                      revolving credit plan will be treated as
                                                                   regation, any account to which a sale                     a sale on the installment plan only if
                                                                   is charged during the taxable year on                     such charge is a sale (as defined in
                                                                   which no payment is credited after the                    paragraph (c)(6) of this section) and
                                                                   billing-month within which the sale is                    meets the following requirements:
                                                                   made (hereinafter called the ‘‘billing-                     (i) The sale must be of the type which
                                                                   month of sale’’) and on or before the                     the terms and conditions of the plan
                                                                   end of the first billing-month ending in                  contemplate will be paid for in two or
                                                                   the taxpayer’s next taxable year shall                    more installments. If the aggregate of
                                                                   be disregarded and not taken into ac-                     sales charged during a billing-month to
                                                                   count in the determination of what                        an account under a revolving credit
                                                                   percentage of charges in the sample is                    plan exceeds the required monthly pay-
                                                                   to be treated as sales on the install-                    ment, then all sales during such bill-
                                                                   ment plan. In order to obtain a prob-                     ing-month shall be considered to be of
                                                                   ability sample, the accounts shall be                     the type which the terms and condi-
                                                                   selected in accordance with generally                     tions of such plan contemplate will be
                                                                   accepted probability sampling tech-                       paid for in two or more installments.
                                                                   niques. The appropriateness of the                        The required monthly payment shall be
                                                                   sampling technique and the accuracy                       the amount of the payment which the
                                                                   and reliability of the results obtained                   terms and conditions of the revolving
                                                                   must, if requested, be demonstrated to                    credit contract require the customer to
                                                                   the satisfaction of the district director.                make with respect to a billing-month.
                                                                   If the district director is not satisfied                 If the amount of such payment is not
                                                                   that the taxpayer’s sample is appro-                      fixed at the date the contract is en-
                                                                   priate or that the results obtained are                   tered into, but is dependent upon the
                                                                   accurate and reliable, the taxpayer                       balance of the account, then such
                                                                   shall recompute the sample percentage                     amount shall be the amount that the
                                                                   or make appropriate adjustments to                        customer is required to pay (but not in-
                                                                   the original computations in a manner                     cluding any past-due payments) as
                                                                   satisfactory to the district director.                    shown on the statement either:
                                                                   The taxpayer shall maintain records in                      (A) For the last billing-month ending
                                                                   sufficient detail to show the method of                   within the taxpayer’s taxable year or
                                                                   computing and applying the sample.                          (B) For the billing-month of sale,
                                                                     (ii) For taxable years ending before                    whichever method the taxpayer adopts
                                                                   January 31, 1964, a taxpayer who has                      for all accounts. A taxpayer shall not
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                                                                   reported for income tax purposes all or                   change such method of determining the
                                                                   a portion of sales under a revolving                      required monthly payment based upon

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                                                                   Internal Revenue Service, Treasury                                                                                § 1.453A–2

                                                                   the balance of the account without ob-                    month of sales. It was more than the $22
                                                                   taining the consent of the district di-                   (20%×$110) that the customer was required to
                                                                   rector. In any case where the required                    pay on the statement rendered for his last
                                                                                                                             billing-month ending within the taxable
                                                                   monthly payment is not set in accord-
                                                                                                                             year, and thus meets the requirements of
                                                                   ance with a consistent method used                        this paragraph (c)(3)(i). If, however, the tax-
                                                                   during the entire taxable year, the dis-                  payer determines the required monthly pay-
                                                                   trict director may determine the re-                      ment by reference to the payment required
                                                                   quired monthly payment in accordance                      on the statement for the billing-month of
                                                                   with the method used during the major                     sale, then the sales making up the aggregate
                                                                   portion of such taxable year if the use                   of sales during such billing-month do not
                                                                   of such method is necessary in order to                   meet the requirements of this paragraph
                                                                   reflect properly the income from sales                    (c)(3)(i) because such aggregate was less than
                                                                                                                             the $30 payment required on the statement
                                                                   under a revolving credit plan. The re-
                                                                                                                             rendered for such month.
                                                                   quirements stated in this paragraph
                                                                   (c)(3)(i) may be illustrated by the fol-                    (ii) The sale must be charged to an
                                                                   lowing examples:                                          account on which the first payment
                                                                                                                             after the billing-month of sale indi-
                                                                     Example 1. Under the terms of a revolving
                                                                   credit plan the required monthly payment to               cates that the sale is being paid in in-
                                                                   be made by customer A is $20. During the                  stallments. The first payment after the
                                                                   billing-month ending in December, sales ag-               billing-month of sale indicates that the
                                                                   gregating $80 are charged to customer A’s ac-             sale is being paid in installments if,
                                                                   count, and during the next billing-month,                 and only if, such payment is an amount
                                                                   ending in January, sales aggregating $19.95               which is less than the balance of the
                                                                   and finance charges of $.60 are charged to A’s            account as of the close of the billing-
                                                                   account. Since the aggregate of sales
                                                                                                                             month of sale. For purposes of this
                                                                   charged to customer A’s account during the
                                                                   billing-month ending in December ($80) ex-                paragraph (c)(3)(ii), such balance shall
                                                                   ceeds the required monthly payment ($20),                 be reduced by any return or allowance
                                                                   the terms and conditions of the plan con-                 credited to the account after the close
                                                                   template that the sales charged during such               of the billing-month of sale and before
                                                                   billing-month are of the type which will be               the close of the billing-month within
                                                                   paid for in two or more installments. Since               which the first payment after the bill-
                                                                   the aggregate of sales charged to customer                ing-month of sale is credited to the ac-
                                                                   A’s account during the billing-month ending
                                                                                                                             count, unless the taxpayer dem-
                                                                   in January ($19.95) does not exceed the re-
                                                                   quired monthly payment, the sales making                  onstrates that the return or allowance
                                                                   up the aggregate of sales in such billing-                was attributable to a charge made in a
                                                                   month are not of the type which the terms                 month subsequent to the billing-month
                                                                   and conditions of the plan contemplate will               of sale. The requirements stated in this
                                                                   be paid for in two or more installments.                  paragraph (c)(3)(ii) may be illustrated
                                                                     Example 2. The terms of a revolving credit              by the following examples, in which it
                                                                   plan require a payment of 20 percent of the               is assumed that the taxpayer’s annual
                                                                   balance of the customer’s account as of the
                                                                   end of the billing-month for which the state-
                                                                                                                             accounting period ends on January 31.
                                                                   ment is rendered. A customer makes pur-                     Example 1. Customer A’s revolving credit
                                                                   chases aggregating $25 in the customer’s                  account shows the following sales and pay-
                                                                   next to the last billing-month ending within              ments:
                                                                   the taxpayer’s taxable year, and the balance
                                                                   at the end of that month is $150. At the end                                                           Aggre-
                                                                   of the customer’s last billing-month ending                                                              gate     Pay-      Bal-
                                                                                                                                        Month ending                      sales in   ments     ance
                                                                   within the taxpayer’s taxable year, the bal-                                                            month
                                                                   ance of the account has decreased to $110. If
                                                                   the taxpayer determines the required month-               December 20 ...........................         $150          0    $150
                                                                   ly payment by reference to the payment re-                January 20 ...............................        75        $30     195
                                                                   quired on the statement for the last billing-             February 20 .............................          0        195       0
                                                                   month ending within the taxable year and
                                                                   applies such method consistently to all ac-               All sales made in the billing-month ending
                                                                   counts, then the sales making up the $25 ag-              December 20 meet the requirements of this
                                                                   gregate of sales are of the type which the                paragraph (c)(3)(ii) because the first payment
                                                                   terms and conditions of the plan con-                     on the account after such billing-month ($30)
                                                                   template will be paid for in two or more in-              was less than the balance of the account as
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                                                                   stallments. Although such aggregate was                   of the close of such billing-month ($150); and
                                                                   less than the $30 payment (20%×$150) required             none of the sales made in the billing-month
                                                                   on the statement rendered for the billing-                ending January 20 meets the requirements of

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                                                                   § 1.453A–2                                                                                                        26 CFR Ch. I (4–1–12 Edition)
                                                                   this paragraph (c)(3)(ii) because the balance                                                  Example 3. Customer C’s revolving credit
                                                                   of the account as of the end of such billing-                                                account shows the following purchases and
                                                                   month was liquidated in one payment. By                                                      credits:
                                                                   application of the rules of paragraph (c)(6)(v)
                                                                   of this section, the balance in the account as                                                  Month ending                 Item          Charges          Credits         Bal-
                                                                   of the last billing-month ending in the tax-                                                                                                                                ance
                                                                   able year ($195) consists of $120 of the $150 of
                                                                                                                                                                January 20 ...........     Coat .........             $55      ............   ..........
                                                                   sales made in the billing-month ending De-
                                                                                                                                                                                           Dress .......                40     ............   ..........
                                                                   cember 20 and all of the $75 of sales made in
                                                                                                                                                                                           Shirt .........                5    ............     $100
                                                                   the billing-month ending January 20. There-
                                                                                                                                                                February 20 .........      Return ......      ..............           $5     ..........
                                                                   fore, $120 of the account balance meets the
                                                                                                                                                                                           Payments           ..............           95             0
                                                                   requirements of this paragraph (c)(3)(ii) and
                                                                   $75 does not.
                                                                     Example 2. Customer B’s revolving credit                                                   None of the sales made in the billing-month
                                                                   account shows the following sales and pay-                                                   ending January 20 meets the requirements of
                                                                   ments:                                                                                       this paragraph (c)(3)(ii) because the first
                                                                                                                                                                payment credited to the account after such
                                                                                                                    Aggre-                                      billing-month ($95) was equal to the balance
                                                                                                                      gate          Pay-             Bal-
                                                                               Month ending                                                                     of the account as of the end of such billing-
                                                                                                                    sales in        ments            ance
                                                                                                                     month                                      month, $95. For this purpose, the balance of
                                                                   December 20 ...........................               $ 50              0          $ 50
                                                                                                                                                                $100 is reduced by the $5 return which was
                                                                   January 20 ...............................             100              0           150      credited to the account after the close of the
                                                                   February 20 .............................                0            $50           100      billing-month of sale and before the close of
                                                                                                                                                                the billing-month within which the first pay-
                                                                   None of the sales made in the billing-month                                                  ment after the billing-month of sale is cred-
                                                                   ending December 20 meets the requirements                                                    ited.
                                                                   of this paragraph (c)(3)(ii) because the first
                                                                                                                                                                  (4) The provisions of paragraphs (c)
                                                                   payment credited to the account after such
                                                                   billing-month ($50) is not less than the bal-                                                (2) and (3) of this section may be illus-
                                                                   ance of the account as of the close of such                                                  trated by the following examples in
                                                                   month ($50). All of the sales made in the bill-                                              which it is assumed that the taxpayer
                                                                   ing-month ending January 20 meet the re-                                                     is a dealer whose annual accounting pe-
                                                                   quirements of this paragraph (c)(3)(ii) be-                                                  riod ends on January 31.
                                                                   cause the first payment after such billing-
                                                                   month ($50) is less than the balance of the                                                    Example 1. Customer A’s revolving credit
                                                                   account as of the close of such month ($150).                                                ledger account shows the following:

                                                                                                                                                      Aggregate       Returns and                                Finance
                                                                                                Month ending                                           sales in                             Payments                                    Balance
                                                                                                                                                                      allowances                                 charges
                                                                                                                                                       month 1

                                                                   January 20 ....................................................................           $15.00                  0                   0                   0                $15.00
                                                                   February 20 ...................................................................                0                  0                   0               $0.15                 15.15
                                                                      1 Including    sales of personal property and nonpersonal property sales.



                                                                   For purposes of the segregation provided for                                                                                                                          Required
                                                                   in paragraph (c)(2)(i) of this section, cus-                                                                                                                          monthly
                                                                                                                                                                                                                                         payment
                                                                   tomer A’s account will be disregarded and
                                                                   not taken into account in the determination                                                  Unpaid balance:
                                                                   of what percentage of charges in the sample                                                          0 to $99.99 ..............................................                $20
                                                                   is to be treated as sales on the installment                                                         $100 to $199.99 ......................................                     40
                                                                   plan because no payment was credited to                                                              $200 to $299.99 ......................................                     60
                                                                   that account after the billing-month of sale
                                                                   and on or before February 20.                                                                  Customer B’s revolving credit ledger ac-
                                                                     Example 2. This example is applicable with                                                 count for the period beginning on September
                                                                   respect to sales made during taxable years                                                   21, 1963, and ending February 20, 1964, shows
                                                                   beginning before January 1, 1964. Under the                                                  the following:
                                                                   terms of corporation X’s revolving credit
                                                                   plan, payments are required in accordance
                                                                   with the following schedule:

                                                                                                                                                      Aggregate       Returns and                                Finance
                                                                                                Month ending                                           sales in                             Payments                                   Balances
                                                                                                                                                                      allowances                                 charges
                                                                                                                                                       month 1
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                                                                   October 20 ....................................................................           $55.00                  0                   0                     0              $55.00



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                                                                   Internal Revenue Service, Treasury                                                                                                                              § 1.453A–2

                                                                                                                                                       Aggregate       Returns and                                    Finance
                                                                                                Month ending                                            sales in                              Payments                                      Balances
                                                                                                                                                                       allowances                                     charges
                                                                                                                                                        month 1

                                                                   November 20 .................................................................              45.00                  0               $20.00                  $0.35                80.35
                                                                   December 20 .................................................................              20.00                  0                20.00                    .60                80.95
                                                                   January 20 ....................................................................            26.00              $5.00                20.00                    .61                82.56
                                                                   February 20 ...................................................................                0              10.00                72.56                      0                    0
                                                                      1 Including    sales of personal property and nonpersonal property sales.



                                                                   The three $20 payments and the $5 return or                                                  ing-month ending within corporation X’s
                                                                   allowance made in the billing-months ending                                                  taxable year, $35 will be treated as sales on
                                                                   in the taxable year are applied under the                                                    the installment plan for purposes of deter-
                                                                   rules in paragraph (c)(6)(v) of this section to                                              mining the percentage provided for para-
                                                                   liquidate the earliest outstanding charges,                                                  graph (c)(2) of this section.
                                                                   first to the $55 aggregate of sales in the bill-                                               Example 3. This example is applicable with
                                                                   ing-month ending October 20 and next to $10                                                  respect to sales made during taxable years
                                                                   of the aggregate of sales made in the billing-                                               beginning after December 31, 1963. Assume
                                                                   month ending November 20. Thus, the bal-                                                     the facts in Example 2, except that Customer
                                                                   ance of the account as of the close of the                                                   B’s revolving credit ledger account is for the
                                                                   billing-month ending January 20, $82.56, is                                                  period beginning on September 21, 1964 and
                                                                   made up as follows:                                                                          ending February 20, 1965. Since payments re-
                                                                   Remainder of sales in billing-month ending Nov. 20                                           ceived are first used to liquidate any out-
                                                                     ($45¥$10) .............................................................         $35.00     standing finance charges under the rule in
                                                                   Finance charges for billing-month ending Nov. 20 ...                                0.35     paragraph (c)(6)(v) of this section, the $20
                                                                   Sales for billing-month ending Dec. 20 .....................                       20.00
                                                                   Finance charge for billing-month ending Dec. 20 .....                               0.60
                                                                                                                                                                payment in December liquidated the $0.35 fi-
                                                                   Sales for billing-month ending Jan. 20 ......................                      26.00     nance charge accrued at the end of the No-
                                                                   Finance charge for billing-month ending Jan. 20 ......                              0.61     vember billing-month and the $20 payment in
                                                                                                                                                                January liquidated the $0.60 finance charge
                                                                                      Total .....................................................     82.56     accrued at the end of the December billing-
                                                                   The sales of $35 remaining from the aggre-                                                   month. The balance of the three $20 pay-
                                                                   gate of sales for the billing-month ending                                                   ments ($59.05) and the $5 return or allowance
                                                                   November 20 meet the requirements of para-                                                   are applied (under the rules in paragraph
                                                                   graph (c)(3)(i) of this section because the ag-                                              (c)(6)(v) of this section) to liquidate the ear-
                                                                   gregate of sales charged during such billing-                                                liest outstanding sales, first to the $55 aggre-
                                                                   month ($45) exceeds the required monthly                                                     gate of sales in the billing-month ending Oc-
                                                                   payment ($20), and such sales meet the re-                                                   tober 20 and next to $9.05 of the aggregate of
                                                                   quirements of paragraph (c)(3)(ii) of this sec-                                              sales made in the billing-month ending No-
                                                                   tion because the first payment after the bill-                                               vember 20. Thus, the balance of the account
                                                                   ing-month of sale ($20) is an amount less                                                    as of the close of the billing-month ending
                                                                   than the balance of the account as of the                                                    January 20, $82.56, is made up as follows:
                                                                   close of such month ($80.35). Therefore, $35 of                                              Remainder of sales in billing-month ending Nov. 20
                                                                   sales will be treated as sales on the install-                                                 ($45-$9.05) .............................................................      $35.95
                                                                   ment plan. The $20 aggregate of sales                                                        Sales for billing-month ending Dec. 20 .....................                      20.00
                                                                                                                                                                Sales for billing-month ending Jan. 20 ......................                     26.00
                                                                   charged during the billing-month ending De-
                                                                                                                                                                Finance charge for billing-month ending Jan. 20 ......                             0.61
                                                                   cember 20 does not meet the requirements of
                                                                   paragraph (c)(3)(i) of this section because it                                                                  Total .....................................................    82.56
                                                                   is in an amount which does not exceed the
                                                                   required monthly payment ($20). (The fi-                                                     The sales of $35.95 remaining from the aggre-
                                                                   nance charge of $0.60 added in the billing-                                                  gate of sales for the billing-month ending
                                                                   month does not enter into the determination                                                  November 20 meet the requirements of para-
                                                                   of the aggregate of sales for the month be-                                                  graph (c)(3)(i) of this section because the ag-
                                                                   cause the term ‘‘sales’’ (as defined in para-                                                gregate of sales charged during such billing-
                                                                   graph (c)(6)(i) of this section does not include                                             month ($45) exceeds the required monthly
                                                                   finance charges). The $26 aggregate of sales                                                 payment ($20), and such sales meet the re-
                                                                   for the billing-month ending January 20 does                                                 quirements of paragraph (c)(3)(ii) of this sec-
                                                                   not meet the requirements of paragraph                                                       tion because the first payment after the bill-
                                                                   (c)(3)(ii) of this section because the first pay-                                            ing-month of sale ($20) is an amount less
                                                                   ment after such billing-month ($72.56) was                                                   than the balance of the account as of the
                                                                   equal to the balance of the account as of the                                                close of such month ($80.35). Therefore, $35.95
                                                                   close of such billing-month ($72.56). For this                                               of sales will be treated as sales on the in-
                                                                   purpose, the balance of $82.56 is reduced by                                                 stallment plan. The $20 aggregate of sales
                                                                   the $10 return or allowance which was cred-                                                  charged during the billing-month ending De-
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                                                                   ited after the billing-month of sale and be-                                                 cember 20 does not meet the requirements of
                                                                   fore February 20. Thus, of the $82.56 balance                                                paragraph (c)(3)(i) of this section because it
                                                                   of B’s account as of the close of the last bill-                                             is in an amount which does not exceed the

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                                                                   § 1.453A–2                                                              26 CFR Ch. I (4–1–12 Edition)
                                                                   required monthly payment ($20). The $26 ag-               erty, in which case such charges shall
                                                                   gregate of sales for the billing-month ending             be considered as constituting part of
                                                                   January 20 does not meet the requirements                 the selling price of such property.
                                                                   of paragraph (c)(3)(ii) of this section because
                                                                   the first payment after such billing-month
                                                                                                                               (v) Except as otherwise provided in
                                                                   ($72.56) was equal to the balance of the ac-              this paragraph (c)(6)(v), each payment
                                                                   count as of the close of such billing-month               received from a customer under a re-
                                                                   ($72.56). For this purpose, the balance of                volving credit plan before the close of
                                                                   $82.56 is reduced by the $10 return or allow-             the last billing-month ending in the
                                                                   ance which was credited after the billing-                taxable year shall be applied to liq-
                                                                   month of sale and before February 20. Thus,               uidate the earliest outstanding charges
                                                                   of the $82.56 balance of B’s account as of the
                                                                   close of the last billing-month ending within
                                                                                                                             under such plan, notwithstanding any
                                                                   corporation X’s taxable year $35.95 will be               rule of law or contract provision to the
                                                                   treated as sales on the installment plan for              contrary. For purposes of determining
                                                                   purposes of determining the percentage pro-               which charges remain in the balance of
                                                                   vided for in paragraph (c)(2) of this section.            an account at the end of the last bill-
                                                                     (5) Sales under a revolving credit                      ing-month ending in the taxable year,
                                                                   plan which are nonpersonal property                       the taxpayer may apply returns and al-
                                                                   sales (as defined in paragraph (c)(6)(iv)                 lowances which are credited before the
                                                                   of this section) do not constitute sales                  close of the last billing-month ending
                                                                   on the installment plan. Therefore, the                   in the taxable year either (A) to liq-
                                                                   charges under a revolving credit plan                     uidate or reduce the charge for the spe-
                                                                   must be reduced by the nonpersonal                        cific item so returned or for which an
                                                                   property sales, if any, under such plan,                  allowance is permitted, or (B) to liq-
                                                                   before application of the sample per-                     uidate or reduce the earliest out-
                                                                   centage as provided for in paragraph                      standing charges. The method so se-
                                                                   (c)(2)(i) of this section. The taxpayer                   lected for applying returns and allow-
                                                                   may treat as the nonpersonal property                     ances shall be followed on a consistent
                                                                   sales under the plan for the taxable                      basis from year to year unless the dis-
                                                                   year an amount which bears the same                       trict director consents to a change. Ad-
                                                                   ratio to the total sales under the re-                    ditionally, finance or service charges
                                                                   volving credit plan made in the taxable                   which are computed on the basis of the
                                                                   year as the total nonpersonal property                    balance of the account at the end of
                                                                   sales made in such year bears to the                      the previous billing-month (usually re-
                                                                   total sales made in such year.                            duced by payments during the current
                                                                     (6) For purposes of this paragraph                      billing-month) are accrued at the end
                                                                   (c)—                                                      of the current billing-month and are
                                                                     (i) The term ‘‘sales’’ includes sales of                therefore considered, for purposes of
                                                                   services, such as a charge for watch re-                  determining the earliest outstanding
                                                                   pair, as well as sales of property, but                   charges, as charged to the account
                                                                   does not include finance or service                       after any sales made during the cur-
                                                                   charges.                                                  rent billing month. However, for pur-
                                                                     (ii) The term ‘‘charges’’ includes                      poses of determining which charges re-
                                                                   sales of services and property as well as                 main in the balance of an account at
                                                                   finance or service charges.                               the end of the last billing-month end-
                                                                     (iii) A billing-month is that period of                 ing in a taxable year which began after
                                                                   time for which a periodic statement of                    December 31, 1963, payments received
                                                                   charges and credits is rendered to a                      during such year shall be applied first
                                                                   customer.                                                 against any finance or service charges
                                                                     (iv) The term ‘‘nonpersonal property                    which were outstanding at the time
                                                                   sales’’ means all sales which are not                     such payment was received. The pre-
                                                                   sales of personal property made by the                    ceding sentence shall not apply with
                                                                   taxpayer. Thus, sales of a department                     respect to a computation made for pur-
                                                                   leased by the taxpayer to another are                     poses of applying the rule described in
                                                                   nonpersonal property sales. Likewise,                     paragraph (c)(2)(ii) of this section.
                                                                   charges for services rendered by the                        (vi) The taxpayer shall allocate those
                                                                   taxpayer are nonpersonal property                         sales under a revolving credit plan
                                                                   sales unless such services are inci-                      which are treated as sales on the in-
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                                                                   dental to and rendered contempora-                        stallment plan to the proper year of
                                                                   neously with the sale of personal prop-                   sale in order to apply the appropriate

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                                                                   Internal Revenue Service, Treasury                                                            § 1.453A–2

                                                                   gross profit percentage as provided for                   ment was credited after a billing-month of
                                                                   in § 1.453A–1(e). This allocation shall be                sale and on or before the end of the first bill-
                                                                   made on the basis of the percentages of                   ing-month ending in the taxable year begin-
                                                                   charges treated as sales on the install-                  ning February 1, 1964. These balances are,
                                                                   ment plan which are attributable to                       therefore, disregarded and not taken into ac-
                                                                   each taxable year as determined in the                    count in the determination of what percent-
                                                                                                                             age of sales in the sample is to be treated as
                                                                   sample of accounts described in para-
                                                                                                                             sales on the installment plan. Of the remain-
                                                                   graph (c)(2) of this section. However, if                 ing $90,000 of balances, the taxpayer deter-
                                                                   the taxpayer demonstrates to the satis-                   mines, by analyzing the ledger cards in the
                                                                   faction of the district director that in-                 sample, that $63,000 of balances are composed
                                                                   come from sales on the installment                        of sales which meet the requirements of
                                                                   plan is clearly reflected, all sales may                  paragraphs (c)(3) (i) and (ii) of this section
                                                                   be considered as being made in the tax-                   and are thus treated as sales on the install-
                                                                   able year for purposes of applying the                    ment plan. The remaining $27,000 of balances
                                                                   gross profit percentage.                                  either did not meet the requirements of
                                                                     (7) The provisions of this paragraph                    paragraphs (c)(3) (i) and (ii) of this section or
                                                                   (c) may be illustrated by the following                   were not sales (as defined in paragraph
                                                                   example:                                                  (c)(6)(i) of this section). The percentage of
                                                                                                                             charges in the sample treated as sales on the
                                                                     Example. Corporation X is a dealer and has              installment plan is, therefore, 70 percent
                                                                   elected to report on the installment method
                                                                                                                             ($63,000 ÷ $90,000).
                                                                   those sales under its revolving credit plan
                                                                   which may be treated as sales on the install-               (iv) The charges in the year-end balance
                                                                   ment plan. Corporation X’s taxable year ends              which are to be treated as sales on the in-
                                                                   on January 31, and the total balance of all               stallment plan, $1,330,000, are computed by
                                                                   its revolving credit accounts as of January               multiplying the charges to which the sample
                                                                   31, 1964, is $2,000,000. The total sales made in          percentage is applied ($1,900,000) by the sam-
                                                                   the taxable year are $10,000,000 of which                 ple percentage (70 percent).
                                                                   $500,000 are nonpersonal property sales. The                (v) The deferred gross profit attributable
                                                                   gross profit percentage realized or to be real-           to sales under the revolving credit plan for
                                                                   ized on all sales made in the taxable year is             the taxable year, $532,000, is determined by
                                                                   40 percent. The amount of the gross profit                multiplying the amount treated as sales on
                                                                   contained in the year-end balance of                      the installment plan ($1,330,000), by the gross
                                                                   $2,000,000 which may be deferred to suc-                  profit percentage (40 percent). (Corporation
                                                                   ceeding years is computed as follows:                     X will be able to demonstrate to the satisfac-
                                                                     (i) In order to reduce the charges appearing            tion of the district director that (A) since
                                                                   in the year-end balance of revolving credit
                                                                                                                             the gross profit percentage for all sales does
                                                                   accounts receivable by the nonpersonal prop-
                                                                                                                             not vary materially from the gross profit
                                                                   erty sales contained therein, corporation X
                                                                   determines the amount of such nonpersonal                 percentage for all sales made under the re-
                                                                   property sales under the method permitted                 volving credit plan, (B) since only an insub-
                                                                   in paragraph (c)(5) of this section. Corpora-             stantial amount of sales included in year-end
                                                                   tion X first determines the ratio which total             account balances was made prior to the tax-
                                                                   nonpersonal property sales made during the                able year, and (C) since the prior year’s gross
                                                                   year ($500,000) bears to total sales made dur-            profit percentage does not vary materially
                                                                   ing the year ($10,000,000), and then applies              from the gross profit percentage for the tax-
                                                                   the percentage (5 percent) thus obtained to               able year, income from sales on the install-
                                                                   the year-end balance of revolving credit ac-              ment plan will be clearly reflected by apply-
                                                                   counts receivable ($2,000,000). The nonper-               ing the current year’s gross profit percent-
                                                                   sonal property sales thus determined                      age for all sales under the revolving credit
                                                                   ($100,000) is subtracted from such year-end               plan treated as sales on the installment
                                                                   balance to obtain the charges under the re-               plan.)
                                                                   volving credit plan appearing in the year-end
                                                                   balance ($1,900,000) to which the sample per-               (d) Effective date. This section applies
                                                                   centage is to be applied.                                 for taxable years beginning after De-
                                                                     (ii) In accordance with generally accepted              cember 31, 1953, and ending after Au-
                                                                   sampling techniques, the taxpayer selects a               gust 16, 1954, but does not apply for any
                                                                   probability sample of all revolving credit ac-
                                                                   counts having balances for billing-months                 taxable year beginning after December
                                                                   ending in January 1964. The technique em-                 31, 1986. For taxable years beginning
                                                                   ployed results in a random selection of ac-               after December 31, 1986, sales under a
                                                                   counts with total balances of $100,000.                   revolving credit plan shall not be treat-
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                                                                     (iii) Analysis of these sample accounts dis-            ed as sales on the installment plan.
                                                                   closes that of the $100,000 of balances, $10,000
                                                                   of balances are in accounts on which no pay-              [T.D. 8269, 54 FR 46375, Nov. 3, 1989]

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                                                                   § 1.453A–3                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                   § 1.453A–3 Requirements for adoption                      stallment plan for which the install-
                                                                        of or change to installment method                   ment method is being elected.
                                                                        by dealers in personal property.                       (4) Deemed elections. A dealer (includ-
                                                                      (a) In general. A dealer (within the                   ing a person who is a dealer as a result
                                                                   meaning of § 1.453A–1(c)(1)) may adopt                    of the recharacterization of trans-
                                                                   or change to the installment method                       actions as sales) is deemed to have
                                                                   for a type or types of sales on the in-                   elected the installment method if the
                                                                   stallment plan (within the meaning of                     dealer treats a sale on the installment
                                                                   § 1.453A–1(c)(3) and (d)) in the manner                   plan as a transaction other than a sale
                                                                   prescribed in this section. This section                  and fails to report the full amount of
                                                                   applies only to dealers and only with                     gain in the year of the sale. For exam-
                                                                   respect to their sales on the install-                    ple, if a transaction treated by a dealer
                                                                   ment plan.                                                as a lease is recharacterized by the In-
                                                                      (b) Time and manner of electing install-               ternal Revenue Service as a sale on the
                                                                   ment method reporting—(1) Time for elec-                  installment plan, the dealer will be
                                                                   tion. An election to adopt or change to                   deemed to have elected the installment
                                                                   the installment method for a type or                      method assuming the dealer failed to
                                                                   types of sales must be made on an in-                     report the full amount of gain in the
                                                                   come tax return for the taxable year of                   year of the transaction.
                                                                   the election, filed on or before the time                   (c) Consent. A dealer may adopt or
                                                                   specified (including extensions thereof)                  change to the installment method for
                                                                   for filing such return.                                   sales on the installment plan without
                                                                      (2) Adoption of installment method. A                  the consent of the Commissioner. How-
                                                                   taxpayer who adopts the installment                       ever, a dealer may not change from the
                                                                   method for the first taxable year in                      installment method to the accrual
                                                                   which sales are made on an installment                    method of accounting or to any other
                                                                                                                             method of accounting without the con-
                                                                   plan of any kind must indicate in the
                                                                                                                             sent of the Commissioner.
                                                                   income tax return for that taxable year
                                                                   that the installment method of ac-                          (d) Cut-off method for amounts pre-
                                                                   counting is being adopted and specify                     viously accrued. An election to change
                                                                   the type or types of sales included                       to the installment method for a type of
                                                                   within the election. If a taxpayer in                     sale applies only with respect to sales
                                                                   the year of the initial election made                     made on or after the first day of the
                                                                   only one type of sale on the install-                     taxable year of change. Thus, pay-
                                                                                                                             ments received in the taxable year of
                                                                   ment plan, but during a subsequent
                                                                                                                             the change, or in subsequent years, in
                                                                   taxable year makes another type of
                                                                                                                             respect of an installment obligation
                                                                   sale on the installment plan and adopts
                                                                                                                             which arose in a taxable year prior to
                                                                   the installment method for that other
                                                                                                                             the taxable year of change are not
                                                                   type of sale, the taxpayer must indi-
                                                                                                                             taken into account on the installment
                                                                   cate in the income tax return for the
                                                                                                                             method, but rather must be accounted
                                                                   subsequent year that an election is
                                                                                                                             for under the taxpayer’s method of ac-
                                                                   being made to adopt the installment
                                                                                                                             counting in use in the prior year.
                                                                   method of accounting for the addi-
                                                                                                                               (e) Effective date. This section applies
                                                                   tional type of sale.
                                                                                                                             to sales by dealers in taxable years
                                                                      (3) Change to installment method. A
                                                                                                                             ending after October 19, 1980, but gen-
                                                                   taxpayer who changes to the install-
                                                                                                                             erally does not apply to sales made
                                                                   ment method for a particular type or
                                                                                                                             after December 31, 1987. For sales made
                                                                   types of sales on the installment plan
                                                                                                                             after December 31, 1987, sales by a deal-
                                                                   in acordance with this section must,
                                                                                                                             er in personal or real property shall
                                                                   for each type of sale on the installment
                                                                                                                             not be treated as sales on the install-
                                                                   plan for which the installment method
                                                                                                                             ment plan. (However, see section
                                                                   is to be used, attach a separate state-
                                                                                                                             453(l)(2) for certain exceptions to this
                                                                   ment to the income tax return for the
                                                                                                                             rule.) For rules relating to sales by
                                                                   taxable year with respect to which the
                                                                                                                             dealers in taxable years ending before
                                                                   change is made. Each statement must
                                                                                                                             October 20, 1980, see 26 CFR 1.453–7 and
                                                                   show the method of accounting used in
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                                                                                                                             1.453–8 (rev. as of April 1, 1987).
                                                                   computing taxable income before the
                                                                   change and the type of sale on the in-                    [T.D. 8269, 54 FR 46375, Nov. 3, 1989]

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                                                                   Internal Revenue Service, Treasury                                                              § 1.454–1

                                                                   § 1.454–1 Obligations issued at dis-                      the taxable year for which the return is
                                                                         count.                                              filed and for all subsequent taxable
                                                                      (a) Certain non-interest-bearing obliga-               years, unless the Commissioner per-
                                                                   tions issued at discount—(1) Election to                  mits the taxpayer to change to a dif-
                                                                   include increase in income currently. If a                ferent method of reporting income
                                                                   taxpayer owns—                                            from such obligations. See section
                                                                      (i) A non-interest-bearing obligation                  446(e) and paragraph (e) of § 1.446–1, re-
                                                                   issued at a discount and redeemable for                   lating to requirement respecting a
                                                                   fixed amounts increasing at stated in-                    change of accounting method. Al-
                                                                   tervals (other than an obligation issued                  though the election once made is bind-
                                                                   by a corporation after May 27, 1969, as                   ing upon the taxpayer, it does not
                                                                   to which ratable inclusion of original                    apply to a transferee of the taxpayer.
                                                                   issue discount is required under section                     (2) Amount of increase in case of non-
                                                                   1232(a)(3)), or                                           interest-bearing obligations. In any case
                                                                      (ii) An obligation of the United                       in which an election is made under sec-
                                                                   States, other than a current income                       tion 454, the amount which accrues in
                                                                   obligation, in which he retains his in-                   any taxable year to which the election
                                                                   vestment in a matured series E U.S.                       applies is measured by the actual in-
                                                                   savings bond, or                                          crease in the redemption price occur-
                                                                      (iii) A nontransferable obligation                     ring in that year. This amount does not
                                                                   (whether or not a current income obli-                    accrue ratably between the dates on
                                                                   gation) of the United States for which                    which the redemption price changes.
                                                                   a series E U.S. savings bond was ex-                      For example, if two dates on which the
                                                                   changed (whether or not at final matu-                    redemption price increases (February 1
                                                                   rity) in an exchange upon which gain is                   and August 1) fall within a taxable
                                                                   not recognized because of section                         year and if the redemption price in-
                                                                   1037(a) (or so much of section 1031(b) as                 creases in the amount of 50 cents on
                                                                   relates to section 1037),                                 each such date, the amount accruing in
                                                                   and if the increase, if any, in redemp-                   that year would be $1 ($0.50 on Feb-
                                                                   tion price of such obligation described                   ruary 1 and $0.50 on August 1). If the
                                                                   in subdivision (i), (ii), or (iii) of this                taxpayer owns a non-interest-bearing
                                                                   subparagraph during the taxable year                      obligation of the character described in
                                                                   (as described in subparagraph (2) of this                 subdivision (i), (ii), or (iii) of subpara-
                                                                   paragraph) does not constitute income                     graph (1) of this paragraph acquired
                                                                   for such year under the method of ac-                     prior to the first taxable year to which
                                                                   counting used in computing his taxable                    his election applies, he must also in-
                                                                   income, then the taxpayer may, at his                     clude in gross income for such first
                                                                   election, treat the increase as consti-                   taxable year (i) the increase in the re-
                                                                   tuting income for the year in which                       demption price of such obligation oc-
                                                                   such increase occurs. If the election is                  curring between the date of acquisition
                                                                   not made and section 1037 (or so much                     of the obligation and the first day of
                                                                   of section 1031 as relates to section                     such first taxable year and (ii), in a
                                                                   1037) does not apply, the taxpayer shall                  case where a series E bond was ex-
                                                                   treat the increase as constituting in-                    changed for such obligation, the in-
                                                                   come for the year in which the obliga-                    crease in the redemption price of such
                                                                   tion is redeemed or disposed of, or fi-                   series E bond occurring between the
                                                                   nally matures, whichever is earlier.                      date of acquisition of such series E
                                                                   Any such election must be made in the                     bond and the date of the exchange.
                                                                   taxpayer’s return and may be made for                        (3) Amount of increase in case of cur-
                                                                   any taxable year. If an election is made                  rent income obligations. If an election is
                                                                   with respect to any such obligation de-                   made under section 454 and the tax-
                                                                   scribed in subdivision (i), (ii), or (iii) of             payer owns, at the beginning of the
                                                                   this subparagraph, it shall apply also                    first taxable year to which the election
                                                                   to all other obligations of the type de-                  applies, a current income obligation of
                                                                   scribed in such subdivisions owned by                     the character described in subpara-
                                                                   the taxpayer at the beginning of the                      graph (1)(iii) of this paragraph acquired
                                                                   first taxable year to which the election                  prior to such taxable year, he must
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                                                                   applies, and to those thereafter ac-                      also include in gross income for such
                                                                   quired by him, and shall be binding for                   first taxable year the increase in the

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                                                                   § 1.454–1                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   redemption price of the series E bond                     the District of Columbia, issued on a
                                                                   which was surrendered to the United                       discount basis and payable without in-
                                                                   States in exchange for such current in-                   terest at a fixed maturity date not ex-
                                                                   come obligation; the amount of the in-                    ceeding one year from the date of issue,
                                                                   crease is that occurring between the                      the amount of discount at which such
                                                                   date of acquisition of the series E bond                  obligation originally sold does not ac-
                                                                   and the date of the exchange.                             crue until the date on which such obli-
                                                                     (4) Illustrations. The application of                   gation is redeemed, sold, or otherwise
                                                                   this paragraph may be illustrated by                      disposed of. This rule applies regardless
                                                                   the following examples:                                   of the method of accounting used by
                                                                     Example 1. Throughout the calendar year
                                                                                                                             the taxpayer. For examples illustrating
                                                                   1954, a taxpayer who uses the cash receipts               rules for computation of income from
                                                                   and disbursements method of accounting                    sale or other disposition of certain ob-
                                                                   holds series E U.S. savings bonds having a                ligations of the type described in this
                                                                   maturity value of $5,000 and a redemption                 paragraph, see section 1221 and the reg-
                                                                   value at the beginning of the year 1954 of                ulations thereunder.
                                                                   $4,050 and at the end of the year 1954 of $4,150.            (c) Matured U.S. savings bonds—(1) In-
                                                                   He purchased the bonds on January 1, 1949,
                                                                                                                             clusion of increase in income upon re-
                                                                   for $3,750, and holds no other obligation of
                                                                   the type described in this section. If the tax-           demption or final maturity. If a taxpayer
                                                                   payer exercises the election in his return for            (other than a corporation) holds—
                                                                   the calendar year 1954, he is required to in-                (i) A matured series E U.S. savings
                                                                   clude $400 in taxable income with respect to              bond,
                                                                   such bonds. Of this amount, $300 represents                  (ii) An obligation of the United
                                                                   the increase in the redemption price before               States, other than a current income
                                                                   1954 and $100 represents the increase in the              obligation, in which he retains his in-
                                                                   redemption price in 1954. The increases in re-
                                                                   demption value occurring in subsequent tax-
                                                                                                                             vestment in a matured series E U.S.
                                                                   able years are includible in gross income for             savings bond, or
                                                                   such taxable years.                                          (iii) A nontransferable obligation
                                                                     Example 2. In 1958 B, a taxpayer who uses               (whether or not a current income obli-
                                                                   the cash receipts and disbursements method                gation) of the United States for which
                                                                   of accounting and the calendar year as his                a series E U.S. savings bond was ex-
                                                                   taxable year, purchased for $7,500 a series E             changed (whether or not at final matu-
                                                                   United States savings bond with a face value
                                                                                                                             rity) in an exchange upon which gain is
                                                                   of $10,000. In 1965, when the stated redemp-
                                                                   tion value of the series E bond is $9,760, B              not recognized because of section
                                                                   surrenders it to the United States in ex-                 1037(a) (or so much of section 1031(b) as
                                                                   change solely for a $10,000 series H U.S. cur-            relates to section 1037(a)),
                                                                   rent income savings bond in an exchange                   the increase in redemption price of the
                                                                   qualifying under section 1037(a), after paying            series E bond in excess of the amount
                                                                   $240 additional consideration. On the ex-
                                                                   change of the series E bond for the series H
                                                                                                                             paid for such series E bond shall be in-
                                                                   bond in 1965, B realizes a gain of $2,260 ($9,760         cluded in the gross income of such tax-
                                                                   less $7,500), none of which is recognized for             payer for the taxable year in which the
                                                                   that year by reason of section 1037(a). B re-             obligation described in subdivision (i),
                                                                   tains the series H bond and redeems it at ma-             (ii), or (iii) of this subparagraph is re-
                                                                   turity in 1975 for $10,000, but in 1966 he exer-          deemed or disposed of, or finally ma-
                                                                   cises the election under section 454(a) in his            tures, whichever is earlier, but only to
                                                                   return for that year with respect to five se-
                                                                                                                             the extent such increase has not pre-
                                                                   ries E bonds he purchased in 1960. B is re-
                                                                   quired to include in gross income for 1966 the            viously been includible in the gross in-
                                                                   increase in redemption price occurring be-                come of such taxpayer or any other
                                                                   fore 1966 and in 1966 with respect to the se-             taxpayer. If such obligation is partially
                                                                   ries E bonds purchased in 1960; he is also re-            redeemed before final maturity, or par-
                                                                   quired to include in gross income for 1966 the            tially disposed of by being partially re-
                                                                   $2,260 increase in redemption price of the se-            issued to another owner, such increase
                                                                   ries E bond which was exchanged in 1965 for               in redemption price shall be included
                                                                   the series H bond.
                                                                                                                             in the gross income of such taxpayer
                                                                     (b) Short-term obligations issued on a                  for such taxable year on a basis propor-
                                                                   discount basis. In the case of obligations                tional to the total denomination of ob-
                                                                   of the United States or any of its pos-                   ligations redeemed or disposed of. The
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                                                                   sessions, or of a State, or Territory, or                 provisions of section 454 (c) and of this
                                                                   any political subdivision thereof, or of                  subparagraph shall not apply in the

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                                                                   Internal Revenue Service, Treasury                                                                 § 1.455–2

                                                                   case of any taxable year for which the                    years in which they are received. On Sep-
                                                                   taxpayer’s taxable income is computed                     tember 1, 1964, prior to maturity of the series
                                                                   under an accrual method of accounting                     H bond, D redeems it for $1,000. For 1964, D
                                                                                                                             must include $180 in gross income under sec-
                                                                   or for a taxable year for which an elec-                  tion 454(c) from the redemption of the series
                                                                   tion made by the taxpayer under sec-                      H bond, that is, the amount of the increase
                                                                   tion 454(a) and paragraph (a) of this                     in the redemption price of the series E bond
                                                                   section applies. For rules respecting                     ($1,000 less $820) occurring between February
                                                                   the character of the gain realized upon                   1, 1955, and January 15, 1960, the period dur-
                                                                   the disposition or redemption of an ob-                   ing which he owned the series E bond.
                                                                   ligation described in subdivision (iii) of                [T.D. 6500, 25 FR 11719, Nov. 26, 1960, as
                                                                   this subparagraph, see paragraph (b) of                   amended by T.D. 6935, 32 FR 15820, Nov. 17,
                                                                   § 1.1037–1.                                               1967; T.D. 7154, 36 FR 24997, Dec. 28, 1971]
                                                                      (2) Illustrations. The application of
                                                                   this paragraph may be illustrated by                      § 1.455–1 Treatment of prepaid sub-
                                                                   the following examples, in which it is                         scription income.
                                                                   assumed that the taxpayer uses the                           Effective with respect to taxable
                                                                   cash receipts and disbursements meth-                     years beginning after December 31,
                                                                   od of accounting and the calendar year                    1957, section 455 permits certain tax-
                                                                   as his taxable year:                                      payers to elect with respect to a trade
                                                                                                                             or business in connection with which
                                                                     Example 1. On June 1, 1941, A purchased for
                                                                   $375 a series E U.S. savings bond which was               prepaid subscription income is re-
                                                                   redeemable at maturity (10 years from issue               ceived, to include such income in gross
                                                                   date) for $500. At maturity of the bond, A ex-            income for the taxable years during
                                                                   ercised the option of retaining the matured               which a liability exists to furnish or
                                                                   series E bond for the 10-year extended matu-              deliver a newspaper, magazine, or other
                                                                   rity period. On June 2, 1961, A redeemed the              periodical. If a taxpayer does not elect
                                                                   series E bond, at which time the stated re-               to treat prepaid subscription income
                                                                   demption value was $674.60. A never elected
                                                                                                                             under the provisions of section 455,
                                                                   under section 454(a) to include the annual in-
                                                                   crease in redemption price in gross income                such income is includible in gross in-
                                                                   currently. Under section 454(c), A is required            come for the taxable year in which re-
                                                                   to include $299.60 ($674.60 less $375) in gross           ceived by the taxpayer, unless under
                                                                   income for 1961 by reason of his redemption               the method or practice of accounting
                                                                   of the bond.                                              used in computing taxable income such
                                                                     Example 2. The facts are the same as in Ex-             amount is to be properly accounted for
                                                                   ample 2 in paragraph (a)(4) of this section.              as of a different period.
                                                                   On redemption of the series H bond received
                                                                   in the exchange qualifying under section                  [T.D. 6591, 27 FR 1798, Feb. 27, 1962]
                                                                   1037(a), B realizes a gain of $2,260, determined
                                                                   as provided in Example 5 in paragraph (b)(4)              § 1.455–2 Scope of election under sec-
                                                                   of § 1.1037–1. None of this amount is includ-                  tion 455.
                                                                   ible in B’s gross income for 1975, such
                                                                   amount having already been includible in his
                                                                                                                                (a) If a taxpayer makes an election
                                                                   gross income for 1966 because of his election             under section 455 and § 1.455–6 with re-
                                                                   under section 454(a).                                     spect to a trade or business, all prepaid
                                                                     Example 3. C, who had elected under section             subscription income from such trade or
                                                                   454(a) to include the annual increase in the              business shall be included in gross in-
                                                                   redemption price of his non-interest-bearing              come for the taxable years during
                                                                   obligations in gross income currently, owned              which the liability exists to furnish or
                                                                   a $1,000 series E U.S. savings bond, which was
                                                                                                                             deliver a newspaper, magazine, or other
                                                                   purchased on October 1, 1949, for $750, C died
                                                                   on February 1, 1955, when the redemption                  periodical. Such election shall be appli-
                                                                   value of the bond was $820. The bond was im-              cable to all prepaid subscription in-
                                                                   mediately reissued to D, his only heir, who               come received in connection with the
                                                                   has not made an election under section                    trade or business for which the election
                                                                   454(a). On January 15, 1960, when the redemp-             is made; except that the taxpayer may
                                                                   tion value of the bond is $1,000, D surrenders            further elect to include in gross income
                                                                   it to the United States in exchange solely for            for the taxable year of receipt (as de-
                                                                   a $1,000 series H U.S. savings bond in an ex-
                                                                                                                             scribed in section 455(d)(3) and para-
                                                                   change qualifying under the provisions of
                                                                   section 1037(a). For 1960 D properly does not             graph (c) of § 1.455–5) the entire amount
                                                                                                                             of any prepaid subscription income if
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                                                                   return any income from the exchange of
                                                                   bonds, although he returns the interest pay-              the liability from which it arose is to
                                                                   ments on the series H bond for the taxable                end within 12 months after the date of

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                                                                   § 1.455–3                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   receipt, hereinafter sometimes referred                   sions of section 455 for the year 1959
                                                                   to as ‘‘within 12 months’’ election.                      and subsequent taxable years. The
                                                                     (b) If the taxpayer is engaged in more                  $135,000 received in 1958 from prepaid
                                                                   than one trade or business in which a                     subscriptions must be included in gross
                                                                   liability is incurred to furnish or de-                   income in full in that year, and no part
                                                                   liver a newspaper, magazine, or other                     of such 1958 income shall be allocated
                                                                   periodical, a separate election 455 with                  to the years 1959, 1960, and 1961 during
                                                                   respect to each such trade or business.                   which M was under a liability to de-
                                                                   In addition, a taxpayer may make a                        liver its magazine. The $142,000 re-
                                                                   separate ‘‘within 12 months’’ election                    ceived in 1959 from prepaid subscrip-
                                                                   for each separate trade or business for                   tions shall be allocated to the years
                                                                   which it has made an election under                       1959, 1960, 1961, and 1962.
                                                                   section 455.                                                (e) No election may be made under
                                                                     (c) An election made under section                      section 455 with respect to a trade or
                                                                   455 shall be binding for the first taxable                business if, in computing taxable in-
                                                                   year for which the election is made and                   come, the cash receipts and disburse-
                                                                   for all subsequent taxable years, unless                  ments method of accounting is used
                                                                   the taxpayer secures the consent of the                   with respect to such trade or business.
                                                                   Commissioner to the revocation of                         However, if the taxpayer is on a ‘‘com-
                                                                   such election. Thus, in any case where                    bination’’ method of accounting under
                                                                   the taxpayer has elected a method pre-                    section 446(c)(4) and the regulations
                                                                   scribed by section 455 for the inclusion                  thereunder, it may elect the benefits of
                                                                   of prepaid subscription income in gross                   section 455 if it uses an accrual method
                                                                   income, such method of reporting in-                      of accounting for subscription income
                                                                   come may not be changed without the                       [T.D. 6591, 27 FR 1798, Feb. 27, 1962]
                                                                   prior approval of the Commissioner. In
                                                                   order to secure the Commissioner’s                        § 1.455–3 Method of allocation.
                                                                   consent to the revocation of such elec-
                                                                                                                                (a) Prepaid subscription income to
                                                                   tion, an application must be filed with
                                                                                                                             which section 455 applies shall be in-
                                                                   the Commissioner in accordance with
                                                                                                                             cluded in gross income for the taxable
                                                                   section 446(e) and the regulations
                                                                                                                             years during which the liability to
                                                                   thereunder. For purposes of subtitle A
                                                                                                                             which the income relates is discharged
                                                                   of the Code, the computation of taxable
                                                                                                                             or is deemed to be discharged on the
                                                                   income under an election made under
                                                                                                                             basis of the taxpayer’s experience.
                                                                   section 455 shall be treated as a method
                                                                                                                                (b) For purposes of determining the
                                                                   of accounting. For adjustments re-
                                                                                                                             period or periods over which the liabil-
                                                                   quired by changes in method of ac-
                                                                                                                             ity of the taxpayer extends, and for
                                                                   counting, see section 481 and the regu-
                                                                                                                             purposes of allocating prepaid subscrip-
                                                                   lations thereunder.
                                                                                                                             tion income to such periods, the tax-
                                                                     (d) An election made under section
                                                                                                                             payer may aggregate similar trans-
                                                                   455 shall not apply to any prepaid sub-
                                                                                                                             actions during the taxable year in any
                                                                   scription income received before the
                                                                                                                             reasonable manner, provided the meth-
                                                                   first taxable year to which the election
                                                                                                                             od of aggregation and allocation is con-
                                                                   applies. For example, Corporation M,
                                                                                                                             sistently followed.
                                                                   which computes its taxable income
                                                                   under an accrual method of accounting                     [T.D. 6591, 27 FR 1798, Feb. 27, 1962]
                                                                   and files its income tax returns on the
                                                                   calendar year basis, publishes a month-                   § 1.455–4 Cessation of taxpayer’s liabil-
                                                                   ly magazine and customarily sells sub-                         ity.
                                                                   scriptions on a 3-year basis. In 1958 it                     (a) If a taxpayer has elected to apply
                                                                   received $135,000 of 3-year prepaid sub-                  the provisions of section 455 to a trade
                                                                   scription income for subscriptions be-                    or business in connection with which
                                                                   ginning during 1958, and in 1959 it re-                   prepaid subscription income is re-
                                                                   ceived $142,000 of prepaid subscription                   ceived, and if its liability to furnish or
                                                                   income for subscriptions beginning                        deliver a newspaper, magazine, or other
                                                                   after December 31, 1958. In February                      periodical ends for any reason, then so
                                                                   1959 it elected, with the consent of the                  much of the prepaid subscription in-
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                                                                   Commissioner, to report its prepaid                       come attributable to such liability as
                                                                   subscription income under the provi-                      was not includible in its gross income

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                                                                   Internal Revenue Service, Treasury                                                                 § 1.455–6

                                                                   under section 455 for preceding taxable                   of several large publishers which
                                                                   years shall be included in its gross in-                  grants it the right to sell subscriptions
                                                                   come for the taxable year in which                        to their periodicals. Corporation D col-
                                                                   such liability ends. A taxpayer’s liabil-                 lects the subscription price from the
                                                                   ity may end, for example, because of                      subscribers, retains a portion thereof
                                                                   the cancellation of a subscription. See                   as its commission and remits the bal-
                                                                   section 381(c)(4) and the regulations                     ance to the publishers. The amount re-
                                                                   thereunder for the treatment of pre-                      tained by Corporation D represents
                                                                   paid subscription income in a trans-                      commissions on the sale of subscrip-
                                                                   action to which section 381(a) applies.                   tions, and is not prepaid subscription
                                                                     (b) If a taxpayer who has elected to                    income for purposes of section 455 since
                                                                   apply the provisions of section 455 to a                  the commissions represent compensa-
                                                                   trade or business dies or ceases to                       tion for services rendered and are not
                                                                   exist, then so much of the prepaid sub-                   directly attributable to a liability of
                                                                   scription income attributable to such                     Corporation D to furnish or deliver a
                                                                   trade or business which was not includ-                   newspaper, magazine, or other peri-
                                                                   ible in its gross income under section                    odical.
                                                                   455 for preceding taxable years shall be                    (b) Liability. The term ‘‘liability’’
                                                                   included in its gross income for the                      means a liability of the taxpayer to
                                                                   taxable year in which such death or                       furnish or deliver a newspaper, maga-
                                                                   cessation of existence occurs. See sec-                   zine, or other periodical.
                                                                   tion 381(c)(4) and the regulations there-                   (c) Receipt of prepaid subscription in-
                                                                   under for the treatment of prepaid sub-                   come. For purposes of section 455, pre-
                                                                   scription income in a transaction to                      paid subscription income shall be
                                                                   which section 381(a) applies.                             treated as received during the taxable
                                                                   [T.D. 6591, 27 FR 1799, Feb. 27, 1962]
                                                                                                                             year for which it is includible in gross
                                                                                                                             income under section 451, relating to
                                                                   § 1.455–5 Definitions and other rules.                    general rule for taxable year of inclu-
                                                                                                                             sion, without regard to section 455.
                                                                      (a) Prepaid subscription income. (1) The
                                                                                                                               (d) Treatment of prepaid subscription
                                                                   term ‘‘prepaid subscription income’’
                                                                                                                             income under an established accounting
                                                                   means any amount includible in gross
                                                                                                                             method. Notwithstanding the provisions
                                                                   income which is received in connection
                                                                                                                             of section 455 and § 1.455–1, any tax-
                                                                   with, and is directly attributable to, a
                                                                                                                             payer who, for taxable years beginning
                                                                   liability of the taxpayer which extends
                                                                                                                             before January 1, 1958, has reported
                                                                   beyond the close of the taxable year in
                                                                                                                             prepaid subscription income for income
                                                                   which such amount is received and
                                                                                                                             tax purposes under an established and
                                                                   which is income from a newspaper,
                                                                   magazine, or other periodical. For ex-                    consistent method or practice of defer-
                                                                   ample where Corporation X, a pub-                         ring such income may continue to re-
                                                                   lisher of newspapers, magazines, and                      port such income in accordance with
                                                                   other periodicals makes sales on a sub-                   such method or practice for all subse-
                                                                   scription basis and the purchaser pays                    quent taxable years to which section
                                                                   the subscription price in advance, pre-                   455 applies without making an election
                                                                   paid subscription income would include                    under section 455.
                                                                   the amounts actually received by X in                     [T.D. 6591, 27 FR 1799, Feb. 27, 1962]
                                                                   connection with its liability to furnish
                                                                   or deliver the newspaper, magazine, or                    § 1.455–6 Time and manner of making
                                                                   other periodical.                                               election.
                                                                      (2) For purposes of section 455, pre-                     (a) Election without consent. (1) A tax-
                                                                   paid subscription income does not in-                     payer may, without consent, elect to
                                                                   clude amounts received by a taxpayer                      treat prepaid subscription income of a
                                                                   in connection with sales of subscrip-                     trade or business under section 455 for
                                                                   tions on a prepaid basis where such                       the first taxable year—
                                                                   taxpayer does not have the liability to                      (i) Which begins after December 31,
                                                                   furnish or deliver a newspaper, maga-                     1957, and
                                                                   zine, or other periodical. The provi-                        (ii) In which there is received prepaid
                                                                   sions of this subparagraph may be il-                     subscription income from the trade or
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                                                                   lustrated by the following example.                       business for which the election is
                                                                   Corporation D has a contract with each                    made. Such an election shall be made

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                                                                   § 1.455–6                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   not later than the time prescribed by                       (2) May 28, 1962, and must contain the
                                                                   law for filing the income tax return for                  information described in paragraph
                                                                   such year (including extensions there-                    (a)(2) of this section.
                                                                   of), and shall be made by means of a                      See paragraph (c) of this section for ad-
                                                                   statement attached to such return.                        ditional information required to be
                                                                     (2) The statement shall indicate that                   submitted with the request if the tax-
                                                                   the taxpayer is electing to apply the                     payer also elects to include in gross in-
                                                                   provisions of section 455 to his trade or                 come for the taxable year of receipt
                                                                   business, and shall contain the fol-                      the entire amount of prepaid subscrip-
                                                                   lowing information:                                       tion income attributable to a liability
                                                                     (i) The name and a description of the
                                                                                                                             which is to end within 12 months after
                                                                   taxpayer’s trade or business to which
                                                                                                                             the date of receipt.
                                                                   the election is to apply;
                                                                     (ii) The method of accounting used in                     (c) ‘‘Within 12 months’’ election. (1) A
                                                                   such trade or business;                                   taxpayer who elects to apply the provi-
                                                                     (iii) The total amount of prepaid sub-                  sions of section 455 to any trade or
                                                                   scription income from such trade or                       business may also elect to include in
                                                                   business for the taxable year;                            gross income for the taxable year of re-
                                                                     (iv) The period or periods over which                   ceipt (as described in section 455(d)(3)
                                                                   the liability of the taxpayer to furnish                  and paragraph (c) of § 1.455–5) the entire
                                                                   or deliver a newspaper, magazine, or                      amount of any prepaid subscription in-
                                                                   other periodical extends;                                 come from such trade or business if the
                                                                     (v) The amount of prepaid subscrip-                     liability from which it arose is to end
                                                                   tion income applicable to each such pe-                   within 12 months after the date of re-
                                                                   riod; and                                                 ceipt. Any such election is binding for
                                                                     (vi) A description of the method used                   the first taxable year for which it is ef-
                                                                   in allocating the prepaid subscription                    fective and for all subsequent taxable
                                                                   income to each such period.                               years, unless the taxpayer secures per-
                                                                   In any case in which prepaid subscrip-                    mission from the Commissioner to
                                                                   tion income is received from more than                    treat such income differently. Applica-
                                                                   one trade or business, the statement                      tion to revoke or change a ‘‘within 12
                                                                   shall set forth the required information                  months’’ election shall be made in ac-
                                                                   with respect to each trade or business                    cordance with the provisions of section
                                                                   subject to the election.                                  446(e) and the regulations thereunder.
                                                                     (3) See paragraph (c) of this section                     (2) The ‘‘within 12 months’’ election
                                                                   for additional information required to                    shall be made by including in the state-
                                                                   be submitted with the statement if the                    ment required by paragraph (a) of this
                                                                   taxpayer also elects to include in gross                  section or the request described in
                                                                   income for the taxable year of receipt                    paragraph (b) of this section, whichever
                                                                   the entire amount of prepaid subscrip-                    is applicable, a declaration that the
                                                                   tion income attributable to a liability                   taxpayer elects to include such income
                                                                   which is to end within 12 months after                    in gross income in the taxable year of
                                                                   the date of receipt.                                      receipt, and the amount of such in-
                                                                     (b) Election with consent. A taxpayer                   come. If the taxpayer is engaged in
                                                                   may, with the consent of the Commis-                      more than one trade or business for
                                                                   sioner, elect at any time to apply the                    which the election under section 455 is
                                                                   provisions of section 455 to any trade                    made, it must include, in such state-
                                                                   or business in which it receives prepaid                  ment or request, a declaration for each
                                                                   subscription income. The request for                      trade or business for which it makes
                                                                   such consent shall be in writing, signed                  the ‘‘within 12 months’’ election. See
                                                                   by the taxpayer or its authorized rep-                    also paragraph (e) of § 1.455–2.
                                                                   resentative, and shall be addressed to                      (3) If the taxpayer does not make the
                                                                   the Commissioner of Internal Revenue,                     ‘‘within 12 months’’ election for its
                                                                   Attention: T:R:C, Washington, D.C.                        trade or business at the time pre-
                                                                   20224. The request must be filed on or                    scribed for making the election to in-
                                                                   before the later of the following dates:                  clude prepaid subscription income in
                                                                     (1) 90 days after the beginning of the                  gross income for the taxable years dur-
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                                                                   first taxable year to which the election                  ing which its liability to furnish or de-
                                                                   is to apply or                                            liver a newspaper, magazine, or other

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                                                                   Internal Revenue Service, Treasury                                                              § 1.456–2

                                                                   periodical exists for such trade or busi-                   (b) If the taxpayer is engaged in more
                                                                   ness, but later wishes to make such                       than one trade or business in connec-
                                                                   election, it must apply for permission                    tion with which prepaid dues income is
                                                                   from the Commissioner. Such applica-                      received, a separate election may be
                                                                   tion shall be made in accordance with                     made under section 456 with respect to
                                                                   the provisions of section 446(e) and the                  each such trade or business. In addi-
                                                                   regulations thereunder.                                   tion, a taxpayer may make a separate
                                                                                                                             ‘‘within 12 months’’ election for each
                                                                   [T.D. 6591, 27 FR 1799, Feb. 27, 1962]                    separate trade or business for which it
                                                                                                                             has made an election under section 456.
                                                                   § 1.456–1 Treatment of prepaid dues
                                                                        income.                                                (c) A section 456 election and a
                                                                                                                             ‘‘within 12 months’’ election shall be
                                                                      Effective for taxable years beginning                  binding for the first taxable year for
                                                                   after December 31, 1960, a taxpayer                       which the election is made and for all
                                                                   which is a membership organization (as                    subsequent taxable years, unless the
                                                                   described in paragraph (c) of § 1.456–5)                  taxpayer secures the consent of the
                                                                   and which receives prepaid dues in-                       Commissioner to the revocation of ei-
                                                                   come as described in paragraph (a) of                     ther election. In order to secure the
                                                                   § 1.456–5 in connection with its trade or                 Commissioner’s consent to the revoca-
                                                                   business of rendering services or mak-                    tion of the section 456 election or the
                                                                   ing available membership privileges                       ‘‘within 12 months’’ election, an appli-
                                                                   may elect under section 456 to include                    cation must be filed with the Commis-
                                                                   such income in gross income ratably                       sioner in accordance with section 446(e)
                                                                   over the taxable years during which its                   and the regulations thereunder. How-
                                                                   liability (as described in paragraph (b)                  ever, an application for consent to re-
                                                                   of § 1.456–5) to render such services or                  voke the section 456 election or the
                                                                   extend such privileges exists, if such li-                ‘‘within 12 months’’ election in the
                                                                   ability does not extend over a period of                  case of all taxable years which end be-
                                                                   time in excess of 36 months. If the tax-                  fore November 30, 1967 must be filed on
                                                                   payer does not elect to treat prepaid                     or before February 28, 1968. For pur-
                                                                   dues income under section 456, or if                      poses of Subtitle A of the Code, the
                                                                   such income may not be reported under                     computation of taxable income under
                                                                   section 456, as for example, where the                    an election made under section 456 or
                                                                   income relates to a liability to render                   under the ‘‘within 12 months’’ election
                                                                   services or make available membership                     shall be treated as a method of ac-
                                                                   privileges which extends beyond 36                        counting. For adjustments required by
                                                                   months, then such income is includible                    changes in method of accounting, see
                                                                   in gross income for the taxable year in                   section 481 and the regulations there-
                                                                   which it is received (as described in                     under.
                                                                   paragraph (d) of § 1.456–5).                                (d) Except as provided in section
                                                                                                                             456(d) and § 1.456–7, an election made
                                                                   [T.D. 6937, 32 FR 16394, Nov. 30, 1967]                   under section 456 shall not apply to any
                                                                                                                             prepaid dues income received before
                                                                   § 1.456–2 Scope of election under sec-
                                                                        tion 456.                                            the first taxable year to which the
                                                                                                                             election applies. For example, Corpora-
                                                                     (a) An election made under section                      tion X, a membership organization
                                                                   456 and § 1.456–6, shall be applicable to                 which files its income tax returns on a
                                                                   all prepaid dues income received in                       calendar year basis, customarily sells
                                                                   connection with the trade or business                     3-year memberships, payable in ad-
                                                                   for which the election is made. How-                      vance. In 1961 it received $160,000 of pre-
                                                                   ever, the taxpayer may further elect to                   paid dues income for 3-year member-
                                                                   include in gross income for the taxable                   ships beginning during 1961, and in 1962
                                                                   year of receipt the entire amount of                      it received $185,000 of prepaid dues in-
                                                                   any prepaid dues income attributable                      come for 3-year memberships beginning
                                                                   to a liability extending beyond the                       on January 1, 1962. In March 1962 it
                                                                   close of the taxable year but ending                      elected, with the consent of the Com-
                                                                   within 12 months after the date of re-                    missioner, to report its prepaid dues in-
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                                                                   ceipt, hereinafter referred to as the                     come under the provisions of section
                                                                   ‘‘within 12 months’’ election.                            456 for the year 1962 and subsequent

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                                                                   § 1.456–3                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   taxable years. The $160,000 received in                     (b) For purposes of determining the
                                                                   1961 from prepaid dues must be in-                        period or periods over which the liabil-
                                                                   cluded in gross income in full in that                    ity of the taxpayer exists, and for pur-
                                                                   year, and except as provided in section                   poses of allocating prepaid dues income
                                                                   456(d) and § 1.456–7, no part of such in-                 to such periods, the taxpayer may ag-
                                                                   come shall be allocated to the taxable                    gregate similar transactions during the
                                                                   years 1962, 1963, and 1964 during which                   taxable year in any reasonable manner,
                                                                   X was under a liability to make avail-                    provided the method of aggregation
                                                                   able its membership privileges. The                       and allocation is consistently followed.
                                                                   $185,000 received in 1962 from prepaid                    [T.D. 6937, 32 FR 16395, Nov. 30, 1967]
                                                                   dues income shall be allocated to the
                                                                   years 1962, 1963, and 1964.                               § 1.456–4 Cessation of liability or exist-
                                                                     (e) No election may be made under                            ence.
                                                                   section 456 with respect to a trade or                      (a) If a taxpayer has elected to apply
                                                                   business if, in computing taxable in-                     the provisions of section 456 to a trade
                                                                   come, the cash receipts and disburse-                     or business in connection with which
                                                                   ments method (or a hybrid thereof) of                     prepaid dues income is received, and if
                                                                   accounting is used with respect to such                   the taxpayer’s liability to render serv-
                                                                   trade or business, unless the combina-                    ices or make available membership
                                                                   tion of the section 456 election and the                  privileges ends for any reason, as for
                                                                   taxpayer’s hybrid method of account-                      example, because of the cancellation of
                                                                   ing does not result in a material distor-                 a membership then so much of the pre-
                                                                   tion of income.                                           paid dues income attributable to such
                                                                   [T.D. 6937, 32 FR 16394, Nov. 30, 1967; 32 FR             liability as was not includible in the
                                                                   17479, Dec. 6, 1967]                                      taxpayer’s gross income under section
                                                                                                                             456 for preceding taxable years shall be
                                                                   § 1.456–3     Method of allocation.                       included in gross income for the tax-
                                                                                                                             able year in which such liability ends.
                                                                     (a) Prepaid dues income for which an
                                                                                                                             This paragraph shall not apply to
                                                                   election has been made under section
                                                                                                                             amounts includible in gross income
                                                                   456 shall be included in gross income
                                                                                                                             under § 1.456–7.
                                                                   over the period of time during which
                                                                                                                               (b) If a taxpayer which has elected to
                                                                   the liability to render services or make
                                                                                                                             apply the provisions of section 456
                                                                   available membership privileges exists.
                                                                                                                             ceases to exist, then the prepaid dues
                                                                   The liability to render the services or
                                                                                                                             income which was not includible in
                                                                   make available the membership privi-
                                                                                                                             gross income under section 456 for pre-
                                                                   leges shall be deemed to exist ratably
                                                                                                                             ceding taxable years shall be included
                                                                   over the period of time such services
                                                                                                                             in the taxpayer’s gross income for the
                                                                   are required to be rendered, or such
                                                                                                                             taxable year in which such cessation of
                                                                   membership privileges are required to
                                                                                                                             existence occurs. This paragraph shall
                                                                   be made available. Thus, the prepaid
                                                                                                                             not apply to amounts includible in
                                                                   dues income shall be included in gross
                                                                                                                             gross income under § 1.456–7.
                                                                   income ratably over the period of the
                                                                                                                               (c) If a taxpayer is a party to a trans-
                                                                   membership contract. For example,
                                                                                                                             action to which section 381(a) applies
                                                                   Corporation X, a membership organiza-
                                                                                                                             and the taxpayer’s method of account-
                                                                   tion, which files its income tax returns
                                                                                                                             ing with respect to prepaid dues in-
                                                                   on a calendar year basis, elects, for its
                                                                                                                             come is used by the acquiring corpora-
                                                                   taxable year beginning January 1, 1961,
                                                                                                                             tion under the provisions of section
                                                                   to report its prepaid dues income in ac-
                                                                                                                             381(c)(4), then neither the liability nor
                                                                   cordance with the provisions of section
                                                                                                                             the existence of the taxpayer shall be
                                                                   456. On March 31, 1961, it sells a 2-year
                                                                                                                             deemed to have ended or ceased. In
                                                                   membership for $48 payable in advance,
                                                                                                                             such cases see section 381(c)(4) and the
                                                                   the membership to extend from May 1,
                                                                                                                             regulations thereunder for the treat-
                                                                   1961, to April 30, 1963. X shall include in
                                                                                                                             ment of the portion of prepaid dues in-
                                                                   its gross income for the taxable year
                                                                                                                             come which was not included in gross
                                                                   1961 8⁄24 of the $48, or $16, and for the
                                                                                                                             income under section 456 for preceding
                                                                   taxable year 1962 12⁄24 of the $48, or $24,
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                                                                                                                             taxable years.
                                                                   and for the taxable year 1963 4⁄24 of the
                                                                   $48, or $8.                                               [T.D. 6937, 32 FR 16395, Nov. 30, 1967]

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                                                                   Internal Revenue Service, Treasury                                                              § 1.456–6

                                                                   § 1.456–5 Definitions and other rules.                       (iii) No part of the net earnings of
                                                                      (a) Prepaid dues income. (1) The term                  which is in fact distributed to any
                                                                   ‘‘prepaid dues income’’ means any                         member either directly or indirectly,
                                                                   amount for membership dues includible                     in money, property, or services.
                                                                   in gross income which is received by a                       (2) For purposes of this paragraph an
                                                                   membership organization in connec-                        increase in services or reduction in
                                                                   tion with, and is directly attributable                   dues to all members shall generally not
                                                                   to, a liability of the taxpayer to render                 be considered distributions of net earn-
                                                                   services or make available membership                     ings.
                                                                                                                                (3) If a corporation, association, fed-
                                                                   privileges over a period of time which
                                                                                                                             eration, or other similar organization
                                                                   extends beyond the close of the taxable
                                                                                                                             subsequent to the time it elects to re-
                                                                   year in which such amount is received.
                                                                      (2) For purposes of section 456, pre-                  port its prepaid dues income in accord-
                                                                   paid dues income does not include                         ance with the provisions of section 456,
                                                                   amounts received by a taxpayer in con-                    (i) issues any kind of capital stock ei-
                                                                   nection with sales of memberships on a                    ther to any member or nonmember, (ii)
                                                                   prepaid basis where the taxpayer does                     amends its charter, bylaws, or other
                                                                   not have the liability to furnish the                     written agreement or contract to per-
                                                                   services or make available the mem-                       mit distributions of its net earnings to
                                                                   bership privileges. For example, where                    any member or, (iii) in fact, distributes
                                                                   a taxpayer has a contract with several                    any part of its net earnings either in
                                                                   membership organizations to sell mem-                     money, property, or services to any
                                                                   berships in such organizations and re-                    member, then immediately after such
                                                                   tains a portion of the amounts received                   event the organization shall not be
                                                                   from the sale of such memberships and                     considered a membership organization
                                                                   remits the balance to the membership                      within the meaning of section 456(e)(3).
                                                                                                                                (d) Receipt of prepaid dues income. For
                                                                   organizations, the amounts retained by
                                                                                                                             purposes of section 456, prepaid dues in-
                                                                   such taxpayer represent commissions
                                                                                                                             come shall be treated as received dur-
                                                                   and do not constitute prepaid dues in-
                                                                                                                             ing the taxable year for which it is in-
                                                                   come for purposes of section 456.
                                                                      (b) Liability. The term ‘‘liability’’                  cludible in gross income under section
                                                                   means a liability of the taxpayer to                      451, relating to the general rule for tax-
                                                                   render services or make available                         able year of inclusion, without regard
                                                                   membership privileges over a period of                    to section 456.
                                                                   time which does not exceed 36 months.                     [T.D. 6937, 32 FR 16395, Nov. 30, 1967]
                                                                   Thus, if during the taxable year a tax-
                                                                   payer sells memberships for more than                     § 1.456–6 Time and manner of making
                                                                   36 months and also memberships for 36                          election.
                                                                   months or less, section 456 does not                         (a) Election without consent. A tax-
                                                                   apply to the income from the sale of                      payer may make an election under sec-
                                                                   memberships for more than 36 months.                      tion 456 without the consent of the
                                                                   For the purpose of determining the du-                    Commissioner for the first taxable year
                                                                   ration of a liability, a bona fide re-                    beginning after December 31, 1960, in
                                                                   newal of a membership shall not be                        which it receives prepaid dues income
                                                                   considered to be a part of the existing                   in the trade or business for which such
                                                                   membership.                                               election is made. The election must be
                                                                      (c) Membership organization. (1) The                   made not later than the time pre-
                                                                   term       ‘‘membership      organization’’               scribed by law for filing the income tax
                                                                   means a corporation, association, fed-                    return for such year (including exten-
                                                                   eration, or other similar organization                    sions thereof). The election must be
                                                                   meeting the following requirements:                       made by means of a statement at-
                                                                      (i) It is organized without capital                    tached to such return. In addition,
                                                                   stock of any kind.                                        there should be attached a copy of a
                                                                      (ii) Its charter, bylaws, or other writ-               typical membership contract used by
                                                                   ten agreement or contract expressly                       the organization and a copy of its char-
                                                                   prohibits the distribution of any part                    ter, bylaws, or other written agree-
                                                                   of the net earnings directly or indi-                     ment or contract of organization or as-
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                                                                   rectly, in money, property, or services,                  sociation. The statement shall indicate
                                                                   to any member, and                                        that the taxpayer is electing to apply

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                                                                   § 1.456–6                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   the provisions of section 456 to the                      year but none are sold for periods in
                                                                   trade or business, and shall contain the                  excess of 2 years, or
                                                                   following information:                                      (c) Each of the 3 taxable years pre-
                                                                     (1) The taxpayer’s name and a de-                       ceding the first taxable year for which
                                                                   scription of the trade or business to                     the election is effective if any member-
                                                                   which the election is to apply.                           ships are sold for periods in excess of 2
                                                                     (2) The method of accounting used for                   years.
                                                                   prepaid dues income in the trade or                       In each case there shall be set forth the
                                                                   business during the first taxable year                    amount of such income which would
                                                                   for which the election is to be effective                 have been includible in each taxable
                                                                   and during each of 3 preceding taxable                    year had the election been effective for
                                                                   years, and if there was a change in the                   the years for which the information is
                                                                   method of accounting for prepaid dues                     required.
                                                                   income during such 3-year period, a de-                   In any case in which prepaid dues in-
                                                                   tailed explanation of such change in-                     come is received from more than one
                                                                   cluding the adjustments necessary to                      trade or business, the statement shall
                                                                   prevent duplications or omissions of in-                  set forth separately the required infor-
                                                                   come.                                                     mation with respect to each trade or
                                                                     (3) Whether any type of deferral                        business for which the election is
                                                                   method for prepaid dues income has                        made. See paragraph (c) of this section
                                                                   been used during any of the 3 taxable                     for additional information required to
                                                                   years preceding the first taxable year                    be submitted with the statement if the
                                                                   for which the election is effective.                      taxpayer also elects to include in gross
                                                                   Where any type of such deferral meth-                     income for the taxable year of receipt
                                                                   od has been used during this period, an                   the entire amount of prepaid dues in-
                                                                   explanation of the method and a sched-                    come attributable to a liability which
                                                                   ule showing the amounts received in                       is to end within 12 months after the
                                                                   each such year and the amounts de-                        date of receipt.
                                                                   ferred to each succeeding year.                             (b) Election with consent. A taxpayer
                                                                     (4) A schedule with appropriate ex-                     may elect with the consent of the Com-
                                                                   planations showing:                                       missioner, to apply the provisions of
                                                                     (i) The total amount of prepaid dues                    section 456 to any trade or business in
                                                                   income received in the trade or busi-                     which it receives prepaid dues income.
                                                                   ness in the first taxable year for which                  The request for such consent shall be
                                                                   the election is effective and the                         in writing, signed by the taxpayer or
                                                                   amount of such income to be included                      its authorized representative, and shall
                                                                   in each taxable year in accordance                        be addressed to the Commissioner of
                                                                   with the election,                                        Internal Revenue, Washington, D.C.
                                                                     (ii) The total amount, if any, of pre-                  20224. The request must be filed on or
                                                                   payments of dues received in the first                    before the later of the following dates:
                                                                   taxable year for which the election is                      (1) 90 days after the beginning of the
                                                                   effective which are directly attrib-                      first taxable year to which the election
                                                                   utable to a liability of the taxpayer to                  is to apply, or
                                                                   render services or make available                           (2) February 28, 1968 and should con-
                                                                   membership privileges over a period of                    tain the information described in para-
                                                                   time in excess of 36 months, and                          graph (a) of this section.
                                                                     (iii) The total amount, if any, of pre-                 See paragraph (c) of this section for ad-
                                                                   paid dues income received in the trade                    ditional information required to be
                                                                   or business in—                                           submitted with the request if the tax-
                                                                     (a) The taxable year preceding the                      payer also elects to include in gross in-
                                                                   first taxable year for which the elec-                    come for the taxable year of receipt
                                                                   tion is effective if all memberships sold                 the entire amount of prepaid dues in-
                                                                   by the taxpayer are for periods of 1                      come attributable to a liability which
                                                                   year or less,                                             is to end within 12 months after the
                                                                     (b) Each of the 2 taxable years pre-                    date of receipt.
                                                                   ceding the first taxable year for which                     (c) ‘‘Within 12 months’’ election. (1)
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                                                                   the election is effective if any member-                  The ‘‘within 12 months’’ election shall
                                                                   ships are sold for periods in excess of 1                 be made by including in the statement

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                                                                   Internal Revenue Service, Treasury                                                              § 1.456–7

                                                                   required by paragraph (a) of this sec-                    fect shall be given to a ‘‘within 12
                                                                   tion or the request described in para-                    months’’ election made under para-
                                                                   graph (b) of this section, whichever is                   graph (c) of § 1.456–6, and
                                                                   applicable, a declaration that the tax-                     (2) There shall be taken into account
                                                                   payer elects to include such income in                    only prepaid dues income arising from
                                                                   gross income in the taxable year of re-                   a trade or business with respect to
                                                                   ceipt, and the amount of such income                      which an election is made under sec-
                                                                   for each taxable year to which the elec-                  tion 456 and § 1.456–6.
                                                                   tion is to apply which has ended prior                    Section 481 and the regulations there-
                                                                   to the time such statement or request                     under shall have no application to the
                                                                   is filed. If the taxpayer is engaged in                   additional amounts includible in gross
                                                                   more than one trade or business for                       income under section 456(d) and this
                                                                   which the election under section 456 is                   section, but section 481 and the regula-
                                                                   made, it must include, in such state-                     tions thereunder shall apply to prevent
                                                                   ment or request, a declaration for each                   other amounts from being duplicated
                                                                   trade or business for which it wishes to                  or omitted.
                                                                   make the ‘‘within 12 months’’ election.                     (b) A taxpayer who makes an election
                                                                     (2) If the taxpayer does not make the                   with respect to prepaid dues income,
                                                                   ‘‘within 12 months’’ election for a trade                 and who includes in gross income for
                                                                   or business at the time it makes the                      any taxable year to which the election
                                                                   election under paragraph (a) or (b) of                    applies an additional amount computed
                                                                   this section, but later wishes to make                    under section 456(d)(1) and paragraph
                                                                   such election, it must apply for permis-                  (a) of this section, shall be permitted
                                                                   sion from the Commissioner. Such ap-                      under section 456(d)(2) to deduct for
                                                                   plication shall be made in accordance                     such taxable year and for each of the 4
                                                                   with the provisions of section 446(e).                    succeeding taxable years an amount
                                                                   [T.D. 6937, 32 FR 16395, Nov. 30, 1967; 32 FR             equal to one-fifth of such additional
                                                                   17479, Dec. 6, 1967]                                      amount, but only to the extent that
                                                                                                                             such additional amount was also in-
                                                                   § 1.456–7 Transitional rule.                              cluded in the taxpayer’s gross income
                                                                      (a) Under section 456(d)(1), a taxpayer                for any of the 3 taxable years preceding
                                                                   making an election under section 456                      the first taxable year to which such
                                                                   shall include in its gross income for the                 election applies. The taxpayer shall
                                                                   first taxable year to which the election                  maintain books and records in suffi-
                                                                   applies and for each of the 2 succeeding                  cient detail to enable the district di-
                                                                   taxable years not only that portion of                    rector to determine upon audit that
                                                                   prepaid dues income which is includ-                      the additional amounts were included
                                                                   ible in gross income for each such tax-                   in the taxpayer’s gross income for any
                                                                   able year under section 456(a), but also                  of the 3 taxable years preceding such
                                                                   an additional amount equal to that                        first taxable year. If, however, the tax-
                                                                   portion of the total prepaid dues in-                     payer ceases to exist, as described in
                                                                   come received in each of the 3 taxable                    paragraph (b) of § 1.456–4, and there is
                                                                   years preceding the first taxable year                    included in gross income, under such
                                                                   to which the election applies which                       paragraph, of the year of cessation the
                                                                   would have been includible in gross in-                   entire portion of prepaid dues income
                                                                   come for such first taxable year and                      not previously includible in gross in-
                                                                   such 2 succeeding taxable years had the                   come under section 456 for preceding
                                                                   election under section 456 been effec-                    taxable years (other than for amounts
                                                                   tive during such 3 preceding taxable                      received prior to the first year for
                                                                   years. In computing such additional                       which an election was made), all the
                                                                   amounts—                                                  amounts not previously deducted under
                                                                      (1) In the case of taxpayers who did                   this paragraph shall be permitted as a
                                                                   not include in gross income for the tax-                  deduction in the year of cessation of
                                                                   able year preceding the first taxable                     existence.
                                                                   year for which the election is effective,                   (c) The provisions of this section may
                                                                   that portion of the prepaid dues income                   be illustrated by the following exam-
                                                                   received in such year attributable to a                   ple:
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                                                                   liability which is to end within 12                        Example. (1) Assume that X Corporation, a
                                                                   months after the date of receipt, no ef-                  membership organization qualified to make

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                                                                   § 1.456–7                                                                                                                             26 CFR Ch. I (4–1–12 Edition)
                                                                   the election under section 456, elects to re-                                                              dues income in connection with a liability to
                                                                   port its prepaid dues income in accordance                                                                 render services over a 3-year period begin-
                                                                   with the provisions of section 456 for its tax-                                                            ning with the date of receipt. Under section
                                                                   able year ending December 31, 1961. Assume                                                                 456(a), X Corporation will report income re-
                                                                   further that X Corporation receives in the                                                                 ceived in 1961 and subsequent years as fol-
                                                                   middle of each taxable year $3,000 of prepaid                                                              lows:

                                                                                                                    Total re-
                                                                             Year of receipt                                          1961              1962                 1963              1964               1965                 1966               1967                 1968
                                                                                                                     ceipts

                                                                   1961     ....................................      $3,000              $500           $1,000               $1,000               $500         ..............     ..............       ..............       ..............
                                                                   1962     ....................................       3,000        ..............            500               1,000             1,000               $500         ..............       ..............       ..............
                                                                   1963     ....................................       3,000        ..............    ..............               500            1,000              1,000               $500           ..............       ..............
                                                                   1964     ....................................       3,000        ..............    ..............       ..............            500             1,000              1,000                 $500           ..............
                                                                   1965     ....................................       3,000        ..............    ..............       ..............    ..............             500             1,000                1,000                 $500
                                                                   1966     ....................................       3,000        ..............    ..............       ..............    ..............     ..............             500               1,000                1,000
                                                                   1967     ....................................       3,000        ..............    ..............       ..............    ..............     ..............     ..............               500               1,000
                                                                   1968     ....................................       3,000        ..............    ..............       ..............    ..............     ..............     ..............       ..............               500

                                                                      Total reportable under section 456(a)                                500             1,500                2,500             3,000               3,000             3,000                3,000                3,000



                                                                     (2) Under section 456(d) (1), X Corporation                                                              included in those years had the election been
                                                                   must include in its gross income for the first                                                             effective 3 years earlier. If the election had
                                                                   taxable year to which the election applies                                                                 been effective in 1958, the following amounts
                                                                   and for each of the 2 succeeding taxable                                                                   received in 1958, 1959, and 1960 would have
                                                                   years, the amounts which would have been                                                                   been reported in 1961 and subsequent years:

                                                                                                                                                                                                                      Years of including additional amounts
                                                                                                                                                                                              Amount re-
                                                                                                                   Year of receipt                                                             ceived                     1961                      1962                     1963

                                                                   1958 ..............................................................................................................                $3,000                      $500       ..................          ..................
                                                                   1959 ..............................................................................................................                 3,000                     1,000                 $500              ..................
                                                                   1960 ..............................................................................................................                 3,000                     1,000                1,000                        $500

                                                                           Total additional amounts to be included under section 456(d)(1)                                                              2,500                    1,500                     500



                                                                     (3) Having included the additional amounts                                                               is effective, X Corporation is entitled to de-
                                                                   as required by section 456(d)(1), and assuming                                                             duct under section 456(d)(2) in the year of in-
                                                                   such amounts were actually included in                                                                     clusion and in each of the succeeding 4 years
                                                                   gross income in the 3 taxable years preceding                                                              an amount equal to one-fifth of the amounts
                                                                   the first taxable year for which the election                                                              included, as follows:

                                                                                                                                                                                                              Years of deduction
                                                                                           Year of inclusion                                         Amount
                                                                                                                                                                        1961            1962            1963             1964             1965               1966               1967

                                                                   1961 ....................................................................          $2,500               $500            $500               $500          $500             $500           ............       ............
                                                                   1962 ....................................................................           1,500           ............          300               300           300              300               $300           ............
                                                                   1963 ....................................................................             500           ............    ............            100           100              100                 100                $10

                                                                         Total amount deductible under section
                                                                           456(d)(2) ...................................................                 500                800              900              900                900           400               100



                                                                     (4) The net result of the inclusions under                                                               section 456(d)(2) may be summarized as fol-
                                                                   section 456(d)(1) and the deductions under                                                                 lows:

                                                                                                                                                      1961              1962            1963            1964             1965             1966               1967               1968

                                                                   Amount includible under section 456(a) ...............                               $500            $1,500         $2,500           $3,000           $3,000           $3,000             $3,000             $3,000
                                                                   Amount includible under section 456(d)(1) ...........                               2,500             1,500            500          ............     ............     ............       ............       ............

                                                                        Total ...........................................................              3,000              3,000             3,000        3,000             3,000           3,000               3,000              3,000
                                                                   Amount deductible under section 456(d)(2) .........                                   500                800               900          900               900             400                 100           ............
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                                                                             Net amount reportable under section 456                                   2,500             2,200              2,100        2,100             2,100           2,600              2,900               3,000




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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–2
                                                                   [T.D. 6937, 32 FR 16396, Nov. 30. 1967]


                                                                   § 1.457–1 General overviews of section                    pensation deferred that is taken into
                                                                        457.                                                 account as an annual deferral in the
                                                                      Section 457 provides rules for non-                    taxable year in which the substantial
                                                                   qualified deferred compensation plans                     risk of forfeiture lapses must be ad-
                                                                   established by eligible employers as de-                  justed to reflect gain or loss allocable
                                                                   fined under § 1.457–2(d). Eligible em-                    to the compensation deferred until the
                                                                   ployers can establish either deferred                     substantial risk of forfeiture lapses.
                                                                   compensation plans that are eligible                         (3) If the eligible plan is a defined
                                                                   plans and that meet the requirements                      benefit plan within the meaning of sec-
                                                                   of section 457(b) and §§ 1.457–3 through                  tion 414(j), the annual deferral for a
                                                                   1.457–10, or deferred compensation                        taxable year is the present value of the
                                                                   plans or arrangements that do not                         increase during the taxable year of the
                                                                   meet the requirements of section 457(b)                   participant’s accrued benefit that is
                                                                   and §§ 1.457–3 through 1.457–10 and that                  not subject to a substantial risk of for-
                                                                   are subject to tax treatment under sec-
                                                                                                                             feiture (disregarding any such increase
                                                                   tion 457(f) and § 1.457–11.
                                                                                                                             attributable to prior annual deferrals).
                                                                   [T.D. 9075, 68 FR 41234, July 11, 2003]                   For this purpose, present value must be
                                                                                                                             determined using actuarial assump-
                                                                   § 1.457–2 Definitions.
                                                                                                                             tions and methods that are reasonable
                                                                      This section sets forth the definitions                (both individually and in the aggre-
                                                                   that are used under §§ 1.457–1 through                    gate), as determined by the Commis-
                                                                   1.457–11.                                                 sioner.
                                                                      (a) Amount(s) deferred. Amount(s) de-                     (4) For purposes solely of applying
                                                                   ferred means the total annual deferrals
                                                                                                                             § 1.457–4 to determine the maximum
                                                                   under an eligible plan in the current
                                                                                                                             amount of the annual deferral for a
                                                                   and prior years, adjusted for gain or
                                                                   loss. Except as provided at §§ 1.457–                     participant for a taxable year under an
                                                                   4(c)(1)(iii) and 1.457–6(a), amount(s) de-                eligible plan, the maximum amount is
                                                                   ferred includes any rollover amount                       reduced by the amount of any deferral
                                                                   held by an eligible plan as provided                      for the participant under a plan de-
                                                                   under § 1.457–10(e).                                      scribed at paragraph (k)(4)(i) of this
                                                                      (b) Annual deferral(s)—(1) Annual de-                  section (relating to certain plans in ex-
                                                                   ferral(s) means, with respect to a tax-                   istence before January 1, 1987) as if
                                                                   able year, the amount of compensation                     that deferral were an annual deferral
                                                                   deferred under an eligible plan, wheth-                   under another eligible plan of the em-
                                                                   er by salary reduction or by nonelec-                     ployer.
                                                                   tive      employer    contribution.   The                    (c) Beneficiary. Beneficiary means a
                                                                   amount of compensation deferred                           person who is entitled to benefits in re-
                                                                   under an eligible plan is taken into ac-                  spect of a participant following the
                                                                   count as an annual deferral in the tax-                   participant’s death or an alternate
                                                                   able year of the participant in which                     payee as described in § 1.457–10(c).
                                                                   deferred, or, if later, the year in which                    (d) Catch-up. Catch-up amount or
                                                                   the amount of compensation deferred is                    catch-up limitation for a participant
                                                                   no longer subject to a substantial risk                   for a taxable year means the annual de-
                                                                   of forfeiture.
                                                                                                                             ferral permitted under section 414(v)
                                                                      (2) If the amount of compensation de-
                                                                                                                             (as described in § 1.457–4(c)(2)) or sec-
                                                                   ferred under the plan during a taxable
                                                                   year is not subject to a substantial risk                 tion 457(b)(3) (as described in § 1.457–
                                                                   of forfeiture, the amount taken into                      4(c)(3)) to the extent the amount of the
                                                                   account as an annual deferral is not ad-                  annual deferral for the participant for
                                                                   justed to reflect gain or loss allocable                  the taxable year is permitted to exceed
                                                                   to the compensation deferred. If, how-                    the plan ceiling applicable under sec-
                                                                   ever, the amount of compensation de-                      tion 457(b)(2) (as described in § 1.457–
                                                                   ferred under the plan during the tax-                     4(c)(1)).
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                                                                   able year is subject to a substantial                        (e) Eligible employer. Eligible employer
                                                                   risk of forfeiture, the amount of com-                    means an entity that is a State that

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                                                                   § 1.457–2                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   establishes a plan or a tax-exempt enti-                    (i) Nonelective employer contribution. A
                                                                   ty that establishes a plan. The per-                      nonelective employer contribution is a
                                                                   formance of services as an independent                    contribution made by an eligible em-
                                                                   contractor for a State or local govern-                   ployer for the participant with respect
                                                                   ment or a tax-exempt entity is treated                    to which the participant does not have
                                                                   as the performance of services for an                     the choice to receive the contribution
                                                                   eligible employer. The term eligible em-                  in cash or property. Solely for purposes
                                                                   ployer does not include a church as de-                   of section 457 and §§ 1.457–2 through
                                                                   fined in section 3121(w)(3)(A), a quali-                  1.457–11, the term nonelective employer
                                                                   fied church-controlled organization as                    contribution includes employer con-
                                                                   defined in section 3121(w)(3)(B), or the                  tributions that would be described in
                                                                   Federal government or any agency or                       section 401(m) if they were contribu-
                                                                   instrumentality thereof. Thus, for ex-                    tions to a qualified plan.
                                                                   ample, a nursing home which is associ-                      (j) Participant. Participant in an eligi-
                                                                   ated with a church, but which is not                      ble plan means an individual who is
                                                                   itself a church (as defined in section                    currently deferring compensation, or
                                                                   3121(w)(3)(A)) or a qualified church-con-                 who has previously deferred compensa-
                                                                   trolled organization as defined in sec-                   tion under the plan by salary reduction
                                                                   tion 3121(w)(3)(B)), would be an eligible                 or by nonelective employer contribu-
                                                                   employer if it is a tax-exempt entity as                  tion and who has not received a dis-
                                                                   defined in paragraph (m) of this sec-                     tribution of his or her entire benefit
                                                                   tion.                                                     under the eligible plan. Only individ-
                                                                                                                             uals who perform services for the eligi-
                                                                      (f) Eligible plan. An eligible plan is a
                                                                                                                             ble employer, either as an employee or
                                                                   plan that meets the requirements of
                                                                                                                             as an independent contractor, may
                                                                   §§ 1.457–3 through 1.457–10 that is estab-
                                                                                                                             defer compensation under the eligible
                                                                   lished and maintained by an eligible
                                                                                                                             plan.
                                                                   employer. An eligible governmental plan
                                                                                                                               (k) Plan. Plan includes any agree-
                                                                   is an eligible plan that is established
                                                                                                                             ment or arrangement between an eligi-
                                                                   and maintained by an eligible em-
                                                                                                                             ble employer and a participant or par-
                                                                   ployer as defined in paragraph (l) of
                                                                                                                             ticipants (including an individual em-
                                                                   this section. An arrangement does not
                                                                                                                             ployment agreement) under which the
                                                                   fail to constitute a single eligible gov-
                                                                                                                             payment of compensation is deferred
                                                                   ernmental plan merely because the ar-                     (whether by salary reduction or by
                                                                   rangement is funded through more                          nonelective employer contribution).
                                                                   than one trustee, custodian, or insur-                    The following types of plans are not
                                                                   ance carrier. An eligible plan of a tax-ex-               treated as agreements or arrangements
                                                                   empt entity is an eligible plan that is es-               under which compensation is deferred:
                                                                   tablished and maintained by an eligible                   a bona fide vacation leave, sick leave,
                                                                   employer as defined in paragraph (m)                      compensatory time, severance pay, dis-
                                                                   of this section.                                          ability pay, or death benefit plan de-
                                                                      (g) Includible compensation. Includible                scribed in section 457(e)(11)(A)(i) and
                                                                   compensation of a participant means,                      any plan paying length of service
                                                                   with respect to a taxable year, the par-                  awards to bona fide volunteers (and
                                                                   ticipant’s compensation, as defined in                    their beneficiaries) on account of quali-
                                                                   section 415(c)(3), for services performed                 fied services performed by such volun-
                                                                   for the eligible employer. The amount                     teers     as    described    in    section
                                                                   of includible compensation is deter-                      457(e)(11)(A)(ii). Further, the term plan
                                                                   mined without regard to any commu-                        does not include any of the following
                                                                   nity property laws.                                       (and section 457 and §§ 1.457–2 through
                                                                      (h) Ineligible plan. Ineligible plan                   1.457–11 do not apply to any of the fol-
                                                                   means a plan established and main-                        lowing)—
                                                                   tained by an eligible employer that is                      (1) Any nonelective deferred com-
                                                                   not maintained in accordance with                         pensation under which all individuals
                                                                   §§ 1.457–3 through 1.457–10. A plan that                  (other than those who have not satis-
                                                                   is not established by an eligible em-                     fied any applicable initial service re-
                                                                   ployer as defined in paragraph (e) of                     quirement) with the same relationship
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                                                                   this section is neither an eligible nor                   with the eligible employer are covered
                                                                   an ineligible plan.                                       under the same plan with no individual

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–4

                                                                   variations or options under the plan as                   § 1.457–3 General introduction to eligi-
                                                                   described in section 457(e)(12), but only                      ble plans.
                                                                   to the extent the compensation is at-                        (a) Compliance in form and operation.
                                                                   tributable to services performed as an                    An eligible plan is a written plan estab-
                                                                   independent contractor;                                   lished and maintained by an eligible
                                                                      (2) An agreement or arrangement de-                    employer that is maintained, in both
                                                                   scribed in § 1.457–11(b);                                 form and operation, in accordance with
                                                                      (3) Any plan satisfying the conditions                 the requirements of §§ 1.457–4 through
                                                                   in section 1107(c)(4) of the Tax Reform                   1.457–10. An eligible plan must contain
                                                                   Act of 1986 (100 Stat. 2494) (TRA ’86) (re-               all the material terms and conditions
                                                                   lating to certain plans for State                         for benefits under the plan. An eligible
                                                                   judges); and                                              plan may contain certain optional fea-
                                                                      (4) Any of the following plans or ar-                  tures not required for plan eligibility
                                                                   rangements (to which specific transi-                     under section 457(b), such as distribu-
                                                                   tional statutory exclusions apply)—                       tions for unforeseeable emergencies,
                                                                      (i) A plan or arrangement of a tax-ex-                 loans, plan-to-plan transfers, addi-
                                                                   empt entity in existence prior to Janu-                   tional deferral elections, acceptance of
                                                                   ary 1, 1987, if the conditions of section                 rollovers to the plan, and distributions
                                                                   1107(c)(3)(B) of the TRA ’86, as amended                  of smaller accounts to eligible partici-
                                                                   by section 1011(e)(6) of the Technical                    pants. However, except as otherwise
                                                                   and Miscellaneous Revenue Act of 1988                     specifically     provided    in    §§ 1.457–4
                                                                   (102 Stat. 3700) (TAMRA), are satisfied                   through 1.457–10, if an eligible plan con-
                                                                   (see § 1.457–2(b)(4) for a special rule re-               tains any optional provisions, the op-
                                                                   garding such plan);                                       tional provisions must meet, in both
                                                                      (ii) A collectively bargained nonelec-                 form and operation, the relevant re-
                                                                   tive deferred compensation plan in ef-                    quirements under section 457 and
                                                                   fect on December 31, 1987, if the condi-                  §§ 1.457–2 through 1.457–10.
                                                                   tions of section 6064(d)(2) of TAMRA                         (b) Treatment as single plan. In any
                                                                   are satisfied;                                            case in which multiple plans are used
                                                                      (iii) Amounts described in section                     to avoid or evade the requirements of
                                                                   6064(d)(3) of TAMRA (relating to cer-                     §§ 1.457–4 through 1.457–10, the Commis-
                                                                   tain nonelective deferred compensation                    sioner may apply the rules under
                                                                   arrangements in effect before 1989); and                  §§ 1.457–4 through 1.457–10 as if the plans
                                                                      (iv) Any plan satisfying the condi-                    were a single plan. See also § 1.457–
                                                                   tions in section 1107(c)(4) or (5) of TRA                 4(c)(3)(v) (requiring an eligible em-
                                                                   ’86 (relating to certain plans for certain                ployer to have no more than one nor-
                                                                   individuals with respect to which the                     mal retirement age for each partici-
                                                                   Service issued guidance before 1977).                     pant under all of the eligible plans it
                                                                      (l) State. State means a State (treat-                 sponsors), the second sentence of
                                                                   ing the District of Columbia as a State                   § 1.457–4(e)(2) (treating deferrals under
                                                                   as provided under section 7701(a)(10)), a                 all eligible plans under which an indi-
                                                                   political subdivision of a State, and                     vidual participates by virtue of his or
                                                                   any agency or instrumentality of a                        her relationship with a single employer
                                                                   State.                                                    as a single plan for purposes of deter-
                                                                      (m) Tax-exempt entity. Tax-exempt en-                  mining excess deferrals), and § 1.457–5
                                                                   tity includes any organization exempt                     (combining annual deferrals under all
                                                                   from tax under subtitle A of the Inter-                   eligible plans).
                                                                   nal Revenue Code, except that a gov-
                                                                                                                             [T.D. 9075, 68 FR 41234, July 11, 2003]
                                                                   ernmental unit (including an inter-
                                                                   national governmental organization) is                    § 1.457–4 Annual deferrals, deferral
                                                                   not a tax-exempt entity.                                       limitations, and deferral agree-
                                                                      (n) Trust. Trust means a trust de-                          ments under eligible plans.
                                                                   scribed under section 457(g) and § 1.457–                    (a) Taxation of annual deferrals. An-
                                                                   8. Custodial accounts and contracts de-                   nual deferrals that satisfy the require-
                                                                   scribed in section 401(f) are treated as                  ments of paragraphs (b) and (c) of this
                                                                   trusts under the rules described in                       section are excluded from the gross in-
                                                                   § 1.457–8(a)(2).                                          come of a participant in the year de-
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                                                                   [T.D. 9075, 68 FR 41234, July 11, 2003; 68 FR             ferred or contributed and are not in-
                                                                   51446, Aug. 27, 2003]                                     cludible in gross income until paid to

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                                                                   § 1.457–4                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   the participant in the case of an eligi-                  include any rollover amounts received
                                                                   ble governmental plan, or until paid or                   by the eligible plan under § 1.457–10(e).
                                                                   otherwise made available to the partic-                     (iv) The provisions of this paragraph
                                                                   ipant in the case of an eligible plan of                  (c)(1) are illustrated by the following
                                                                   a tax-exempt entity. See § 1.457–7.                       examples:
                                                                      (b) Agreement for deferral. In order to                  Example 1. (i) Facts. Participant A, who
                                                                   be an eligible plan, the plan must pro-                   earns $14,000 a year, enters into a salary re-
                                                                   vide that compensation may be de-                         duction agreement in 2006 with A’s eligible
                                                                   ferred for any calendar month by sal-                     employer and elects to defer $13,000 of A’s
                                                                   ary reduction only if an agreement pro-                   compensation for that year. A is not eligible
                                                                   viding for the deferral has been entered                  for the catch-up described in paragraph (c)(2)
                                                                   into before the first day of the month                    or (3) of this section, participates in no other
                                                                                                                             retirement plan, and has no other income ex-
                                                                   in which the compensation is paid or                      clusions taken into account in computing in-
                                                                   made available. A new employee may                        cludible compensation.
                                                                   defer compensation payable in the cal-                      (ii) Conclusion. The annual deferral limit
                                                                   endar month during which the partici-                     for A in 2006 is the lesser of $15,000 or 100 per-
                                                                   pant first becomes an employee if an                      cent of includible compensation, $14,000. A’s
                                                                   agreement providing for the deferral is                   annual deferral of $13,000 is permitted under
                                                                   entered into on or before the first day                   the plan because it is not in excess of $14,000
                                                                                                                             and thus does not exceed 100 percent of A’s
                                                                   on which the participant performs                         includible compensation.
                                                                   services for the eligible employer. An                      Example 2. (i) Facts. Assume the same facts
                                                                   eligible plan may provide that if a par-                  as in Example 1, except that A’s eligible em-
                                                                   ticipant enters into an agreement pro-                    ployer provides an immediately vested,
                                                                   viding for deferral by salary reduction                   matching employer contribution under the
                                                                   under the plan, the agreement will re-                    plan for participants who make salary reduc-
                                                                   main in effect until the participant re-                  tion deferrals under A’s eligible plan. The
                                                                                                                             matching contribution is equal to 100 per-
                                                                   vokes or alters the terms of the agree-                   cent of elective contributions, but not in ex-
                                                                   ment. Nonelective employer contribu-                      cess of 10 percent of compensation (in A’s
                                                                   tions are treated as being made under                     case, $1,400).
                                                                   an agreement entered into before the                        (ii) Conclusion. Participant A’s annual de-
                                                                   first day of the calendar month.                          ferral exceeds the limitations of this para-
                                                                      (c) Maximum deferral limitations—(1)                   graph (c)(1). A’s maximum deferral limita-
                                                                   Basic annual limitation. (i) Except as de-                tion in 2006 is $14,000. A’s salary reduction
                                                                                                                             deferral of $13,000 combined with A’s eligible
                                                                   scribed in paragraphs (c)(2) and (3) of                   employer’s nonelective employer contribu-
                                                                   this section, in order to be an eligible                  tion of $1,400 exceeds the basic annual limi-
                                                                   plan, the plan must provide that the                      tation of this paragraph (c)(1) because A’s
                                                                   annual deferral amount for a taxable                      annual deferrals total $14,400. A has an ex-
                                                                   year (the plan ceiling) may not exceed                    cess deferral for the taxable year of $400, the
                                                                   the lesser of—                                            amount exceeding A’s permitted annual de-
                                                                      (A) The applicable annual dollar                       ferral limitation. The $400 excess deferral is
                                                                                                                             treated as described in paragraph (e) of this
                                                                   amount specified in section 457(e)(15):
                                                                                                                             section.
                                                                   $11,000 for 2002; $12,000 for 2003; $13,000                 Example 3. (i) Facts. Beginning in year 2002,
                                                                   for 2004; $14,000 for 2005; and $15,000 for               Eligible Employer X contributes $3,000 per
                                                                   2006 and thereafter. After 2006, the                      year for five years to B’s eligible plan ac-
                                                                   $15,000 amount is adjusted for cost-of-                   count. B’s interest in the account vests in
                                                                   living in the manner described in para-                   2006. B has annual compensation of $50,000 in
                                                                   graph (c)(4) of this section; or                          each of the five years 2002 through 2006. B is
                                                                                                                             41 years old. B is not eligible for the catch-
                                                                      (B) 100 percent of the participant’s
                                                                                                                             up described in paragraph (c)(2) or (3) of this
                                                                   includible compensation for the tax-                      section, participates in no other retirement
                                                                   able year.                                                plan, and has no other income exclusions
                                                                      (ii) The amount of annual deferrals                    taken into account in computing includible
                                                                   permitted by the 100 percent of includ-                   compensation. Adjusted for gain or loss, the
                                                                   ible compensation limitation under                        value of B’s benefit when B’s interest in the
                                                                   paragraph (c)(1)(i)(B) of this section is                 account vests in 2006 is $17,000.
                                                                                                                               (ii) Conclusion. Under this vesting schedule,
                                                                   determined under section 457(e)(5) and
                                                                                                                             $17,000 is taken into account as an annual de-
                                                                   § 1.457–2(g).                                             ferral in 2006. B’s annual deferrals under the
                                                                      (iii) For purposes of determining the
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                                                                                                                             plan are limited to a maximum of $15,000 in
                                                                   plan ceiling under this paragraph (c),                    2006. Thus, the aggregate of the amounts de-
                                                                   the annual deferral amount does not                       ferred, $17,000, is in excess of B’s maximum

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–4
                                                                   deferral limitation by $2,000. The $2,000 is                (B) The plan ceiling under paragraph
                                                                   treated as an excess deferral described in                (c)(1) of this section and the special
                                                                   paragraph (e) of this section.
                                                                                                                             section 457 catch-up described in para-
                                                                     (2) Age 50 catch-up—(i) In general. In                  graph (c)(3) of this section (and dis-
                                                                   accordance with section 414(v) and the                    regarding the age 50 catch-up described
                                                                   regulations thereunder, an eligible gov-                  in this paragraph (c)(2)).
                                                                   ernmental plan may provide for catch-                       (iii) Examples. The provisions of this
                                                                   up contributions for a participant who                    paragraph (c)(2) are illustrated by the
                                                                   is age 50 by the end of the year, pro-                    following examples:
                                                                   vided that such age 50 catch-up con-
                                                                   tributions do not exceed the catch-up                       Example 1. (i) Facts. Participant C, who is
                                                                   limit under section 414(v)(2) for the                     55, is eligible to participate in an eligible
                                                                                                                             governmental plan in 2006. The plan provides
                                                                   taxable year. The maximum amount of
                                                                                                                             a normal retirement age of 65. The plan pro-
                                                                   age 50 catch-up contributions for a tax-                  vides limitations on annual deferrals up to
                                                                   able year under section 414(v) is as fol-                 the maximum permitted under paragraphs
                                                                   lows: $1,000 for 2002; $2,000 for 2003;                   (c)(1) and (3) of this section and the age 50
                                                                   $3,000 for 2004; $4,000 for 2005; and $5,000              catch-up described in this paragraph (c)(2).
                                                                   for 2006 and thereafter. After 2006, the                  For 2006, C will receive compensation of
                                                                   $5,000 amount is adjusted for cost-of-                    $40,000 from the eligible employer. C desires
                                                                   living. For additional guidance, see                      to defer the maximum amount possible in
                                                                   regulations under section 414(v).                         2006. The applicable basic dollar limit of
                                                                     (ii) Coordination with special section                  paragraph (c)(1)(i)(A) of this section is $15,000
                                                                                                                             for 2006 and the additional dollar amount
                                                                   457 catch-up. In accordance with sec-
                                                                                                                             permitted under the age 50 catch-up is $5,000
                                                                   tions 414(v)(6)(C) and 457(e)(18), the age                for 2006.
                                                                   50 catch-up described in this paragraph                     (ii) Conclusion. C is eligible for the age 50
                                                                   (c)(2) does not apply for any taxable                     catch-up in 2006 because C is 55 in 2006. How-
                                                                   year for which a higher limitation ap-                    ever, C is not eligible for the special section
                                                                   plies under the special section 457                       457 catch-up under paragraph (c)(3) of this
                                                                   catch-up under paragraph (c)(3) of this                   section in 2006 because 2006 is not one of the
                                                                   section. Thus, for purposes of this para-                 last three taxable years ending before C at-
                                                                   graph (c)(2)(ii) and paragraph (c)(3) of                  tains normal retirement age. Accordingly,
                                                                   this section, the special section 457                     the maximum that C may defer for 2006 is
                                                                                                                             $20,000.
                                                                   catch-up under paragraph (c)(3) of this
                                                                                                                               Example 2. (i) Facts. The facts are the same
                                                                   section applies for any taxable year if                   as in Example 1, except that, in 2006, C will
                                                                   and only if the plan ceiling taking into                  attain age 62. The maximum amount that C
                                                                   account paragraph (c)(1) of this section                  can elect under the special section 457 catch-
                                                                   and the special section 457 catch-up de-                  up under paragraph (c)(3) of this section is
                                                                   scribed in paragraph (c)(3) of this sec-                  $2,000 for 2006.
                                                                   tion (and disregarding the age 50 catch-                    (ii) Conclusion. The maximum that C may
                                                                   up described in this paragraph (c)(2)) is                 defer for 2006 is $20,000. This is the sum of the
                                                                   larger than the plan ceiling taking into                  basic plan ceiling under paragraph (c)(1) of
                                                                   account paragraph (c)(1) of this section                  this section equal to $15,000 and the age 50
                                                                   and the age 50 catch-up described in                      catch-up equal to $5,000. The special section
                                                                                                                             457 catch-up under paragraph (c)(3) of this
                                                                   this paragraph (c)(2) (and disregarding                   section is not applicable since it provides a
                                                                   the special section 457 catch-up de-                      smaller plan ceiling.
                                                                   scribed in paragraph (c)(3) of this sec-                    Example 3. (i) Facts. The facts are the same
                                                                   tion). Thus, if a plan so provides, a par-                as in Example 2, except that the maximum
                                                                   ticipant who is eligible for the age 50                   additional amount that C can elect under the
                                                                   catch-up for a year and for whom the                      special section 457 catch-up under paragraph
                                                                   year is also one of the participant’s                     (c)(3) of this section is $7,000 for 2006.
                                                                   last three taxable years ending before                      (ii) Conclusion. The maximum that C may
                                                                   the participant attains normal retire-                    defer for 2006 is $22,000. This is the sum of the
                                                                   ment age is eligible for the larger of—                   basic plan ceiling under paragraph (c)(1) of
                                                                                                                             this section equal to $15,000, plus the addi-
                                                                     (A) The plan ceiling under paragraph
                                                                                                                             tional special section 457 catch-up under
                                                                   (c)(1) of this section and the age 50                     paragraph (c)(3) of this section equal to
                                                                   catch-up described in this paragraph                      $7,000. The additional dollar amount per-
                                                                   (c)(2) (and disregarding the special sec-
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                                                                                                                             mitted under the age 50 catch-up is not ap-
                                                                   tion 457 catch-up described in para-                      plicable to C for 2006 because it provides a
                                                                   graph (c)(3) of this section) or                          smaller plan ceiling.

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                                                                   § 1.457–4                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                     (3) Special section 457 catch-up—(i) In                 cial section 457 catch-up under this
                                                                   general. Except as provided in para-                      paragraph (c)(3) for years in effect
                                                                   graph (c)(2)(ii) of this section, an eligi-               prior to 2002 are reduced, for purposes
                                                                   ble plan may provide that, for one or                     of determining a participant’s under-
                                                                   more of the participant’s last three                      utilized amount under a plan, by
                                                                   taxable years ending before the partici-                  amounts excluded from the partici-
                                                                   pant attains normal retirement age,                       pant’s income for any prior taxable
                                                                   the plan ceiling is an amount not in ex-                  year by reason of a nonelective em-
                                                                   cess of the lesser of—                                    ployer contribution, salary reduction
                                                                     (A) Twice the dollar amount in effect                   or elective contribution under any
                                                                   under paragraph (c)(1)(i)(A) of this sec-                 other eligible section 457(b) plan, or a
                                                                   tion; or                                                  salary reduction or elective contribu-
                                                                     (B) The underutilized limitation de-                    tion under any 401(k) qualified cash or
                                                                   termined under paragraph (c)(3)(ii) of                    deferred       arrangement,       section
                                                                   this section.                                             402(h)(1)(B) simplified employee pen-
                                                                     (ii) Underutilized limitation. The un-                  sion (SARSEP), section 403(b) annuity
                                                                   derutilized amount determined under                       contract, and section 408(p) simple re-
                                                                   this paragraph (c)(3)(ii) is the sum of—                  tirement account, or under any plan
                                                                     (A) The plan ceiling established                        for which a deduction is allowed be-
                                                                   under paragraph (c)(1) of this section                    cause of a contribution to an organiza-
                                                                   for the taxable year; plus                                tion described in section 501(c)(18) (pre-
                                                                     (B) The plan ceiling established                        2002 coordination plans). Similarly, in
                                                                   under paragraph (c)(1) of this section                    applying the section 457(b)(2)(B) limita-
                                                                   (or under section 457(b)(2) for any year                  tion for includible compensation for
                                                                   before the applicability date of this                     years prior to 2002, the limitation is
                                                                   section) for any prior taxable year or                    331⁄3 percent of the participant’s com-
                                                                   years, less the amount of annual defer-                   pensation includible in gross income.
                                                                   rals under the plan for such prior tax-                     (B) Coordination limitation applied to
                                                                   able year or years (disregarding any                      participant. For purposes of deter-
                                                                   annual deferrals under the plan per-                      mining the underutilized limitation for
                                                                   mitted under the age 50 catch-up under                    years prior to 2002, the coordination
                                                                   paragraph (c)(2) of this section).                        limitation applies to pre-2002 coordina-
                                                                     (iii) Determining underutilized limita-                 tion plans of all employers for whom a
                                                                   tion under paragraph (c)(3)(ii)(B) of this                participant has performed services,
                                                                   section. A prior taxable year is taken                    whether or not those are plans of the
                                                                   into      account     under     paragraph                 participant’s current eligible employer.
                                                                   (c)(3)(ii)(B) of this section only if it is               Thus, for purposes of determining the
                                                                   a year beginning after December 31,                       amount excluded from a participant’s
                                                                   1978, in which the participant was eligi-                 gross income in any prior taxable year
                                                                   ble to participate in the plan, and in                    under paragraph (c)(3)(ii)(B) of this sec-
                                                                   which compensation deferred (if any)                      tion, the participant’s annual deferrals
                                                                   under the plan during the year was                        under an eligible plan, and salary re-
                                                                   subject to a plan ceiling established                     duction or elective deferrals under all
                                                                   under paragraph (c)(1) of this section.                   other pre-2002 coordination plans, must
                                                                   This paragraph (c)(3)(iii) is subject to                  be determined on an aggregate basis.
                                                                   the special rules in paragraph (c)(3)(iv)                 To the extent that the combined defer-
                                                                   of this section.                                          rals for years prior to 2002 exceeded the
                                                                     (iv) Special rules concerning applica-                  maximum deferral limitations, the
                                                                   tion of the coordination limit for years                  amount is treated as an excess deferral
                                                                   prior to 2002 for purposes of determining                 under paragraph (e) of this section for
                                                                   the underutilized limitation—(A) General                  those prior years.
                                                                   rule. For purposes of determining the                       (C) Special rule where no annual defer-
                                                                   underutilized limitation for years prior                  rals under the eligible plan. A partici-
                                                                   to 2002, participants remain subject to                   pant who, although eligible, did not
                                                                   the rules in effect prior to the repeal of                defer any compensation under the eli-
                                                                   the coordination limitation under sec-                    gible plan in any year before 2002 is not
                                                                   tion 457(c)(2). Thus, the applicable                      subject to the coordinated deferral
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                                                                   basic annual limitation under para-                       limit, even though the participant may
                                                                   graph (c)(1) of this section and the spe-                 have deferred compensation under one

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–4

                                                                   of the other pre-2002 coordination                        of this section under all of D’s coordinated
                                                                   plans. An individual is treated as not                    plans.
                                                                   having deferred compensation under an                       Example 2. (i) Facts. Assume the same facts
                                                                                                                             as in Example 1, except that D only deferred
                                                                   eligible plan for a prior taxable year if                 $2,500 per year under the section 401(k) plan
                                                                   all annual deferrals under the plan are                   for one year before 2002.
                                                                   distributed in accordance with para-                        (ii) Conclusion. D is treated as having an
                                                                   graph (e) of this section. Thus, to the                   underutilized     amount     under   paragraph
                                                                   extent that a participant participated                    (c)(3)(ii)(B) of this section for 2002 for pur-
                                                                   solely in one or more of the other pre-                   poses of the special section 457 catch-up limi-
                                                                   2002 coordination plans during a prior                    tation. This is because D has deferred an
                                                                                                                             amount for prior years that is less than the
                                                                   taxable year (and not the eligible                        limitation of paragraph (c)(1)(i) of this sec-
                                                                   plan), the participant is not subject to                  tion under all of D’s coordinated plans.
                                                                   the coordinated limitation for that                         Example 3. (i) Facts. Participant E, who
                                                                   prior taxable year. However, the par-                     earned $15,000 for 2000, entered into a salary
                                                                   ticipant is treated as having deferred                    reduction agreement in 2000 with E’s eligible
                                                                   an amount in a prior taxable year, for                    employer and elected to defer $3,000 for that
                                                                   purposes of determining the underuti-                     year under E’s eligible plan. For 2000, E’s eli-
                                                                                                                             gible employer provided an immediately
                                                                   lized limitation for that prior taxable
                                                                                                                             vested, matching employer contribution
                                                                   year under this paragraph (c)(3)(iv)(C),                  under the plan for participants who make
                                                                   to the extent of the participant’s ag-                    salary reduction deferrals under E’s eligible
                                                                   gregate salary reduction contributions                    plan. The matching contribution was equal
                                                                   and elective deferrals under all pre-2002                 to 67 percent of elective contributions, but
                                                                   coordination plans up to the maximum                      not in excess of 10 percent of compensation
                                                                   deferral limitations in effect under sec-                 before salary reduction deferrals (in E’s case,
                                                                   tion 457(b) for that prior taxable year.                  $1,000). For 2000, E was not eligible for any
                                                                                                                             catch-up contribution, participated in no
                                                                   To the extent an employer did not offer
                                                                                                                             other retirement plan, and had no other in-
                                                                   an eligible plan to an individual in a                    come exclusions taken into account in com-
                                                                   prior given year, no underutilized limi-                  puting taxable compensation.
                                                                   tation is available to the individual for                   (ii) Conclusion. Participant E’s annual de-
                                                                   that prior year, even if the employee                     ferral equaled the maximum limitation of
                                                                   subsequently becomes eligible to par-                     section 457(b) for 2000. E’s maximum deferral
                                                                   ticipate in an eligible plan of the em-                   limitation in 2000 was $4,000 because E’s in-
                                                                   ployer.                                                   cludible compensation was $12,000 ($15,000
                                                                                                                             minus the deferral of $3,000) and the applica-
                                                                     (D) Examples. The provisions of this                    ble limitation for 2000 was one third of the
                                                                   paragraph (c)(3)(iv) are illustrated by                   individual’s includible compensation (one-
                                                                   the following examples:                                   third of $12,000 equals $4,000). E’s salary re-
                                                                                                                             duction deferral of $3,000 combined with E’s
                                                                     Example 1. (i) Facts. In 2001 and in years
                                                                                                                             eligible employer’s matching contribution of
                                                                   prior to 2001, Participant D earned $50,000 a
                                                                                                                             $1,000 equals the limitation of section 457(b)
                                                                   year and was eligible to participate in both
                                                                                                                             for 2000 because E’s annual deferrals totaled
                                                                   an eligible plan and a section 401(k) plan.
                                                                                                                             $4,000. E’s underutilized amount for 2000 is
                                                                   However, D had always participated only in
                                                                                                                             zero.
                                                                   the section 401(k) plan and had always de-
                                                                   ferred the maximum amount possible. For                      (v) Normal retirement age—(A) General
                                                                   each year before 2002, the maximum amount                 rule. For purposes of the special section
                                                                   permitted under section 401(k) exceeded the               457 catch-up in this paragraph (c)(3), a
                                                                   limitation of paragraph (c)(3)(i) of this sec-
                                                                                                                             plan must specify the normal retire-
                                                                   tion. In 2002, D is in the 3-year period prior
                                                                   to D’s attainment of the eligible plan’s nor-             ment age under the plan. A plan may
                                                                   mal retirement age of 65, and D now wants to              define normal retirement age as any
                                                                   participate in the eligible plan and make an-             age that is on or after the earlier of age
                                                                   nual deferrals of up to $30,000 under the                 65 or the age at which participants
                                                                   plan’s special section 457 catch-up provi-                have the right to retire and receive,
                                                                   sions.                                                    under the basic defined benefit pension
                                                                     (ii) Conclusion. Participant D is treated as            plan of the State or tax-exempt entity
                                                                   having no underutilized amount under para-                (or a money purchase pension plan in
                                                                   graph (c)(3)(ii)(B) of this section for 2002 for
                                                                                                                             which the participant also participates
                                                                   purposes of the catch-up limitation under
                                                                   section 457(b)(3) and paragraph (c)(3) of this            if the participant is not eligible to par-
                                                                                                                             ticipate in a defined benefit plan), im-
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                                                                   section because, in each of the years before
                                                                   2002, D has deferred an amount equal to or in             mediate retirement benefits without
                                                                   excess of the limitation of paragraph (c)(3)(i)           actuarial or similar reduction because

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                                                                   § 1.457–4                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   of retirement before some later speci-                    of this section continues to be $15,000 for 2007
                                                                   fied age, and that is not later than age                  and the additional dollar amount permitted
                                                                   701⁄2. Alternatively, a plan may provide                  under the age 50 catch-up in paragraph (c)(2)
                                                                                                                             of this section for an individual who is at
                                                                   that a participant is allowed to des-                     least age 50 continues to be $5,000 for 2007. In
                                                                   ignate a normal retirement age within                     F’s taxable year 2007, which is one of the last
                                                                   these ages. For purposes of the special                   three taxable years ending before F attains
                                                                   section 457 catch-up in this paragraph                    the plan’s normal retirement age of 65, F
                                                                   (c)(3), an entity sponsoring more than                    again receives a salary of $40,000 and elects
                                                                   one eligible plan may not permit a par-                   to defer the maximum amount permissible
                                                                   ticipant to have more than one normal                     under the plan’s catch-up provisions pre-
                                                                                                                             scribed under paragraph (c) of this section.
                                                                   retirement age under the eligible plans                     (ii) Conclusion. For 2007, which is one of the
                                                                   it sponsors.                                              last three taxable years ending before F at-
                                                                     (B) Special rule for eligible plans of                  tains the plan’s normal retirement age of 65,
                                                                   qualified police or firefighters. An eligi-               the applicable limit on deferrals for F is the
                                                                   ble plan with participants that include                   larger of the amount under the special sec-
                                                                   qualified police or firefighters as de-                   tion 457 catch-up or $20,000, which is the
                                                                   fined under section 415(b)(2)(H)(ii)(I)                   basic annual limitation ($15,000) and the age
                                                                                                                             50 catch-up limit of section 414(v) ($5,000).
                                                                   may designate a normal retirement age
                                                                                                                             For 2007, F’s special section 457 catch-up
                                                                   for such qualified police or firefighters                 amount is the lesser of two times the basic
                                                                   that is earlier than the earliest normal                  annual limitation ($30,000) or the sum of the
                                                                   retirement age designated under the                       basic annual limitation ($15,000) plus the
                                                                   general rule of paragraph (c)(3)(i)(A) of                 $13,000 underutilized limitation under para-
                                                                   this section, but in no event may the                     graph (c)(3)(ii) of this section (the $15,000
                                                                   normal retirement age be earlier than                     plan ceiling in 2006, minus the $2,000 contrib-
                                                                                                                             uted for F in 2006), or $28,000. Thus, the max-
                                                                   age 40. Alternatively, a plan may allow
                                                                                                                             imum amount that F may defer in 2007 is
                                                                   a qualified police or firefighter partici-                $28,000.
                                                                   pant to designate a normal retirement                       Example 3. (i) Facts. The facts are the same
                                                                   age that is between age 40 and age 701⁄2.                 as in Examples 1 and 2, except that F does not
                                                                     (vi) Examples. The provisions of this                   make any contributions to the plan before
                                                                   paragraph (c)(3) are illustrated by the                   2010. In addition, assume that the applicable
                                                                   following examples:                                       basic     dollar   limitation    of   paragraph
                                                                                                                             (c)(1)(i)(A) of this section continues to be
                                                                     Example 1. (i) Facts. Participant F, who will           $15,000 for 2010 and the additional dollar
                                                                   turn 61 on April 1, 2006, becomes eligible to             amount permitted under the age 50 catch-up
                                                                   participate in an eligible plan on January 1,             in paragraph (c)(2) of this section for an indi-
                                                                   2006. The plan provides a normal retirement               vidual who is at least age 50 continues to be
                                                                   age of 65. The plan provides limitations on               $5,000 for 2010. In F’s taxable year 2010, the
                                                                   annual deferrals up to the maximum per-                   year in which F attains age 65 (which is the
                                                                   mitted under paragraphs (c)(1) through (3) of             normal retirement age under the plan), F de-
                                                                   this section. For 2006, F will receive com-               sires to defer the maximum amount possible
                                                                   pensation of $40,000 from the eligible em-                under the plan. F’s compensation for 2010 is
                                                                   ployer. F desires to defer the maximum                    again $40,000.
                                                                   amount possible in 2006. The applicable basic               (ii) Conclusion. For 2010, the maximum
                                                                   dollar limit of paragraph (c)(1)(i)(A) of this            amount that F may defer is $20,000. The spe-
                                                                   section is $15,000 for 2006 and the additional            cial section 457 catch-up provisions under
                                                                   dollar amount permitted under the age 50                  paragraph (c)(3) of this section are not appli-
                                                                   catch-up in paragraph (c)(2) of this section              cable because 2010 is not a taxable year end-
                                                                   for an individual who is at least age 50 is               ing before the year in which F attains nor-
                                                                   $5,000 for 2006.                                          mal retirement age.
                                                                     (ii) Conclusion. F is not eligible for the spe-
                                                                   cial section 457 catch-up under paragraph                   (4) Cost-of-living adjustment. For years
                                                                   (c)(3) of this section in 2006 because 2006 is            beginning after December 31, 2006, the
                                                                   not one of the last three taxable years end-              $15,000 dollar limitation in paragraph
                                                                   ing before F attains normal retirement age.               (c)(1)(i)(A) of this section will be ad-
                                                                   Accordingly, the maximum that F may defer                 justed to take into account increases
                                                                   for 2006 is $20,000. See also paragraph                   in the cost-of-living. The adjustment in
                                                                   (c)(2)(iii) Example 1 of this section.                    the dollar limitation is made at the
                                                                     Example 2. (i) Facts. The facts are the same
                                                                                                                             same time and in the same manner as
                                                                   as in Example 1 except that, in 2006, F elects
                                                                   to defer only $2,000 under the plan (rather               under section 415(d) (relating to quali-
                                                                                                                             fied plans under section 401(a)), except
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                                                                   than the maximum permitted amount of
                                                                   $20,000). In addition, assume that the applica-           that the base period is the calendar
                                                                   ble basic dollar limit of paragraph (c)(1)(i)(A)          quarter beginning July 1, 2005 and any

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–4

                                                                   increase which is not a multiple of $500                  ployer’s eligible plan and the sick leave and
                                                                   will be rounded to the next lowest mul-                   vacation pay program, G is permitted to
                                                                   tiple of $500.                                            make a one-time election to contribute
                                                                                                                             amounts representing accumulated sick pay
                                                                      (d) Deferrals after severance from em-                 to the eligible plan. G has a severance from
                                                                   ployment, including sick, vacation, and                   employment on January 12, 2008, at which
                                                                   back pay under an eligible plan—(1) In                    time G’s accumulated sick and vacation pay
                                                                   general. An eligible plan may provide                     that is payable on March 15, 2008, totals
                                                                   that a participant who has not had a                      $12,000. G elects, on February 4, 2008, to have
                                                                   severance from employment may elect                       the $12,000 of accumulated sick and vacation
                                                                   to defer accumulated sick pay, accu-                      pay contributed to the eligible plan.
                                                                                                                                (ii) Conclusion. Under the terms of the eli-
                                                                   mulated vacation pay, and back pay                        gible plan and the sick and vacation pay pro-
                                                                   under an eligible plan if the require-                    gram, G may elect before March 1, 2008, to
                                                                   ments of section 457(b) are satisfied.                    defer the accumulated sick and vacation pay
                                                                   For example, the plan must provide, in                    because the agreement providing for the de-
                                                                   accordance with paragraph (b) of this                     ferral is entered into before the beginning of
                                                                   section, that these amounts may be de-                    the month in which the amount is currently
                                                                   ferred for any calendar month only if                     available and the amount is bona fide accu-
                                                                                                                             mulated sick and vacation pay, as described
                                                                   an agreement providing for the deferral                   in § 1.415(c)–2(e)(3)(ii), and that is payable by
                                                                   is entered into before the beginning of                   the later of 21⁄2 months after severance from
                                                                   the month in which the amounts would                      employment or the end of the calendar year
                                                                   otherwise be paid or made available                       that includes the date of severance from em-
                                                                   and the participant is an employee on                     ployment by G. Thus, under this section and
                                                                   the date the amounts would otherwise                      § 1.415(c)–2(e)(3)(ii), the $12,000 is included in
                                                                   be paid or made available. For purposes                   G’s includible compensation for purposes of
                                                                                                                             determining G’s includible compensation in
                                                                   of section 457, compensation that                         year 2008.
                                                                   would otherwise be paid for a payroll                        Example 2. (i) Facts. Same facts as in Exam-
                                                                   period that begins before severance                       ple 1, except that G’s severance from employ-
                                                                   from employment is treated as an                          ment is on May 31, 2008, G’s $12,000 of accu-
                                                                   amount that would otherwise be paid                       mulated sick and vacation pay is payable on
                                                                   or made available before an employee                      September 15, 2008 (which is by the later of
                                                                   has a severance from employment. In                       21⁄2 months after severance from employment
                                                                                                                             or the end of the calendar year that includes
                                                                   addition, deferrals may be made for                       the date of severance from employment by
                                                                   former employees with respect to com-                     G), and G’s election to defer the accumulated
                                                                   pensation      described    in   § 1.415(c)–              sick and vacation pay is made before May 1,
                                                                   2(e)(3)(i) (relating to certain compensa-                 2008.
                                                                   tion paid by the later of 21⁄2 months                        (ii) Conclusion. Under this section and
                                                                   after severance from employment or                        § 1.415(c)–2(e)(3)(ii), the $12,000 is included in
                                                                   the end of the limitation year that in-                   G’s includible compensation for purposes of
                                                                                                                             determining G’s includible compensation in
                                                                   cludes the date of severance from em-
                                                                                                                             year 2008.
                                                                   ployment). For this purpose, the cal-                        Example 3. (i) Facts. Employer X maintains
                                                                   endar year is substituted for the limi-                   an eligible plan and a vacation leave plan.
                                                                   tation year. In addition, compensation                    Under the terms of the vacation leave plan,
                                                                   described in § 1.415(c)–2(e)(4), (g)(4), or               employees generally accrue three weeks of
                                                                   (g)(7) (relating to compensation paid to                  vacation per year. Up to one week’s unused
                                                                   participants who are permanently and                      vacation may be carried over from one year
                                                                   totally disabled or compensation relat-                   to the next, so that in any single year an em-
                                                                                                                             ployee may have a maximum of four weeks’
                                                                   ing to qualified military service under                   vacation time. At the beginning of each cal-
                                                                   section 414(u)), provided those amounts                   endar year, under the terms of the eligible
                                                                   represent compensation described in                       plan (which constitutes an agreement pro-
                                                                   § 1.415(c)–2(e)(3)(i).                                    viding for the deferral), the value of any un-
                                                                      (2) Examples. The provisions of this                   used vacation time from the prior year in ex-
                                                                   paragraph (d) are illustrated by the fol-                 cess of one week is automatically contrib-
                                                                   lowing examples:                                          uted to the eligible plan, to the extent of the
                                                                                                                             employee’s maximum deferral limitations.
                                                                     Example 1. (i) Facts. Participant G, who is             Amounts in excess of the maximum deferral
                                                                   age 62 in year 2007, is an employee who par-              limitations are forfeited.
                                                                   ticipates in an eligible plan providing a nor-               (ii) Conclusion. The value of the unused va-
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                                                                   mal retirement age of 65 and a bona fide sick             cation pay contributed to X’s eligible plan
                                                                   leave and vacation pay program of the eligi-              pursuant to the terms of the plan and the
                                                                   ble employer. Under the terms of G’s em-                  terms of the vacation leave plan is treated as

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                                                                   § 1.457–4                                                               26 CFR Ch. I (4–1–12 Edition)
                                                                   an annual deferral to the eligible plan for                  (3) Excess deferrals under an eligible
                                                                   January of the calendar year. No amounts                  plan of a tax-exempt employer other than
                                                                   contributed to the eligible plan will be con-
                                                                                                                             as a result of the individual limitation. If
                                                                   sidered made available to a participant in
                                                                   X’s eligible plan.                                        a plan of a tax-exempt employer fails
                                                                                                                             to comply with the limitations of para-
                                                                      (e) Excess deferrals under an eligible                 graphs (c)(1) through (3) of this section,
                                                                   plan—(1) In general. Any amount de-                       the plan will be an ineligible plan
                                                                   ferred under an eligible plan for the                     under which benefits are taxable in ac-
                                                                   taxable year of a participant that ex-                    cordance with § 1.457–11. However, a
                                                                   ceeds the maximum deferral limita-                        plan may distribute to a participant
                                                                   tions set forth in paragraphs (c)(1)
                                                                                                                             any excess deferrals (and any income
                                                                   through (3) of this section, and any
                                                                                                                             allocable to such amount) not later
                                                                   amount that exceeds the individual
                                                                                                                             than the first April 15 following the
                                                                   limitation under § 1.457–5, constitutes
                                                                   an excess deferral that is taxable in ac-                 close of the taxable year of the excess
                                                                   cordance with § 1.457–11 for that taxable                 deferrals. In such a case, the plan will
                                                                   year. Thus, an excess deferral is includ-                 continue to be treated as an eligible
                                                                   ible in gross income in the taxable year                  plan. However, any excess deferral is
                                                                   deferred or, if later, the first taxable                  included in the gross income of a par-
                                                                   year in which there is no substantial                     ticipant for the taxable year of the ex-
                                                                   risk of forfeiture.                                       cess deferral. If the excess deferrals are
                                                                      (2) Excess deferrals under an eligible                 not corrected by distribution under
                                                                   governmental plan other than as a result                  this paragraph (e)(3), the plan is an in-
                                                                   of the individual limitation. In order to                 eligible plan under which benefits are
                                                                   be an eligible governmental plan, the                     taxable in accordance with § 1.457–11.
                                                                   plan must provide that any excess de-                     For purposes of determining whether
                                                                   ferral resulting from a failure of a plan                 there is an excess deferral resulting
                                                                   to apply the limitations of paragraphs                    from a failure of a plan to apply the
                                                                   (c)(1) through (3) of this section to                     limitations      of    paragraphs     (c)(1)
                                                                   amounts deferred under the eligible                       through (3) of this section, all eligible
                                                                   plan (computed without regard to the                      plans under which an individual par-
                                                                   individual limitation under § 1.457–5)                    ticipates by virtue of his or her rela-
                                                                   will be distributed to the participant,                   tionship with a single employer are
                                                                   with allocable net income, as soon as                     treated as a single plan.
                                                                   administratively practicable after the                       (4) Excess deferrals arising from appli-
                                                                   plan determines that the amount is an                     cation of the individual limitation. An el-
                                                                   excess deferral. For purposes of deter-                   igible plan may provide that an excess
                                                                   mining whether there is an excess de-                     deferral that is a result solely of a fail-
                                                                   ferral resulting from a failure of a plan                 ure to comply with the individual limi-
                                                                   to apply the limitations of paragraphs                    tation under § 1.457–5 for a taxable year
                                                                   (c)(1) through (3) of this section, all                   may be distributed to the participant,
                                                                   plans under which an individual par-
                                                                                                                             with allocable net income, as soon as
                                                                   ticipates by virtue of his or her rela-
                                                                                                                             administratively practicable after the
                                                                   tionship with a single employer are
                                                                                                                             plan determines that the amount is an
                                                                   treated as a single plan (without regard
                                                                   to any differences in funding). An eligi-                 excess deferral. An eligible plan does
                                                                   ble governmental plan does not fail to                    not fail to satisfy the requirements of
                                                                   satisfy the requirements of paragraphs                    paragraphs (a) through (d) of this sec-
                                                                   (a) through (d) of this section or                        tion or §§ 1.457–6 through 1.457–10 (in-
                                                                   §§ 1.457–6 through 1.457–10 (including the                cluding the distribution rules under
                                                                   distribution rules under § 1.457–6 and                    § 1.457–6 and the funding rules under
                                                                   the funding rules under § 1.457–8) solely                 § 1.457–8) solely by reason of a distribu-
                                                                   by reason of a distribution made under                    tion made under this paragraph (e)(4).
                                                                   this paragraph (e)(2). If such excess de-                 Although a plan will still maintain eli-
                                                                   ferrals are not corrected by distribu-                    gible status if excess deferrals are not
                                                                   tion under this paragraph (e)(2), the                     distributed under this paragraph (e)(4),
                                                                   plan will be an ineligible plan under                     a participant must include the excess
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                                                                   which benefits are taxable in accord-                     amounts in income as provided in para-
                                                                   ance with § 1.457–11.                                     graph (e)(1) of this section.

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–5

                                                                     (5) Examples. The provisions of this                    different employer. Participant H is age 45
                                                                   paragraph (e) are illustrated by the fol-                 and normal retirement age under both eligi-
                                                                   lowing examples:                                          ble plans is age 65.
                                                                                                                                (ii) Conclusion. Because of the application
                                                                     Example 1. (i) Facts. In 2006, the eligible             of the individual limitation under § 1.457–5, H
                                                                   plan of State Employer X in which Partici-                has an excess deferral of $3,000 (the sum of
                                                                   pant H participates permits a maximum de-                 $14,000 plus $4,000 equals $18,000, which is
                                                                   ferral of the lesser of $15,000 or 100 percent of         $3,000 in excess of the dollar limitation of
                                                                   includible compensation. In 2006, H, who has              $15,000). The $3,000 excess deferral, with allo-
                                                                   compensation of $28,000, nevertheless defers              cable net income, may be distributed from
                                                                   $16,000 under the eligible plan. Participant H            either plan as soon as administratively prac-
                                                                   is age 45 and normal retirement age under                 ticable after determining that the combined
                                                                   the plan is age 65. For 2006, the applicable              amount exceeds the deferral limitations. If
                                                                   dollar limit under paragraph (c)(1)(i)(A) of              the $3,000 excess deferral is not distributed to
                                                                   this section is $15,000. Employer X discovers             H, each plan will continue to be an eligible
                                                                   the error in January of 2007 when it com-                 plan, but the $3,000 must be included by H in
                                                                   pletes H’s 2006 Form W-2 and promptly dis-                H’s income for 2006.
                                                                   tributes $1,022 to H (which is the sum of the                Example 5. (i) Facts. Assume the same facts
                                                                   $1,000 excess and $22 of allocable net income).           as in Example 3, except that H’s deferral
                                                                     (ii) Conclusion. Participant H has deferred             under the eligible governmental plan is lim-
                                                                   $1,000 in excess of the $15,000 limitation pro-           ited to $14,000 and H also makes a deferral of
                                                                   vided for under the plan for 2006. The $1,000             $4,000 to an eligible plan of Employer Y, a
                                                                   excess must be included by H in H’s income                tax-exempt entity.
                                                                   for 2006. In order to correct the failure and                (ii) Conclusion. The results are the same as
                                                                   still be an eligible plan, the plan must dis-             in Example 3, namely, because of the applica-
                                                                   tribute the excess deferral, with allocable               tion of the individual limitation under
                                                                   net income, as soon as administratively                   § 1.457–5, H has an excess deferral of $3,000. If
                                                                   practicable after determining that the                    the $3,000 excess deferral is not distributed to
                                                                   amount exceeds the plan deferral limita-                  H, each plan will continue to be an eligible
                                                                   tions. In this case, $22 of the distribution of           plan, but the $3,000 must be included by H in
                                                                   $1,022 is included in H’s gross income for 2007           H’s income for 2006.
                                                                   (and is not an eligible rollover distribution).              Example 6. (i) Facts. Assume the same facts
                                                                   If the excess deferral were not distributed,              as in Example 5, except that X is a tax-ex-
                                                                   the plan would be an ineligible plan with re-             empt entity and thus its plan is an eligible
                                                                   spect to which benefits are taxable in ac-                plan of a tax-exempt entity.
                                                                   cordance with § 1.457–11.                                    (ii) Conclusion. The results are the same as
                                                                     Example 2. (i) Facts. The facts are the same            in Example 5, namely, because of the appli-
                                                                   as in Example 1, except that X uses a number              cation of the individual limitation under
                                                                   of separate arrangements with different                   § 1.457–5, H has an excess deferral of $3,000. If
                                                                   trustees and annuity insurers to permit em-               the $3,000 excess deferral is not distributed to
                                                                   ployees to defer and H elects deferrals under             H, each plan will continue to be an eligible
                                                                   several of the funding arrangements none of               plan, but the $3,000 must be included by H
                                                                   which exceeds $15,000 for any individual fund-            into H’s income for 2006.
                                                                   ing arrangement, but which total $16,000.
                                                                     (ii) Conclusion. The conclusion is the same             [T.D. 9075, 68 FR 41234, July 11, 2003; 68 FR
                                                                   as in Example 1.                                          51446, Aug. 27, 2003; T.D. 9319, 72 FR 16930,
                                                                     Example 3. (i) Facts. The facts are the same            Apr. 5, 2007]
                                                                   as in Example 1, except that H’s deferral
                                                                   under the eligible plan is limited to $11,000             § 1.457–5 Individual limitation for com-
                                                                   and H also makes a salary reduction con-                       bined annual deferrals under mul-
                                                                   tribution of $5,000 to an annuity contract                     tiple eligible plans
                                                                   under section 403(b) with the same Employer                  (a) General rule. The individual limi-
                                                                   X.
                                                                                                                             tation under section 457(c) and this sec-
                                                                     (ii) Conclusion. H’s deferrals are within the
                                                                   plan deferral limitations of Employer X. Be-              tion equals the basic annual deferral
                                                                   cause of the repeal of the application of the             limitation under § 1.457–4(c)(1)(i)(A),
                                                                   coordination limitation under former para-                plus either the age 50 catch-up amount
                                                                   graph (2) of section 457(c), H’s salary reduc-            under § 1.457–4(c)(2), or the special sec-
                                                                   tion deferrals under the annuity contract are             tion 457 catch-up amount under § 1.457–
                                                                   no longer considered in determining H’s ap-               4(c)(3), applied by taking into account
                                                                   plicable deferral limits under paragraphs                 the combined annual deferral for the
                                                                   (c)(1) through (3) of this section.
                                                                                                                             participant for any taxable year under
                                                                     Example 4. (i) Facts. The facts are the same
                                                                   as in Example 1, except that H’s deferral                 all eligible plans. While an eligible plan
                                                                                                                             may include provisions under which it
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                                                                   under the eligible governmental plan is lim-
                                                                   ited to $14,000 and H also makes a deferral of            will limit deferrals to meet the indi-
                                                                   $4,000 to an eligible governmental plan of a              vidual limitation under section 457(c)

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                                                                   § 1.457–5                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   and this section, annual deferrals by a                      Example 1. (i) Facts. Participant F is age 62
                                                                   participant that exceed the individual                    in 2006 and participates in two eligible plans
                                                                   limit under section 457(c) and this sec-                  during 2006, Plans J and K, which are each el-
                                                                                                                             igible plans of two different governmental
                                                                   tion (but do not exceed the limits                        entities. Each plan includes provisions al-
                                                                   under § 1.457–4(c)) will not cause a plan                 lowing the maximum annual deferral per-
                                                                   to lose its eligible status. However, to                  mitted under § 1.457–4(c)(1) through (3). For
                                                                   the extent the combined annual defer-                     2006, the underutilized amount under § 1.457–
                                                                   rals for a participant for any taxable                    4 (c)(3)(ii)(B) is $20,000 under Plan J and is
                                                                   year exceed the individual limitation                     $40,000 under Plan K. Normal retirement age
                                                                   under section 457(c) and this section for                 is age 65 under both plans. Participant F de-
                                                                                                                             fers $15,000 under each plan. Participant F’s
                                                                   that year, the amounts are treated as                     includible compensation is in each case in
                                                                   excess deferrals as described in § 1.457–                 excess of the deferral. Neither plan des-
                                                                   4(e).                                                     ignates the $15,000 contribution as a catch-up
                                                                      (b) Limitation applied to participant.                 permitted under each plan’s special section
                                                                   The individual limitation in this sec-                    457 catch-up provisions.
                                                                   tion applies to eligible plans of all em-                    (ii) Conclusion. For purposes of applying
                                                                   ployers for whom a participant has per-                   this section to Participant F for 2006, the
                                                                                                                             maximum exclusion is $20,000. This is equal
                                                                   formed services, including both eligible                  to the sum of $15,000 plus $5,000, which is the
                                                                   governmental plans and eligible plans                     age 50 catch-up amount. Thus, F has an ex-
                                                                   of a tax-exempt entity and both eligi-                    cess amount of $10,000 which is treated as an
                                                                   ble plans of the employer and eligible                    excess deferral for Participant F for 2006
                                                                   plans of other employers. Thus, for                       under § 1.457–4(e).
                                                                   purposes of determining the amount                           Example 2. (i) Facts. Participant E, who will
                                                                   excluded from a participant’s gross in-                   turn 63 on April 1, 2006, participates in four
                                                                                                                             eligible plans during year 2006: Plan W which
                                                                   come in any taxable year (including
                                                                                                                             is an eligible governmental plan; and Plans
                                                                   the underutilized limitation under                        X, Y, and Z which are each eligible plans of
                                                                   § 1.457–4 (c)(3)(ii)(B)), the participant’s               three different tax-exempt entities. For year
                                                                   annual deferral under an eligible plan,                   2006, the limitation that applies to Partici-
                                                                   and the participant’s annual deferrals                    pant E under all four plans under § 1.457–
                                                                   under all other eligible plans, must be                   4(c)(1)(i)(A) is $15,000. For year 2006, the addi-
                                                                   determined on an aggregate basis. To                      tional age 50 catch-up limitation that ap-
                                                                                                                             plies to Participant E under all four plans
                                                                   the extent that the combined annual
                                                                                                                             under § 1.457–4(c)(2) is $5,000. Further, for year
                                                                   deferral amount exceeds the maximum                       2006, different limitations under § 1.457–4(c)(3)
                                                                   deferral limitation applicable under                      and (c)(3)(ii)(B) apply to Participant E under
                                                                   § 1.457–4 (c)(1)(i)(A), (c)(2), or (c)(3), the            each of these plans, as follows: under Plan W,
                                                                   amount is treated as an excess deferral                   the underutilized limitation under § 1.457–
                                                                   under § 1.457–4(e).                                       4(c)(3)(ii)(B) is $7,000; under Plan X, the un-
                                                                      (c) Special rules for catch-up amounts                 derutilized       limitation      under     § 1.457–
                                                                   under multiple eligible plans. For pur-                   4(c)(3)(ii)(B) is $2,000; under Plan Y, the un-
                                                                                                                             derutilized       limitation      under     § 1.457–
                                                                   poses of applying section 457(c) and this                 4(c)(3)(ii)(B) is $8,000; and under Plan Z,
                                                                   section, the special section 457 catch-                   § 1.457–4(c)(3) is not applicable since normal
                                                                   up under § 1.457–4 (c)(3) is taken into ac-               retirement age is 62 under Plan Z. Partici-
                                                                   count only to the extent that an an-                      pant E’s includible compensation is in each
                                                                   nual deferral is made for a participant                   case in excess of any applicable deferral.
                                                                   under an eligible plan as a result of                        (ii) Conclusion. For purposes of applying
                                                                   plan provisions permitted under § 1.457–                  this section to Participant E for year 2006,
                                                                                                                             Participant E could elect to defer $23,000
                                                                   4 (c)(3). In addition, if a participant has
                                                                                                                             under Plan Y, which is the maximum defer-
                                                                   annual deferrals under more than one                      ral limitation under § 1.457–4(c)(1) through
                                                                   eligible plan and the applicable catch-                   (3), and to defer no amount under Plans W,
                                                                   up amount under § 1.457–4 (c)(2) or (3) is                X, and Z. The $23,000 maximum amount is
                                                                   not the same for each such eligible                       equal to the sum of $15,000 plus $8,000, which
                                                                   plan for the taxable year, section 457(c)                 is the catch-up amount applicable to Partici-
                                                                   and this section are applied using the                    pant E under Plan Y and which is the largest
                                                                   catch-up amount under whichever plan                      catch-up amount applicable to Participant E
                                                                                                                             under any of the four plans for year 2006. Al-
                                                                   has the largest catch-up amount appli-
                                                                                                                             ternatively, Participant E could instead
                                                                   cable to the participant.                                 elect to defer the following combination of
                                                                      (d) Examples. The provisions of this
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                                                                                                                             amounts: An aggregate total of $15,000 to
                                                                   section are illustrated by the following                  Plans X, Y, and Z, if no contribution is made
                                                                   examples:                                                 to Plan W; an aggregate total of $20,000 to

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–6
                                                                   any of the four plans, assuming at least                  ployment with the eligible employer
                                                                   $5,000 is contributed to Plan W; or $22,000 to            upon the expiration of the contract (or
                                                                   Plan W and none to any of the other three                 in the case of more than one contract,
                                                                   plans.
                                                                     (iii) If the underutilized amount under
                                                                                                                             all contracts) under which services are
                                                                   Plans W, X, and Y for year 2006 were in each              performed for the eligible employer if
                                                                   case zero (because E had always contributed               the expiration constitutes a good-faith
                                                                   the maximum amount or E was a new partic-                 and complete termination of the con-
                                                                   ipant) or an amount not in excess of $5,000,              tractual relationship. An expiration
                                                                   the maximum exclusion under this section                  does not constitute a good faith and
                                                                   would be $20,000 for Participant E for year               complete termination of the contrac-
                                                                   2006 ($15,000 plus the $5,000 age 50 catch-up
                                                                   amount), which Participant E could con-
                                                                                                                             tual relationship if the eligible em-
                                                                   tribute to any of the plans assuming at least             ployer anticipates a renewal of a con-
                                                                   $5,000 is contributed to Plan W.                          tractual relationship or the inde-
                                                                                                                             pendent contractor becoming an em-
                                                                   [T.D. 9075, 68 FR 41240, July 11, 2003; 68 FR
                                                                   51446, Aug. 26, 2003; T.D. 9319, 72 FR 16930,             ployee. For this purpose, an eligible
                                                                   Apr. 5, 2007; 72 FR 28854, May 23, 2007]                  employer is considered to anticipate
                                                                                                                             the renewal of the contractual rela-
                                                                   § 1.457–6 Timing of distributions under                   tionship with an independent con-
                                                                        eligible plans.                                      tractor if it intends to contract again
                                                                      (a) In general. Except as provided in                  for the services provided under the ex-
                                                                   paragraph (c) of this section (relating                   pired contract, and neither the eligible
                                                                   to distributions on account of an un-                     employer nor the independent con-
                                                                   foreseeable emergency), paragraph (e)                     tractor has eliminated the independent
                                                                   of this section (relating to distribu-                    contractor as a possible provider of
                                                                   tions of small accounts), § 1.457–10(a)                   services under any such new contract.
                                                                   (relating to plan terminations), or                       Further, an eligible employer is consid-
                                                                   § 1.457–10(c) (relating to domestic rela-                 ered to intend to contract again for the
                                                                   tions orders), amounts deferred under                     services provided under an expired con-
                                                                   an eligible plan may not be paid to a                     tract if the eligible employer’s doing so
                                                                   participant or beneficiary before the                     is conditioned only upon incurring a
                                                                   participant has a severance from em-                      need for the services, the availability
                                                                   ployment with the eligible employer or                    of funds, or both.
                                                                   when the participant attains age 701⁄2,                     (ii) Special rule. Notwithstanding
                                                                   if earlier. For rules relating to loans,                  paragraph (b)(2)(i) of this section, the
                                                                   see paragraph (f) of this section. This                   plan is considered to satisfy the re-
                                                                   section does not apply to distributions                   quirement described in paragraph (a) of
                                                                   of excess amounts under § 1.457–4(e).                     this section that no amounts deferred
                                                                   However, except to the extent set forth                   under the plan be paid or made avail-
                                                                   by the Commissioner in revenue rul-                       able to the participant before the par-
                                                                   ings, notices, and other guidance pub-                    ticipant has a severance from employ-
                                                                   lished in the Internal Revenue Bulletin                   ment with the eligible employer if,
                                                                   (see § 601.601(d) of this chapter), this                  with respect to amounts payable to a
                                                                   section applies to amounts held in a                      participant who is an independent con-
                                                                   separate account for eligible rollover                    tractor, an eligible plan provides that—
                                                                   distributions maintained by an eligible                     (A) No amount will be paid to the
                                                                   governmental plan as described in                         participant before a date at least 12
                                                                   § 1.457–10(e)(2).                                         months after the day on which the con-
                                                                      (b) Severance from employment—(1) Em-                  tract expires under which services are
                                                                   ployees. An employee has a severance                      performed for the eligible employer (or,
                                                                   from employment with the eligible em-                     in the case of more than one contract,
                                                                   ployer if the employee dies, retires, or                  all such contracts expire); and
                                                                   otherwise has a severance from em-                          (B) No amount payable to the partici-
                                                                   ployment with the eligible employer.                      pant on that date will be paid to the
                                                                   See regulations under section 401(k) for                  participant if, after the expiration of
                                                                   additional guidance concerning sever-                     the contract (or contracts) and before
                                                                   ance from employment.                                     that date, the participant performs
                                                                      (2) Independent contractors—(i) In gen-                services for the eligible employer as an
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                                                                   eral. An independent contractor is con-                   independent contractor or an em-
                                                                   sidered to have a severance from em-                      ployee.

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                                                                   § 1.457–6                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                     (c) Rules applicable to distributions for               determined based on the relevant facts
                                                                   unforeseeable emergencies—(1) In general.                 and circumstances of each case, but, in
                                                                   An eligible plan may permit a distribu-                   any case, a distribution on account of
                                                                   tion to a participant or beneficiary for                  unforeseeable emergency may not be
                                                                   an unforeseeable emergency. The dis-                      made to the extent that such emer-
                                                                   tribution must satisfy the require-                       gency is or may be relieved through re-
                                                                   ments of paragraph (c)(2) of this sec-                    imbursement or compensation from in-
                                                                   tion.                                                     surance or otherwise, by liquidation of
                                                                     (2)    Requirements—(i)     Unforeseeable               the participant’s assets, to the extent
                                                                   emergency defined. An unforeseeable                       the liquidation of such assets would
                                                                   emergency must be defined in the plan                     not itself cause severe financial hard-
                                                                   as a severe financial hardship of the                     ship, or by cessation of deferrals under
                                                                   participant or beneficiary resulting                      the plan.
                                                                   from an illness or accident of the par-                      (iii) Distribution necessary to satisfy
                                                                   ticipant or beneficiary, the partici-                     emergency need. Distributions because
                                                                   pant’s or beneficiary’s spouse, or the                    of an unforeseeable emergency must be
                                                                   participant’s or beneficiary’s depend-                    limited to the amount reasonably nec-
                                                                   ent (as defined in section 152, and, for                  essary to satisfy the emergency need
                                                                   taxable years beginning on or after                       (which may include any amounts nec-
                                                                   January 1, 2005, without regard to sec-                   essary to pay for any federal, state, or
                                                                   tion 152(b)(1), (b)(2), and (d)(1)(B)); loss              local income taxes or penalties reason-
                                                                   of the participant’s or beneficiary’s                     ably anticipated to result from the dis-
                                                                   property due to casualty (including the
                                                                                                                             tribution).
                                                                   need to rebuild a home following dam-
                                                                                                                                (d) Minimum required distributions for
                                                                   age to a home not otherwise covered by
                                                                                                                             eligible plans. In order to be an eligible
                                                                   homeowner’s insurance, such as dam-
                                                                   age that is the result of a natural dis-                  plan, a plan must meet the distribution
                                                                   aster); or other similar extraordinary                    requirements of section 457(d)(1) and
                                                                   and unforeseeable circumstances aris-                     (2). Under section 457(d)(2), a plan must
                                                                   ing as a result of events beyond the                      meet the minimum distribution re-
                                                                   control of the participant or the bene-                   quirements of section 401(a)(9). See sec-
                                                                   ficiary. For example, the imminent                        tion 401(a)(9) and the regulations there-
                                                                   foreclosure of or eviction from the par-                  under for these requirements. Section
                                                                   ticipant’s or beneficiary’s primary resi-                 401(a)(9) requires that a plan begin life-
                                                                   dence may constitute an unforeseeable                     time distributions to a participant no
                                                                   emergency. In addition, the need to                       later than April 1 of the calendar year
                                                                   pay for medical expenses, including                       following the later of the calendar year
                                                                   non-refundable deductibles, as well as                    in which the participant attains age
                                                                   for the cost of prescription drug medi-                   701⁄2 or the calendar year in which the
                                                                   cation, may constitute an unforesee-                      participant retires.
                                                                   able emergency. Finally, the need to                         (e) Distributions of smaller accounts—
                                                                   pay for the funeral expenses of a spouse                  (1) In general. An eligible plan may pro-
                                                                   or a dependent (as defined in section                     vide for a distribution of all or a por-
                                                                   152, and, for taxable years beginning on                  tion of a participant’s benefit if this
                                                                   or after January 1, 2005, without regard                  paragraph (e)(1) is satisfied. This para-
                                                                   to section 152(b)(1), (b)(2), and (d)(1)(B))              graph (e)(1) is satisfied if the partici-
                                                                   of a participant or beneficiary may                       pant’s total amount deferred (the par-
                                                                   also constitute an unforeseeable emer-                    ticipant’s total account balance) which
                                                                   gency. Except as otherwise specifically                   is not attributable to rollover con-
                                                                   provided in this paragraph (c)(2)(i), the                 tributions (as defined in section
                                                                   purchase of a home and the payment of                     411(a)(11)(D)) is not in excess of the dol-
                                                                   college tuition are not unforeseeable                     lar limit under section 411(a)(11)(A), no
                                                                   emergencies under this paragraph                          amount has been deferred under the
                                                                   (c)(2)(i).                                                plan by or for the participant during
                                                                     (ii) Unforeseeable emergency distribu-                  the two-year period ending on the date
                                                                   tion standard. Whether a participant or                   of the distribution, and there has been
                                                                   beneficiary is faced with an unforesee-                   no prior distribution under the plan to
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                                                                   able emergency permitting a distribu-                     the participant under this paragraph
                                                                   tion under this paragraph (c) is to be                    (e). An eligible plan is not required to

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–6

                                                                   permit distributions under this para-                     ple, a loan must bear a reasonable rate
                                                                   graph (e).                                                of interest in order to satisfy the exclu-
                                                                     (2) Alternative provisions possible. Con-               sive benefit requirement of section
                                                                   sistent with the provisions of para-                      457(g)(1) and § 1.457–8(a)(1). See also
                                                                   graph (e)(1) of this section, a plan may                  § 1.457–7(b)(3) relating to the applica-
                                                                   provide that the total amount deferred                    tion of section 72(p) with respect to the
                                                                   for a participant or beneficiary will be                  taxation of a loan made under an eligi-
                                                                   distributed automatically to the par-                     ble governmental plan, and § 1.72(p)-1
                                                                   ticipant or beneficiary if the require-                   relating to section 72(p)(2).
                                                                   ments of paragraph (e)(1) of this sec-                       (3) Example. The provisions of para-
                                                                   tion are met. Alternatively, if the re-
                                                                                                                             graph (f)(2) of this section are illus-
                                                                   quirements of paragraph (e)(1) of this
                                                                                                                             trated by the following example:
                                                                   section are met, the plan may provide
                                                                   for the total amount deferred for a par-                    Example. (i) Facts. Eligible Plan X of State
                                                                   ticipant or beneficiary to be distrib-                    Y is funded through Trust Z. Plan X permits
                                                                   uted to the participant or beneficiary                    an employee’s account balance under Plan X
                                                                   only if the participant or beneficiary so                 to be paid in a single sum at severance from
                                                                   elects. The plan is permitted to sub-                     employment with State Y. Plan X includes a
                                                                   stitute a specified dollar amount that                    loan program under which any active em-
                                                                   is less than the total amount deferred.                   ployee with a vested account balance may
                                                                                                                             receive a loan from Trust Z. Loans are made
                                                                   In addition, these two alternatives can
                                                                                                                             pursuant to plan provisions regarding loans
                                                                   be combined; for example, a plan could
                                                                                                                             that are set forth in the plan under which
                                                                   provide for automatic distributions for                   loans bear a reasonable rate of interest and
                                                                   up to $500, but allow a participant or                    are secured by the employee’s account bal-
                                                                   beneficiary to elect a distribution if                    ance. In order to avoid taxation under § 1.457–
                                                                   the total account balance is above $500.                  7(b)(3) and section 72(p)(1), the plan provi-
                                                                     (f) Loans from eligible plans—(1) Eligi-                sions limit the amount of loans and require
                                                                   ble plans of tax-exempt entities. If a par-               loans to be repaid in level installments as re-
                                                                   ticipant or beneficiary receives (di-                     quired under section 72(p)(2). Participant J’s
                                                                   rectly or indirectly) any amount de-                      vested account balance under Plan X is
                                                                   ferred as a loan from an eligible plan of                 $50,000. J receives a loan from Trust Z in the
                                                                   a tax-exempt entity, that amount will                     amount of $5,000 on December 1, 2003, to be
                                                                   be treated as having been paid or made                    repaid in level installments made quarterly
                                                                                                                             over the 5-year period ending on November
                                                                   available to the individual as a dis-
                                                                                                                             30, 2008. Participant J makes the required re-
                                                                   tribution under the plan, in violation                    payments until J has a severance from em-
                                                                   of the distribution requirements of sec-                  ployment from State Y in 2005 and subse-
                                                                   tion 457(d).                                              quently fails to repay the outstanding loan
                                                                     (2) Eligible governmental plans. The de-                balance of $2,250. The $2,250 loan balance is
                                                                   termination of whether the availability                   offset against J’s $80,000 account balance
                                                                   of a loan, the making of a loan, or a                     benefit under Plan X, and J elects to be paid
                                                                   failure to repay a loan made from a                       the remaining $77,750 in 2005.
                                                                   trustee (or a person treated as a trust-                    (ii) Conclusion. The making of the loan to
                                                                   ee under section 457(g)) of an eligible                   J will not be treated as a violation of the re-
                                                                   governmental plan to a participant or                     quirements of section 457(b) or the regula-
                                                                   beneficiary is treated as a distribution                  tions. The cancellation of the loan at sever-
                                                                                                                             ance from employment does not cause Plan
                                                                   (directly or indirectly) for purposes of
                                                                                                                             X to fail to satisfy the requirements for plan
                                                                   this section, and the determination of                    eligibility under section 457. In addition, be-
                                                                   whether the availability of the loan,                     cause the loan satisfies the maximum
                                                                   the making of the loan, or a failure to                   amount and repayment requirements of sec-
                                                                   repay the loan is in any other respect                    tion 72(p)(2), J is not required to include any
                                                                   a violation of the requirements of sec-                   amount in income as a result of the loan
                                                                   tion 457(b) and the regulations, depends                  until 2005, when J has income of $2,250 as a
                                                                   on the facts and circumstances. Among                     result of the offset (which is a permissible
                                                                   the facts and circumstances are wheth-                    distribution under this section) and income
                                                                   er the loan has a fixed repayment                         of $77,750 as a result of the distribution made
                                                                   schedule and bears a reasonable rate of                   in 2005.
                                                                   interest, and whether there are repay-
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                                                                                                                             [T.D. 9075, 68 FR 41240, July 11, 2003; 68 FR
                                                                   ment safeguards to which a prudent                        51446, Aug. 27, 2003; T.D. 9319, 72 FR 16930,
                                                                   lender would adhere. Thus, for exam-                      Apr. 5, 2007]

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                                                                   § 1.457–7                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   § 1.457–7 Taxation        of   Distributions              eligible governmental plan to a partici-
                                                                        Under Eligible Plans.                                pant or beneficiary (including any
                                                                      (a) General rules for when amounts are                 pledge or assignment treated as a loan
                                                                   included in gross income. The rules for                   under section 72(p)(1)(B)) is treated as
                                                                   determining when an amount deferred                       having been received as a distribution
                                                                   under an eligible plan is includible in                   from the plan under section 72(p)(1), ex-
                                                                   the gross income of a participant or                      cept to the extent set forth in section
                                                                   beneficiary depend on whether the plan                    72(p)(2) (relating to loans that do not
                                                                   is an eligible governmental plan or an                    exceed a maximum amount and that
                                                                   eligible plan of a tax-exempt entity.                     are repayable in accordance with cer-
                                                                   Paragraph (b) of this section sets forth                  tain terms) and § 1.72(p)–1. Thus, except
                                                                   the rules for an eligible governmental                    to the extent a loan satisfies section
                                                                   plan. Paragraph (c) of this section sets                  72(p)(2), any amount loaned from an el-
                                                                   forth the rules for an eligible plan of a                 igible governmental plan to a partici-
                                                                   tax-exempt entity.                                        pant or beneficiary (including any
                                                                      (b) Amounts included in gross income                   pledge or assignment treated as a loan
                                                                   under an eligible governmental plan—(1)                   under section 72(p)(1)(B)) is includible
                                                                   Amounts included in gross income in year                  in the gross income of the participant
                                                                   paid under an eligible governmental plan.                 or beneficiary for the taxable year in
                                                                   Except as provided in paragraphs (b)(2)                   which the loan is made. See generally
                                                                   and (3) of this section (or in § 1.457–10(c)              § 1.72(p)–1.
                                                                   relating to payments to a spouse or                          (4) Examples. The provisions of this
                                                                   former spouse pursuant to a qualified                     paragraph (b) are illustrated by the fol-
                                                                   domestic relations order), amounts de-                    lowing examples:
                                                                   ferred under an eligible governmental                       Example 1. (i) Facts. Eligible Plan G of a
                                                                   plan are includible in the gross income                   governmental entity permits distribution of
                                                                   of a participant or beneficiary for the                   benefits in a single sum or in installments of
                                                                   taxable year in which paid to the par-                    up to 20 years, with such benefits to com-
                                                                   ticipant or beneficiary under the plan.                   mence at any date that is after severance
                                                                      (2) Rollovers to individual retirement ar-             from employment (up to the later of sever-
                                                                                                                             ance from employment or the plan’s normal
                                                                   rangements and other eligible retirement
                                                                                                                             retirement age of 65). Effective for partici-
                                                                   plans. A trustee-to-trustee transfer in                   pants who have a severance from employ-
                                                                   accordance with section 401(a)(31) (gen-                  ment after December 31, 2001, Plan X allows
                                                                   erally referred to as a direct rollover)                  an election—as to both the date on which
                                                                   from an eligible government plan is                       payments are to begin and the form in which
                                                                   not includible in gross income of a par-                  payments are to be made—to be made by the
                                                                   ticipant or beneficiary in the year                       participant at any time that is before the
                                                                   transferred. In addition, any payment                     commencement date selected. However, Plan
                                                                                                                             X chooses to require elections to be filed at
                                                                   made from an eligible government plan
                                                                                                                             least 30 days before the commencement date
                                                                   in the form of an eligible rollover dis-                  selected in order for Plan X to have enough
                                                                   tribution (as defined in section                          time to be able to effectuate the election.
                                                                   402(c)(4)) is not includible in gross in-                   (ii) Conclusion. No amounts are included in
                                                                   come in the year paid to the extent the                   gross income before actual payments begin.
                                                                   payment is transferred to an eligible                     If installment payments begin (and the in-
                                                                   retirement plan (as defined in section                    stallment payments are payable over at least
                                                                   402(c)(8)(B)) within 60 days, including                   10 years so as not to be eligible rollover dis-
                                                                                                                             tributions), the amount included in gross in-
                                                                   the transfer to the eligible retirement
                                                                                                                             come for any year is equal to the amount of
                                                                   plan of any property distributed from                     the installment payment paid during the
                                                                   the eligible governmental plan. For                       year.
                                                                   this purpose, the rules of section                          Example 2. (i) Facts. Same facts as in Exam-
                                                                   402(c)(2) through (7) and (9) apply. Any                  ple 1, except that the same rules are ex-
                                                                   trustee-to-trustee transfer under this                    tended to participants who had a severance
                                                                   paragraph (b)(2) from an eligible gov-                    from employment before January 1, 2002.
                                                                   ernment plan is a distribution that is                      (ii) Conclusion. For all participants (that
                                                                                                                             is, both those who have a severance from em-
                                                                   subject to the distribution require-                      ployment after December 31, 2001, and those
                                                                   ments of § 1.457–6.                                       who have a severance from employment be-
                                                                      (3) Amounts taxable under section
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                                                                                                                             fore January 1, 2002, including those whose
                                                                   72(p)(1). In accordance with section                      benefit payments have commenced before
                                                                   72(p), the amount of any loan from an                     January 1, 2002), no amounts are included in

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–7
                                                                   gross income before actual payments begin.                available prior to the applicable date
                                                                   If installment payments begin (and the in-                under paragraphs (c)(2)(ii) through (iv)
                                                                   stallment payments are payable over at least              of this section. In addition, no portion
                                                                   10 years so as not to be eligible rollover dis-
                                                                   tributions), the amount included in gross in-
                                                                                                                             of a participant or beneficiary’s ac-
                                                                   come for any year is equal to the amount of               count is treated as made available (and
                                                                   the installment payment paid during the                   thus currently includible in income)
                                                                   year.                                                     under an eligible plan of a tax-exempt
                                                                                                                             entity merely because the participant
                                                                      (c) Amounts included in gross income
                                                                                                                             or beneficiary under the plan may elect
                                                                   under an eligible plan of a tax-exempt en-
                                                                   tity—(1) Amounts included in gross in-                    to receive a distribution in any of the
                                                                   come in year paid or made available under                 following circumstances:
                                                                   an eligible plan of a tax-exempt entity.                     (A) A distribution in the event of an
                                                                   Amounts deferred under an eligible                        unforeseeable emergency to the extent
                                                                   plan of a tax-exempt entity are includ-                   the distribution is permitted under
                                                                   ible in the gross income of a partici-                    § 1.457–6(c).
                                                                   pant or beneficiary for the taxable year                     (B) A distribution from an account
                                                                   in which paid or otherwise made avail-                    for which the total amount deferred is
                                                                   able to the participant or beneficiary                    not in excess of the dollar limit under
                                                                   under the plan. Thus, amounts deferred                    section 411(a)(11)(A) to the extent the
                                                                   under an eligible plan of a tax-exempt                    distribution is permitted under § 1.457–
                                                                   entity are includible in the gross in-                    6(e).
                                                                   come of the participant or beneficiary                       (ii) Initial election to defer commence-
                                                                   in the year the amounts are first made                    ment of distributions—(A) In general. An
                                                                   available under the terms of the plan,                    eligible plan of a tax-exempt entity
                                                                   even if the plan has not distributed the                  may provide a period for making an
                                                                   amounts deferred. Amounts deferred                        initial election during which the par-
                                                                   under an eligible plan of a tax-exempt                    ticipant or beneficiary may elect, in
                                                                   entity are not considered made avail-                     accordance with the terms of the plan,
                                                                   able to the participant or beneficiary                    to defer the payment of some or all of
                                                                   solely because the participant or bene-                   the amounts deferred to a fixed or de-
                                                                   ficiary is permitted to choose among                      terminable future time. The period for
                                                                   various investments under the plan.                       making this initial election must ex-
                                                                      (2) When amounts deferred are consid-                  pire prior to the first time that any
                                                                   ered to be made available under an eligi-                 such amounts would be considered
                                                                   ble plan of a tax-exempt entity—(i) Gen-                  made available under the plan under
                                                                   eral rule. Except as provided in para-                    paragraph (c)(2)(i) of this section.
                                                                   graphs (c)(2)(ii) through (iv) of this sec-                  (B) Failure to make initial election to
                                                                   tion, amounts deferred under an eligi-                    defer commencement of distributions.
                                                                   ble plan of a tax-exempt entity are con-                  Generally, if no initial election is made
                                                                   sidered made available (and, thus, are                    by a participant or beneficiary under
                                                                   includible in the gross income of the                     this paragraph (c)(2)(ii), then the
                                                                   participant or beneficiary under this                     amounts deferred under an eligible
                                                                   paragraph (c)) at the earliest date, on                   plan of a tax-exempt entity are consid-
                                                                   or after severance from employment,                       ered made available and taxable to the
                                                                   on which the plan allows distributions                    participant or beneficiary in accord-
                                                                   to commence, but in no event later                        ance with paragraph (c)(2)(i) of this
                                                                   than the date on which distributions                      section at the earliest time, on or after
                                                                   must commence pursuant to section                         severance from employment (but in no
                                                                   401(a)(9). For example, in the case of a                  event later than the date on which dis-
                                                                   plan that permits distribution to com-                    tributions must commence pursuant to
                                                                   mence on the date that is 60 days after                   section 401(a)(9)), that distribution is
                                                                   the close of the plan year in which the                   permitted to commence under the
                                                                   participant has a severance from em-                      terms of the plan. However, the plan
                                                                   ployment with the eligible employer,                      may provide for a default payment
                                                                   amounts deferred are considered to be                     schedule that applies if no election is
                                                                   made available on that date. However,                     made. If the plan provides for a default
                                                                   distributions deferred in accordance                      payment schedule, the amounts de-
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                                                                   with paragraphs (c)(2)(ii) through (iv)                   ferred are includible in the gross in-
                                                                   of this section are not considered made                   come of the participant or beneficiary

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                                                                   § 1.457–7                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   in the year the amounts deferred are                      amounts are considered made available
                                                                   first made available under the terms of                   and taxable when paid under the terms
                                                                   the default payment schedule.                             of the default payment schedule). A
                                                                     (iii) Additional election to defer com-                 method of payment means a distribu-
                                                                   mencement of distribution. An eligible                    tion or a series of periodic distribu-
                                                                   plan of a tax-exempt entity is per-                       tions commencing on a date deter-
                                                                   mitted to provide that a participant or                   mined in accordance with paragraph
                                                                   beneficiary who has made an initial                       (c)(2)(ii) or (iii) of this section.
                                                                   election under paragraph (c)(2)(ii)(A) of                   (3) Examples. The provisions of this
                                                                   this section may make one additional                      paragraph (c) are illustrated by the fol-
                                                                   election to defer (but not accelerate)                    lowing examples:
                                                                   commencement of distributions under
                                                                                                                               Example 1. (i) Facts. Eligible Plan X of a
                                                                   the plan before distributions have com-
                                                                                                                             tax-exempt entity provides that a partici-
                                                                   menced in accordance with the initial                     pant’s total account balance, representing
                                                                   deferral election under paragraph                         all amounts deferred under the plan, is pay-
                                                                   (c)(2)(ii)(A) of this section. Amounts                    able to a participant in a single sum 60 days
                                                                   payable to a participant or beneficiary                   after severance from employment through-
                                                                   under an eligible plan of a tax-exempt                    out these examples, unless, during a 30-day
                                                                   entity are not treated as made avail-                     period immediately following the severance,
                                                                   able merely because the plan allows                       the participant elects to receive the single
                                                                                                                             sum payment at a later date (that is not
                                                                   the participant to make an additional
                                                                                                                             later than the plan’s normal retirement age
                                                                   election under this paragraph (c)(2)(iii).                of 65) or elects to receive distribution in 10
                                                                   A participant or beneficiary is not pre-                  annual installments to begin 60 days after
                                                                   cluded from making an additional elec-                    severance from employment (or at a later
                                                                   tion to defer commencement of dis-                        date, if so elected, that is not later than the
                                                                   tributions merely because the partici-                    plan’s normal retirement age of 65). On No-
                                                                   pant or beneficiary has previously re-                    vember 13, 2004, K, a calendar year taxpayer,
                                                                   ceived a distribution under § 1.457–6(c)                  has a severance from employment with the
                                                                                                                             eligible employer. K does not, within the 30-
                                                                   because of an unforeseeable emergency,
                                                                                                                             day window period, elect to postpone dis-
                                                                   has received a distribution of smaller                    tributions to a later date or to receive pay-
                                                                   amounts under § 1.457–6(e), has made                      ment in 10 fixed annual installments.
                                                                   (and revoked) other deferral or method                      (ii) Conclusion. The single sum payment is
                                                                   of payment elections within the initial                   payable to K 60 days after the date K has a
                                                                   election period, or is subject to a de-                   severance from employment (January 12,
                                                                   fault payment schedule under which                        2005), and is includible in the gross income of
                                                                   the commencement of benefits is de-                       K in 2005 under section 457(a).
                                                                   ferred (for example, until a participant                    Example 2. (i) Facts. The terms of eligible
                                                                                                                             Plan X are the same as described in Example
                                                                   is age 65).
                                                                                                                             1. Participant L participates in eligible Plan
                                                                     (iv) Election as to method of payment.                  X. On November 11, 2003, L has a severance
                                                                   An eligible plan of a tax-exempt entity                   from the employment of the eligible em-
                                                                   may provide that an election as to the                    ployer. On November 24, 2003, L makes an
                                                                   method of payment under the plan may                      initial deferral election not to receive the
                                                                   be made at any time prior to the time                     single-sum payment payable 60 days after
                                                                   the amounts are distributed in accord-                    the severance, and instead elects to receive
                                                                   ance with the participant or bene-                        the amounts in 10 annual installments to
                                                                                                                             begin 60 days after severance from employ-
                                                                   ficiary’s initial or additional election
                                                                                                                             ment.
                                                                   to defer commencement of distribu-                          (ii) Conclusion. No portion of L’s account is
                                                                   tions under paragraph (c)(2)(ii) or (iii)                 considered made available in 2003 or 2004 be-
                                                                   of this section. Where no method of                       fore a payment is made and no amount is in-
                                                                   payment is elected, the entire amount                     cludible in the gross income of L until dis-
                                                                   deferred will be includible in the gross                  tributions commence. The annual install-
                                                                   income of the participant or bene-                        ment payable in 2004 will be includible in L’s
                                                                   ficiary when the amounts first become                     gross income in 2004.
                                                                   made available in accordance with a                         Example 3. (i) Facts. The facts are the same
                                                                                                                             as in Example 1, except that eligible Plan X
                                                                   participant’s initial or additional elec-
                                                                                                                             also provides that those participants who are
                                                                   tions to defer under paragraphs                           receiving distributions in 10 annual install-
                                                                   (c)(2)(ii) and (iii) of this section, unless
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                                                                                                                             ments may, at any time and without restric-
                                                                   the eligible plan provides for a default                  tion, elect to receive a cash out of all re-
                                                                   method of payment (in which case                          maining installments. Participant M elects

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                                                                   Internal Revenue Service, Treasury                                                              § 1.457–8
                                                                   to receive a distribution in 10 annual install-           date under the plan. Therefore, the plan is
                                                                   ments commencing in 2004.                                 not precluded from allowing N to make the
                                                                     (ii) Conclusion. M’s total account balance,             additional deferral election. However, N can
                                                                   representing the total of the amounts de-                 make no further election to defer distribu-
                                                                   ferred under the plan, is considered made                 tions beyond age 65 (or accelerate distribu-
                                                                   available and is includible in M’s gross in-              tion before age 65) because this additional
                                                                   come in 2004.                                             deferral election can only be made once.
                                                                     Example 4. (i) Facts. The facts are the same
                                                                                                                             [T.D. 9075, 68 FR 41240, July 11, 2003; 68 FR
                                                                   as in Example 3, except that, instead of pro-
                                                                                                                             51447, Aug. 27, 2003]
                                                                   viding for an unrestricted cashout of remain-
                                                                   ing payments, the plan provides that partici-
                                                                   pants or beneficiaries who are receiving dis-
                                                                                                                             § 1.457–8 Funding rules for eligible
                                                                   tributions in 10 annual installments may ac-
                                                                                                                                   plans.
                                                                   celerate the payment of the amount remain-                   (a) Eligible governmental plans—(1) In
                                                                   ing payable to the participant upon the oc-               general. In order to be an eligible gov-
                                                                   currence of an unforeseeable emergency as                 ernmental plan, all amounts deferred
                                                                   described in § 1.457–6(c)(1) in an amount not             under the plan, all property and rights
                                                                   exceeding that described in § 1.457–6(c)(2).
                                                                     (ii) Conclusion. No amount is considered
                                                                                                                             purchased with such amounts, and all
                                                                   made available to participant M on account                income attributable to such amounts,
                                                                   of M’s right to accelerate payments upon the              property, or rights, must be held in
                                                                   occurrence of an unforeseeable emergency.                 trust for the exclusive benefit of par-
                                                                     Example 5. (i) Facts. Eligible Plan Y of a              ticipants and their beneficiaries. A
                                                                   tax-exempt entity provides that distribu-                 trust described in this paragraph (a)
                                                                   tions will commence 60 days after a partici-              that also meets the requirements of
                                                                   pant’s severance from employment unless                   §§ 1.457–3 through 1.457–10 is treated as
                                                                   the participant elects, within a 30-day win-
                                                                   dow period following severance from employ-
                                                                                                                             an organization exempt from tax under
                                                                   ment, to defer distributions to a later date              section 501(a), and a participant’s or
                                                                   (but no later than the year following the cal-            beneficiary’s interest in amounts in
                                                                   endar year the participant attains age 701⁄2).            the trust is includible in the gross in-
                                                                   The plan provides that a participant who has              come of the participants and bene-
                                                                   elected to defer distributions to a later date            ficiaries only to the extent, and at the
                                                                   may make an election as to form of distribu-              time, provided for in section 457(a) and
                                                                   tion at any time prior to the 30th day before             §§ 1.457–4 through 1.457–10.
                                                                   distributions are to commence.
                                                                     (ii) Conclusion. No amount is considered                   (2) Trust requirement. (i) A trust de-
                                                                   made available prior to the date distribu-                scribed in this paragraph (a) must be
                                                                   tions are to commence by reason of a partici-             established pursuant to a written
                                                                   pant’s right to defer or make an election as              agreement that constitutes a valid
                                                                   to the form of distribution.                              trust under State law. The terms of the
                                                                     Example 6. (i) Facts. The facts are the same            trust must make it impossible, prior to
                                                                   as in Example 1, except that the plan also                the satisfaction of all liabilities with
                                                                   permits participants who have made an ini-
                                                                                                                             respect to participants and their bene-
                                                                   tial election to defer distribution to make
                                                                   one additional deferral election at any time              ficiaries, for any part of the assets and
                                                                   prior to the date distributions are scheduled             income of the trust to be used for, or
                                                                   to commence. Participant N has a severance                diverted to, purposes other than for the
                                                                   from employment at age 50. The next day,                  exclusive benefit of participants and
                                                                   during the 30-day period provided in the                  their beneficiaries.
                                                                   plan, N elects to receive distribution in the                (ii) Amounts deferred under an eligi-
                                                                   form of 10 annual installment payments be-                ble governmental plan must be trans-
                                                                   ginning at age 55. Two weeks later, within
                                                                                                                             ferred to a trust within a period that is
                                                                   the 30-day window period, N makes a new
                                                                   election permitted under the plan to receive              not longer than is reasonable for the
                                                                   10 annual installment payments beginning at               proper administration of the partici-
                                                                   age 60 (instead of age 55). When N is age 59,             pant accounts (if any). For purposes of
                                                                   N elects under the additional deferral elec-              this requirement, the plan may provide
                                                                   tion provisions, to defer distributions until             for amounts deferred for a participant
                                                                   age 65.                                                   under the plan to be transferred to the
                                                                     (ii) Conclusion. In this example, N’s elec-             trust within a specified period after the
                                                                   tion to defer distributions until age 65 is a
                                                                                                                             date the amounts would otherwise have
                                                                   valid election. The two elections N makes
                                                                   during the 30-day window period are not ad-               been paid to the participant. For exam-
                                                                                                                             ple, the plan could provide for amounts
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                                                                   ditional deferral elections described in para-
                                                                   graph (c)(2)(iii) of this section because they            deferred under the plan at the election
                                                                   are made before the first permissible payout              of the participant to be contributed to

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                                                                   § 1.457–8                                                               26 CFR Ch. I (4–1–12 Edition)

                                                                   the trust within 15 business days fol-                    the requirements of § 1.408–2(e) in con-
                                                                   lowing the month in which these                           nection with a qualified trust (or cus-
                                                                   amounts would otherwise have been                         todial account or annuity contract)
                                                                   paid to the participant.                                  under section 401(a), that person is
                                                                     (3) Custodial accounts and annuity con-                 deemed to satisfy the requirements of
                                                                   tracts treated as trusts—(i) In general.                  this paragraph (a)(3)(ii)(B).
                                                                   For purposes of the trust requirement                        (iii) Annuity contracts. An annuity
                                                                   of this paragraph (a), custodial ac-                      contract is treated as a trust for pur-
                                                                   counts and annuity contracts described                    poses of section 457(g)(1) and paragraph
                                                                   in section 401(f) that satisfy the re-                    (a)(1) of this section if the contract is
                                                                   quirements of this paragraph (a)(3) are                   an annuity contract, as defined in sec-
                                                                   treated as trusts under rules similar to                  tion 401(g), that has been issued by an
                                                                   the rules of section 401(f). Therefore,                   insurance company qualified to do
                                                                   the provisions of § 1.401(f)–1(b) will gen-               business in the State, and the contract
                                                                   erally apply to determine whether a                       meets the requirements of paragraphs
                                                                   custodial account or an annuity con-                      (a)(1) and (2) of this section, other than
                                                                   tract is treated as a trust. The use of a                 the requirement that it be a trust. An
                                                                   custodial account or annuity contract                     annuity contract does not include a
                                                                   as part of an eligible governmental                       life, health or accident, property, cas-
                                                                   plan does not preclude the use of a                       ualty, or liability insurance contract.
                                                                   trust or another custodial account or                        (4) Combining assets. [Reserved]
                                                                   annuity contract as part of the same                         (b) Eligible plans maintained by tax-ex-
                                                                   plan, provided that all such vehicles                     empt entity—(1) General rule. In order to
                                                                   satisfy the requirements of section                       be an eligible plan of a tax-exempt en-
                                                                   457(g)(1) and (3) and paragraphs (a)(1)                   tity, the plan must be unfunded and
                                                                   and (2) of this section and that all as-                  plan assets must not be set aside for
                                                                   sets and income of the plan are held in                   participants or their beneficiaries.
                                                                   such vehicles.                                            Under section 457(b)(6) and this para-
                                                                     (ii) Custodial accounts—(A) In general.                 graph (b), an eligible plan of a tax-ex-
                                                                   A custodial account is treated as a                       empt entity must provide that all
                                                                   trust, for purposes of section 457(g)(1)                  amounts deferred under the plan, all
                                                                   and paragraphs (a)(1) and (2) of this                     property and rights to property (in-
                                                                   section, if the custodian is a bank, as                   cluding rights as a beneficiary of a con-
                                                                   described in section 408(n), or a person                  tract providing life insurance protec-
                                                                   who meets the nonbank trustee re-                         tion) purchased with such amounts,
                                                                   quirements of paragraph (a)(3)(ii)(B) of                  and all income attributable to such
                                                                   this section, and the account meets the                   amounts, property, or rights, must re-
                                                                   requirements of paragraphs (a)(1) and                     main (until paid or made available to
                                                                   (2) of this section, other than the re-                   the participant or beneficiary) solely
                                                                   quirement that it be a trust.                             the property and rights of the eligible
                                                                     (B) Nonbank trustee status. The custo-                  employer (without being restricted to
                                                                   dian of a custodial account may be a                      the provision of benefits under the
                                                                   person other than a bank only if the                      plan), subject only to the claims of the
                                                                   person demonstrates to the satisfac-                      eligible employer’s general creditors.
                                                                   tion of the Commissioner that the                            (2) Additional requirements. For pur-
                                                                   manner in which the person will ad-                       poses of paragraph (b)(1) of this sec-
                                                                   minister the custodial account will be                    tion, the plan must be unfunded re-
                                                                   consistent with the requirements of                       gardless of whether or not the amounts
                                                                   section 457(g)(1) and (3). To do so, the                  were deferred pursuant to a salary re-
                                                                   person must demonstrate that the re-                      duction agreement between the eligible
                                                                   quirements of § 1.408–2(e)(2) through (6)                 employer and the participant. Any
                                                                   (relating to nonbank trustees) are met.                   funding arrangement under an eligible
                                                                   The written application must be sent                      plan of a tax-exempt entity that sets
                                                                   to the address prescribed by the Com-                     aside assets for the exclusive benefit of
                                                                   missioner in the same manner as pre-                      participants violates this requirement,
                                                                   scribed under § 1.408–2(e). To the extent                 and amounts deferred are generally im-
                                                                   that a person has already dem-                            mediately includible in the gross in-
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                                                                   onstrated to the satisfaction of the                      come of plan participants and bene-
                                                                   Commissioner that the person satisfies                    ficiaries. Nothing in this paragraph (b)

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                                                                   Internal Revenue Service, Treasury                                                             § 1.457–10

                                                                   prohibits an eligible plan from permit-                   nate future deferrals for existing par-
                                                                   ting participants and their bene-                         ticipants or to limit participation to
                                                                   ficiaries to make an election among                       existing participants and employees.
                                                                   different investment options available                    An eligible plan may also contain pro-
                                                                   under the plan, such as an election af-                   visions that permit plan termination
                                                                   fecting the investment of the amounts                     and permit amounts deferred to be dis-
                                                                   described in paragraph (b)(1) of this                     tributed on termination. In order for a
                                                                   section.                                                  plan to be considered terminated,
                                                                   [T.D. 9075, 68 FR 41240, July 11, 2003; 68 FR             amounts deferred under an eligible
                                                                   51447, Aug. 27, 2003]                                     plan must be distributed to all plan
                                                                                                                             participants and beneficiaries as soon
                                                                   § 1.457–9 Effect on eligible plans when                   as administratively practicable after
                                                                        not administered in accordance                       termination of the eligible plan. The
                                                                        with eligibility requirements.                       mere provision for, and making of, dis-
                                                                      (a) Eligible governmental plans. A plan                tributions to participants or bene-
                                                                   of a State ceases to be an eligible gov-                  ficiaries upon a plan termination will
                                                                   ernmental plan on the first day of the                    not cause an eligible plan to cease to
                                                                   first plan year beginning more than 180                   satisfy the requirements of section
                                                                   days after the date on which the Com-                     457(b) or the regulations.
                                                                   missioner notifies the State in writing                      (2) Employers that cease to be eligible
                                                                   that the plan is being administered in                    employers—(i) Plan not terminated. An
                                                                   a manner that is inconsistent with one                    eligible employer that ceases to be an
                                                                   or more of the requirements of §§ 1.457–                  eligible employer may no longer main-
                                                                   3 through 1.457–8 or 1.447–10. However,                   tain an eligible plan. If the employer
                                                                   the plan may correct the plan incon-                      was a tax-exempt entity and the plan is
                                                                   sistencies specified in the written noti-                 not terminated as permitted under
                                                                   fication before the first day of that                     paragraph (a)(2)(ii) of this section, the
                                                                   plan year and continue to maintain                        tax consequences to participants and
                                                                   plan eligibility. If a plan ceases to be                  beneficiaries in the previously eligible
                                                                   an      eligible    governmental      plan,               (unfunded) plan of an ineligible em-
                                                                   amounts subsequently deferred by par-                     ployer are determined in accordance
                                                                   ticipants will be includible in income                    with either section 451 if the employer
                                                                   when deferred, or, if later, when the                     becomes an entity other than a State
                                                                   amounts deferred cease to be subject to                   or § 1.457–11 if the employer becomes a
                                                                   a substantial risk of forfeiture, as pro-                 State. If the employer was a State and
                                                                   vided at § 1.457–11. Amounts deferred                     the plan is neither terminated as per-
                                                                   before the date on which the plan                         mitted under paragraph (a)(2)(ii) of this
                                                                   ceases to be an eligible governmental                     section nor transferred to another eli-
                                                                   plan, and any earnings thereon, will be                   gible plan of that State as permitted
                                                                   treated as if the plan continues to be                    under paragraph (b) of this section, the
                                                                   an eligible governmental plan and will                    tax consequences to participants in the
                                                                   not be includible in participant’s or                     previously eligible governmental plan
                                                                   beneficiary’s gross income until paid to                  of an ineligible employer, the assets of
                                                                   the participant or beneficiary.                           which are held in trust pursuant to
                                                                      (b) Eligible plans of tax-exempt entities.             § 1.457–8(a), are determined in accord-
                                                                   A plan of a tax-exempt entity ceases to                   ance with section 402(b) (section 403(c)
                                                                   be an eligible plan on the first day that                 in the case of an annuity contract) and
                                                                   the plan fails to satisfy one or more of                  the trust is no longer to be treated as
                                                                   the requirements of §§ 1.457–3 through                    a trust that is exempt from tax under
                                                                   1.457–8, or § 1.457–10. See § 1.457–11 for                section 501(a).
                                                                   rules regarding the treatment of an in-                      (ii) Plan termination. As an alter-
                                                                   eligible plan.                                            native to determining the tax con-
                                                                   [T.D. 9075, 68 FR 41240, July 11, 2003; 68 FR             sequences to the plan and participants
                                                                   51447, Aug. 27, 2003]                                     under paragraph (a)(2)(i) of this sec-
                                                                                                                             tion, the employer may terminate the
                                                                   § 1.457–10 Miscellaneous provisions.                      plan and distribute the amounts de-
                                                                      (a) Plan terminations and frozen                       ferred (and all plan assets) to all plan
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                                                                   plans—(1) In general. An eligible em-                     participants as soon as administra-
                                                                   ployer may amend its plan to elimi-                       tively practicable in accordance with

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                                                                   § 1.457–10                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                   paragraph (a)(1) of this section. Such                    in the gross income of the participant or
                                                                   distribution may include eligible roll-                   beneficiary in the year distributed.
                                                                   over distributions in the case of a plan                    Example 4. (i) Facts. The facts are the same
                                                                   that was an eligible governmental                         as in Example 3, except that Employer Z de-
                                                                   plan. In addition, if the employer is a                   cides to maintain instead of terminate the
                                                                   State, another alternative to deter-                      plan.
                                                                                                                               (ii) Conclusion. If Employer Z maintains
                                                                   mining the tax consequences under
                                                                                                                             the plan, the tax consequences to partici-
                                                                   paragraph (a)(2)(i) of this section is to
                                                                                                                             pants and beneficiaries in the plan will
                                                                   transfer the assets of the eligible gov-                  thereafter be determined in accordance with
                                                                   ernmental plan to an eligible govern-                     section 451.
                                                                   mental plan of another eligible em-
                                                                   ployer within the same State under the                      (b) Plan-to-plan transfers—(1) General
                                                                   plan-to-plan transfer rules of para-                      rule. An eligible governmental plan
                                                                   graph (b) of this section.                                may provide for the transfer of
                                                                     (3) Examples. The provisions of this                    amounts deferred by a participant or
                                                                   paragraph (a) are illustrated by the fol-                 beneficiary to another eligible govern-
                                                                   lowing examples:                                          mental plan if the conditions in para-
                                                                      Example 1. (i) Facts. Employer Y, a corpora-           graphs (b)(2), (3), or (4) of this section
                                                                   tion that owns a State hospital, sponsors an              are met. An eligible plan of a tax-ex-
                                                                   eligible governmental plan funded through a               empt entity may provide for transfers
                                                                   trust. Employer Y is acquired by a for-profit             of amounts deferred by a participant to
                                                                   hospital and Employer Y ceases to be an eli-              another eligible plan of a tax-exempt
                                                                   gible employer under section 457(e)(1) or
                                                                   § 1.457–2(e). Employer Y terminates the plan
                                                                                                                             entity if the conditions in paragraph
                                                                   and, during the next 6 months, distributes to             (b)(5) of this section are met. In addi-
                                                                   participants and beneficiaries all amounts                tion, an eligible governmental plan
                                                                   deferred that were under the plan.                        may accept transfers from another eli-
                                                                      (ii) Conclusion. The termination and dis-              gible governmental plan as described in
                                                                   tribution does not cause the plan to fail to              the first sentence of this paragraph
                                                                   be an eligible governmental plan. Amounts
                                                                   that are distributed as eligible rollover dis-
                                                                                                                             (b)(1), and an eligible plan of a tax-ex-
                                                                   tributions may be rolled over to an eligible              empt entity may accept transfers from
                                                                   retirement      plan    described   in   section          another eligible plan of a tax-exempt
                                                                   402(c)(8)(B).                                             entity as described in the preceding
                                                                      Example 2. (i) Facts. The facts are the same           sentence. However, a State may not
                                                                   as in Example 1, except that Employer Y de-               transfer the assets of its eligible gov-
                                                                   cides to continue to maintain the plan.
                                                                                                                             ernmental plan to a tax-exempt enti-
                                                                      (ii) Conclusion. If Employer Y continues to
                                                                   maintain the plan, the tax consequences to                ty’s eligible plan and the plan of a tax-
                                                                   participants and beneficiaries will be deter-             exempt entity may not accept such a
                                                                   mined in accordance with either section                   transfer. Similarly, a tax-exempt enti-
                                                                   402(b) if the compensation deferred is funded             ty may not transfer the assets of its el-
                                                                   through a trust, section 403(c) if the com-               igible plan to an eligible governmental
                                                                   pensation deferred is funded through annuity              plan and an eligible governmental plan
                                                                   contracts, or § 1.457–11 if the compensation
                                                                   deferred is not funded through a trust or an-
                                                                                                                             may not accept such a transfer. In ad-
                                                                   nuity contract. In addition, if Employer Y                dition, if the conditions in paragraph
                                                                   continues to maintain the plan, the trust                 (b)(4) of this section (relating to per-
                                                                   will no longer be treated as exempt from tax              missive past service credit and repay-
                                                                   under section 501(a).                                     ments under section 415) are met, an el-
                                                                      Example 3. (i) Facts. Employer Z, a corpora-           igible governmental plan of a State
                                                                   tion that owns a tax-exempt hospital, spon-
                                                                                                                             may provide for the transfer of
                                                                   sors an unfunded eligible plan. Employer Z is
                                                                   acquired by a for-profit hospital and is no               amounts deferred by a participant or
                                                                   longer an eligible employer under section                 beneficiary to a qualified plan (under
                                                                   457(e)(1) or § 1.457–2(e). Employer Z termi-              section 401(a)) maintained by a State.
                                                                   nates the plan and distributes all amounts                However, a qualified plan may not
                                                                   deferred under the eligible plan to partici-              transfer assets to an eligible govern-
                                                                   pants and beneficiaries within a one-year pe-             mental plan or to an eligible plan of a
                                                                   riod.
                                                                      (ii) Conclusion. Distributions under the
                                                                                                                             tax-exempt entity, and an eligible gov-
                                                                                                                             ernmental plan or the plan of a tax-ex-
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                                                                   plan are treated as made under an eligible
                                                                   plan of a tax-exempt entity and the distribu-             empt entity may not accept such a
                                                                   tions of the amounts deferred are includible              transfer.

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                                                                   Internal Revenue Service, Treasury                                                             § 1.457–10

                                                                     (2) Requirements for post-severance                     the same employer. A transfer under
                                                                   plan-to-plan transfers among eligible gov-                paragraph (b)(1) of this section from an
                                                                   ernmental plans. A transfer under para-                   eligible governmental plan to another
                                                                   graph (b)(1) of this section from an eli-                 eligible governmental plan is per-
                                                                   gible governmental plan to another eli-                   mitted if the following conditions are
                                                                   gible governmental plan is permitted if                   met—
                                                                   the following conditions are met—                           (i) The transfer is from an eligible
                                                                     (i) The transferor plan provides for                    governmental plan to another eligible
                                                                   transfers;                                                governmental plan of the same em-
                                                                     (ii) The receiving plan provides for                    ployer (and, for this purpose, the em-
                                                                   the receipt of transfers;                                 ployer is not treated as the same em-
                                                                     (iii) The participant or beneficiary                    ployer if the participant’s compensa-
                                                                   whose amounts deferred are being                          tion is paid by a different entity);
                                                                   transferred will have an amount de-                         (ii) The transferor plan provides for
                                                                   ferred immediately after the transfer                     transfers;
                                                                   at least equal to the amount deferred                       (iii) The receiving plan provides for
                                                                   with respect to that participant or ben-                  the receipt of transfers;
                                                                   eficiary immediately before the trans-
                                                                                                                               (iv) The participant or beneficiary
                                                                   fer; and
                                                                                                                             whose amounts deferred are being
                                                                     (iv) In the case of a transfer for a par-
                                                                                                                             transferred will have an amount de-
                                                                   ticipant, the participant has had a sev-
                                                                                                                             ferred immediately after the transfer
                                                                   erance from employment with the
                                                                                                                             at least equal to the amount deferred
                                                                   transferring employer and is per-
                                                                                                                             with respect to that participant or ben-
                                                                   forming services for the entity main-
                                                                                                                             eficiary immediately before the trans-
                                                                   taining the receiving plan.
                                                                                                                             fer; and
                                                                     (3) Requirements for plan-to-plan trans-
                                                                                                                               (v) The participant or beneficiary
                                                                   fers of all plan assets of eligible govern-
                                                                                                                             whose deferred amounts are being
                                                                   mental plan. A transfer under paragraph
                                                                                                                             transferred is not eligible for addi-
                                                                   (b)(1) of this section from an eligible
                                                                                                                             tional annual deferrals in the receiving
                                                                   governmental plan to another eligible
                                                                                                                             plan unless the participant or bene-
                                                                   governmental plan is permitted if the
                                                                                                                             ficiary is performing services for the
                                                                   following conditions are met—
                                                                                                                             entity maintaining the receiving plan.
                                                                     (i) The transfer is from an eligible
                                                                   governmental plan to another eligible                       (5) Requirements for post-severance
                                                                   governmental plan within the same                         plan-to-plan transfers among eligible
                                                                   State;                                                    plans of tax-exempt entities. A transfer
                                                                     (ii) All of the assets held by the                      under paragraph (b)(1) of this section
                                                                   transferor plan are transferred;                          from an eligible plan of a tax-exempt
                                                                     (iii) The transferor plan provides for                  employer to another eligible plan of a
                                                                   transfers;                                                tax-exempt employer is permitted if
                                                                     (iv) The receiving plan provides for                    the following conditions are met—
                                                                   the receipt of transfers;                                   (i) The transferor plan provides for
                                                                     (v) The participant or beneficiary                      transfers;
                                                                   whose amounts deferred are being                            (ii) The receiving plan provides for
                                                                   transferred will have an amount de-                       the receipt of transfers;
                                                                   ferred immediately after the transfer                       (iii) The participant or beneficiary
                                                                   at least equal to the amount deferred                     whose amounts deferred are being
                                                                   with respect to that participant or ben-                  transferred will have an amount de-
                                                                   eficiary immediately before the trans-                    ferred immediately after the transfer
                                                                   fer; and                                                  at least equal to the amount deferred
                                                                     (vi) The participants or beneficiaries                  with respect to that participant or ben-
                                                                   whose deferred amounts are being                          eficiary immediately before the trans-
                                                                   transferred are not eligible for addi-                    fer; and
                                                                   tional annual deferrals in the receiving                    (iv) In the case of a transfer for a par-
                                                                   plan unless they are performing serv-                     ticipant, the participant has had a sev-
                                                                   ices for the entity maintaining the re-                   erance from employment with the
                                                                   ceiving plan.                                             transferring employer and is per-
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                                                                     (4) Requirements for plan-to-plan trans-                forming services for the entity main-
                                                                   fers among eligible governmental plans of                 taining the receiving plan.

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                                                                   § 1.457–10                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                     (6) Treatment of amount transferred fol-                the transfer and acceptance of the transfer
                                                                   lowing a plan-to-plan transfer between el-                (and the other requirements of paragraph
                                                                   igible plans. Following a transfer of any                 (b)(1) of this section are satisfied), then the
                                                                                                                             requirements of paragraph (b)(2) of this sec-
                                                                   amount between eligible plans under                       tion are satisfied and, thus, the transfer will
                                                                   paragraphs (b)(1) through (b)(5) of this                  not cause either plan to violate the require-
                                                                   section—                                                  ments of section 457 or these regulations.
                                                                     (i) The transferred amount is subject                      Example 3. (i) Facts. City Employer Z, a
                                                                   to the restrictions of § 1.457–6 (relating                hospital, sponsors an eligible governmental
                                                                   to when distributions are permitted to                    plan. City Employer Z is located in State B.
                                                                   be made to a participant under an eli-                    All of the assets of City Employer Z are
                                                                   gible plan) in the receiving plan in the                  being acquired by a tax-exempt hospital.
                                                                                                                             City Employer Z, in accordance with the
                                                                   same manner as if the transferred                         plan-to-plan transfer rules of paragraph (b)
                                                                   amount had been originally been de-                       of this section, would like to transfer the
                                                                   ferred under the receiving plan if the                    total amount of assets deferred under City
                                                                   participant is performing services for                    Employer Z’s eligible governmental plan to
                                                                   the entity maintaining the receiving                      the acquiring tax-exempt entity’s eligible
                                                                   plan, and                                                 plan.
                                                                     (ii) In the case of a transfer between                     (ii) Conclusion. City Employer Z may not
                                                                   eligible plans of tax-exempt entities,                    permit participants to transfer the amounts
                                                                                                                             to the eligible plan of the tax-exempt entity.
                                                                   except as otherwise determined by the                     In addition, because the amounts deferred
                                                                   Commissioner, the transferred amount                      would no longer be held in trust for the ex-
                                                                   is subject to § 1.457–7(c)(2) (relating to                clusive benefit of participants and their
                                                                   when amounts are considered to be                         beneficiaries, the transfer would violate the
                                                                   made available under an eligible plan                     exclusive benefit rule of section 457(g) and
                                                                   of a tax-exempt entity) in the same                       § 1.457–8(a).
                                                                   manner as if the elections made by the                       Example 4. (i) Facts. The facts are the same
                                                                                                                             as in Example 3, except that City Employer
                                                                   participant or beneficiary under the                      Z, instead of transferring all of its assets to
                                                                   transferor plan had been made under                       the eligible plan of the tax-exempt entity,
                                                                   the receiving plan.                                       decides to transfer all of the amounts de-
                                                                     (7) Examples. The provisions of para-                   ferred under City Z’s eligible governmental
                                                                   graphs (b)(1) through (6) of this section                 plan to the eligible governmental plan of
                                                                   are illustrated by the following exam-                    County B in which City Z is located. County
                                                                   ples:                                                     B’s eligible plan does not cover employees of
                                                                                                                             City Z, but is willing to allow the assets of
                                                                     Example 1. (i) Facts. Participant A, the                City Z’s plan to be transferred to County B’s
                                                                   president of City X’s hospital, has accepted a            plan, a related state government entity, also
                                                                   position with another hospital which is a                 located in State B.
                                                                   tax-exempt entity. A participates in the eli-                (ii) Conclusion. If City Employer Z’s (trans-
                                                                   gible governmental plan of City X. A would                feror) eligible governmental plan provides
                                                                   like to transfer the amounts deferred under               for such transfer and the eligible govern-
                                                                   City X’s eligible governmental plan to the                mental plan of County B permits the accept-
                                                                   eligible plan of the tax-exempt hospital.                 ance of such a transfer (and the other re-
                                                                     (ii) Conclusion. City X’s plan may not                  quirements of paragraph (b)(1) of this section
                                                                   transfer A’s amounts deferred to the tax-ex-              are satisfied), then the requirements of para-
                                                                   empt employer’s eligible plan. In addition,               graph (b)(3) of this section are satisfied and,
                                                                   because the amounts deferred would no                     thus, City Employer Z may transfer the
                                                                   longer be held in trust for the exclusive ben-            total amounts deferred under its eligible
                                                                   efit of participants and their beneficiaries,             governmental plan, prior to termination of
                                                                   the transfer would violate the exclusive ben-             that plan, to the eligible governmental plan
                                                                   efit rule of section 457(g) and § 1.457–8(a).             maintained by County B. However, the par-
                                                                     Example 2. (i) Facts. County M, located in              ticipants of City Employer Z whose deferred
                                                                   State S, operates several health clinics and              amounts are being transferred are not eligi-
                                                                   maintains an eligible governmental plan for               ble to participate in the eligible govern-
                                                                   employees of those clinics. One of the clinics            mental plan of County B, the receiving plan,
                                                                   operated by County M is being acquired by a               unless they are performing services for Coun-
                                                                   hospital operated by State S, and employees               ty B.
                                                                   of that clinic will become employees of State                Example 5. (i) Facts. State C has an eligible
                                                                   S. County M permits those employees to                    governmental plan. Employees of City U in
                                                                   transfer their balances under County M’s eli-             State C are among the eligible employees for
                                                                   gible governmental plan to the eligible gov-              State C’s plan and City U decides to adopt
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                                                                   ernmental plan of State S.                                another eligible governmental plan only for
                                                                     (ii) Conclusion. If the eligible governmental           its employees. State C decides to allow em-
                                                                   plans of County M and State S provide for                 ployees to elect to transfer all of the

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                                                                   Internal Revenue Service, Treasury                                                             § 1.457–10
                                                                   amounts deferred for an employee under                    fer assets to Plan S for the purchase of serv-
                                                                   State C’s eligible governmental plan to City              ice credit under Plan S and does not permit
                                                                   U’s eligible governmental plan.                           the amount transferred to exceed the
                                                                     (ii) Conclusion. If State C’s (transferor) eli-         amount necessary to fund the benefit result-
                                                                   gible governmental plan provides for such                 ing from the service credit. Although not re-
                                                                   transfer and the eligible governmental plan               quired to do so, Plan X allows Employee A to
                                                                   of City U permits the acceptance of such a                transfer assets to Plan S to provide a service
                                                                   transfer (and the other requirements of para-             benefit under Plan S.
                                                                   graph (b)(1) of this section are satisfied),                (ii) Conclusion. The transfer is permitted
                                                                   then the requirements of paragraph (b)(4) of              under this paragraph (b)(8).
                                                                   this section are satisfied and, thus, State C
                                                                   may transfer the total amounts deferred                     (c) Qualified domestic relations orders
                                                                   under its eligible governmental plan to the               under eligible plans—(1) General rule. An
                                                                   eligible governmental plan maintained by                  eligible plan does not become an ineli-
                                                                   City U.                                                   gible plan described in section 457(f)
                                                                      (8) Purchase of permissive service credit              solely because its administrator or
                                                                   by plan-to-plan transfers from an eligible                sponsor complies with a qualified do-
                                                                   governmental plan to a qualified plan—(i)                 mestic relations order as defined in
                                                                   General rule. An eligible governmental                    section 414(p), including an order re-
                                                                   plan of a State may provide for the                       quiring the distribution of the benefits
                                                                   transfer of amounts deferred by a par-                    of a participant to an alternate payee
                                                                   ticipant or beneficiary to a defined                      in advance of the general rules for eli-
                                                                   benefit governmental plan (as defined                     gible plan distributions under § 1.457–6.
                                                                   in section 414(d)), and no amount shall                   If a distribution or payment is made
                                                                   be includible in gross income by reason                   from an eligible plan to an alternate
                                                                   of the transfer, if the conditions in                     payee pursuant to a qualified domestic
                                                                   paragraph (b)(8)(ii) of this section are                  relations order, rules similar to the
                                                                   met. A transfer under this paragraph                      rules of section 402(e)(1)(A) shall apply
                                                                   (b)(8) is not treated as a distribution                   to the distribution or payment.
                                                                   for purposes of § 1.457–6. Therefore, such                  (2) Examples. The provisions of this
                                                                   a transfer may be made before sever-                      paragraph (c) are illustrated by the fol-
                                                                   ance from employment.                                     lowing examples:
                                                                      (ii) Conditions for plan-to-plan trans-
                                                                   fers from an eligible governmental plan to                  Example 1. (i) Facts. Participant C and C’s
                                                                   a qualified plan. A transfer may be                       spouse D are divorcing. C is employed by
                                                                                                                             State S and is a participant in an eligible
                                                                   made under this paragraph (b)(8) only
                                                                                                                             plan maintained by State S. C has an ac-
                                                                   if the transfer is either—                                count valued at $100,000 under the plan. Pur-
                                                                      (A) For the purchase of permissive                     suant to the divorce, a court issues a quali-
                                                                   service credit (as defined in section                     fied domestic relations order on September
                                                                   415(n)(3)(A)) under the receiving de-                     1, 2003 that allocates 50 percent of C’s $100,000
                                                                   fined benefit governmental plan; or                       plan account to D and specifically provides
                                                                      (B) A repayment to which section 415                   for an immediate distribution to D of D’s
                                                                   does not apply by reason of section                       share within 6 months of the order. Payment
                                                                   415(k)(3).                                                is made to D in January of 2004.
                                                                      (iii) Example. The provisions of this                    (ii) Conclusion. State S’s eligible plan does
                                                                                                                             not become an ineligible plan described in
                                                                   paragraph (b)(8) are illustrated by the
                                                                                                                             section 457(f) and § 1.457–11 solely because its
                                                                   following example:                                        administrator or sponsor complies with the
                                                                     Example. (i) Facts. Plan X is an eligible gov-          qualified domestic relations order requiring
                                                                   ernmental plan maintained by County Y for                 the immediate distribution to D in advance
                                                                   its employees. Plan X provides for distribu-              of the general rules for eligible plan distribu-
                                                                   tions only in the event of death, an unfore-              tions under § 1.457–6. In accordance with sec-
                                                                   seeable emergency, or severance from em-                  tion 402(e)(1)(A), D (not C) must include the
                                                                   ployment with County Y (including retire-                 distribution in gross income. The distribu-
                                                                   ment from County Y). Plan S is a qualified                tion is includible in D’s gross income in 2004.
                                                                   defined benefit plan maintained by State T                If the qualified domestic relations order were
                                                                   for its employees. County Y is within State               to provide for distribution to D at a future
                                                                   T. Employee A is an employee of County Y                  date, amounts deferred attributable to D’s
                                                                   and is a participant in Plan X. Employee A                share will be includible in D’s gross income
                                                                   previously was an employee of State T and is              when paid to D.
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                                                                   still entitled to benefits under Plan S. Plan               Example 2. (i) Facts. The facts are the same
                                                                   S includes provisions allowing participants               as in Example 1, except that S is a tax-ex-
                                                                   in certain plans, including Plan X, to trans-             empt entity, instead of a State.

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                                                                   § 1.457–10                                                              26 CFR Ch. I (4–1–12 Edition)
                                                                     (ii) Conclusion. State S’s eligible plan does           made under other eligible govern-
                                                                   not become an ineligible plan described in                mental plans and a separate account
                                                                   section 457(f) and § 1.457–11 solely because its
                                                                                                                             for amounts attributable to other eligi-
                                                                   administrator or sponsor complies with the
                                                                   qualified domestic relations order requiring              ble rollover distributions), but this re-
                                                                   the immediate distribution to D in advance                quirement is not satisfied if any such
                                                                   of the general rules for eligible plan distribu-          separate account includes any amount
                                                                   tions under § 1.457–6. In accordance with sec-            that is not attributable to an eligible
                                                                   tion 402(e)(1)(A), D (not C) must include the             rollover distribution.
                                                                   distribution in gross income. The distribu-
                                                                   tion is includible in D’s gross income in 2004,             (3) Example. The provisions of this
                                                                   assuming that the plan did not make the dis-              paragraph (e) are illustrated by the fol-
                                                                   tribution available to D in 2003. If the quali-           lowing example:
                                                                   fied domestic relations order were to provide
                                                                   for distribution to D at a future date,                     Example. (i) Facts. Plan T is an eligible gov-
                                                                   amounts deferred attributable to D’s share                ernmental plan that provides that employees
                                                                   would be includible in D’s gross income when              who are eligible to participate in Plan T may
                                                                   paid or made available to D.                              make rollover contributions to Plan T from
                                                                                                                             amounts distributed to an employee from an
                                                                      (d) Death benefits and life insurance                  eligible retirement plan. An eligible retire-
                                                                   proceeds. A death benefit plan under                      ment plan is defined in Plan T as another eli-
                                                                   section 457(e)(11) is not an eligible plan.               gible governmental plan, a qualified section
                                                                   In addition, no amount paid or made                       401(a) or 403(a) plan, or a section 403(b) con-
                                                                   available under an eligible plan as                       tract, or an individual retirement arrange-
                                                                   death benefits or life insurance pro-                     ment (IRA) that holds such amounts. Plan T
                                                                   ceeds is excludable from gross income                     requires rollover contributions to be paid by
                                                                   under section 101.                                        the eligible retirement plan directly to Plan
                                                                      (e) Rollovers to eligible governmental                 T (a direct rollover) or to be paid by the par-
                                                                   plans—(1) General rule. An eligible gov-                  ticipant within 60 days after the date on
                                                                   ernmental plan may accept contribu-                       which the participant received the amount
                                                                                                                             from the other eligible retirement plan. Plan
                                                                   tions that are eligible rollover dis-
                                                                                                                             T does not take rollover contributions into
                                                                   tributions (as defined in section                         account for purposes of the plan’s limits on
                                                                   402(c)(4)) made from another eligible                     amounts deferred that conform to § 1.457–4(c).
                                                                   retirement plan (as defined in section                    Rollover contributions paid to Plan T are in-
                                                                   402(c)(8)(B)) if the conditions in para-                  vested in the trust in the same manner as
                                                                   graph (e)(2) of this section are met.                     amounts deferred under Plan T and rollover
                                                                   Amounts contributed to an eligible                        contributions (and earnings thereon) are
                                                                   governmental plan as eligible rollover                    available for distribution to the participant
                                                                   distributions are not taken into ac-                      at the same time and in the same manner as
                                                                   count for purposes of the annual limit                    amounts deferred under Plan T. In addition,
                                                                   on annual deferrals by a participant in                   Plan T provides that, for each participant
                                                                   § 1.457–4(c) or § 1.457–5, but are otherwise              who makes a rollover contribution to Plan
                                                                   treated in the same manner as                             T, the Plan T record-keeper is to establish a
                                                                                                                             separate account for the participant’s roll-
                                                                   amounts deferred under section 457 for
                                                                                                                             over contributions. The record-keeper cal-
                                                                   purposes of §§ 1.457–3 through 1.457–9                    culates earnings and losses for investments
                                                                   and this section.                                         held in the rollover account separately from
                                                                      (2) Conditions for rollovers to an eligible            earnings and losses on other amounts held
                                                                   governmental plan. An eligible govern-                    under the plan and calculates disbursements
                                                                   mental plan that permits eligible roll-                   from and payments made to the rollover ac-
                                                                   over distributions made from another                      count separately from disbursements from
                                                                   eligible retirement plan to be paid into                  and payments made to other amounts held
                                                                   the eligible governmental plan is re-                     under the plan.
                                                                   quired under this paragraph (e)(2) to                       (ii) Conclusion. Plan T does not lose its sta-
                                                                   provide that it will separately account                   tus as an eligible governmental plan as a re-
                                                                   for any eligible rollover distributions                   sult of the receipt of rollover contributions.
                                                                   it receives. A plan does not fail to sat-                 The conclusion would not be different if the
                                                                                                                             Plan T record-keeper were to establish two
                                                                   isfy this requirement if it separately                    separate accounts, one of which is for the
                                                                   accounts for particular types of eligi-                   participant’s rollover contributions attrib-
                                                                   ble rollover distributions (for example,                  utable to annual deferrals that were made
                                                                   if it maintains a separate account for
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                                                                                                                             under an eligible governmental plan and the
                                                                   eligible rollover distributions attrib-                   other of which is for other rollover contribu-
                                                                   utable to annual deferrals that were                      tions.

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                                                                   Internal Revenue Service, Treasury                                                             § 1.457–11

                                                                     (f) Deemed IRAs under eligible govern-                    (1) A plan described in section 401(a)
                                                                   mental plans. See regulations under sec-                  which includes a trust exempt from tax
                                                                   tion 408(q) for guidance regarding the                    under section 501(a);
                                                                   treatment of separate accounts or an-                       (2) An annuity plan or contract de-
                                                                   nuities as individual retirement plans                    scribed in section 403;
                                                                   (IRAs).                                                     (3) That portion of any plan which
                                                                                                                             consists of a transfer of property de-
                                                                   [T.D. 9075, 68 FR 41240, July 11, 2003; 68 FR             scribed in section 83;
                                                                   51447, Aug. 27, 2003; T.D. 9319, 72 FR 16931,
                                                                                                                               (4) That portion of any plan which
                                                                   Apr. 5, 2007]
                                                                                                                             consists of a trust to which section
                                                                   § 1.457–11 Tax treatment of partici-                      402(b) applies; or
                                                                        pants if plan is not an eligible plan.                 (5) A qualified governmental excess
                                                                                                                             benefit arrangement described in sec-
                                                                     (a) In general. Under section 457(f), if                tion 415(m).
                                                                   an eligible employer provides for a de-                     (c) Amount included in income. The
                                                                   ferral of compensation under any                          amount included in gross income on
                                                                   agreement or arrangement that is an                       the applicable date under paragraphs
                                                                   ineligible plan—                                          (a)(1) and (a)(2) of this section is equal
                                                                     (1) Compensation deferred under the                     to the present value of the compensa-
                                                                   agreement or arrangement is includ-                       tion (including earnings to the extent
                                                                   ible in the gross income of the partici-                  provided in paragraph (a)(2) of this sec-
                                                                   pant or beneficiary for the first taxable                 tion) on that date. For purposes of ap-
                                                                   year in which there is no substantial                     plying section 72 on the applicable date
                                                                   risk of forfeiture (within the meaning                    under paragraphs (a)(3) and (4) of this
                                                                   of section 457(f)(3)(B)) of the rights to                 section, the participant is treated as
                                                                   such compensation;                                        having paid investment in the contract
                                                                     (2) If the compensation deferred is                     (or basis) to the extent that the de-
                                                                   subject to a substantial risk of for-                     ferred compensation has been taken
                                                                   feiture, the amount includible in gross                   into account by the participant in ac-
                                                                   income for the first taxable year in                      cordance with paragraphs (a)(1) and
                                                                   which there is no substantial risk of                     (a)(2) of this section.
                                                                   forfeiture includes earnings thereon to                     (d) Coordination of section 457(f) with
                                                                   the date on which there is no substan-                    section 83—(1) General rules. Under para-
                                                                   tial risk of forfeiture;                                  graph (b)(3) of this section, section
                                                                     (3) Earnings credited on the com-                       457(f) and paragraph (a) of this section
                                                                   pensation deferred under the agree-                       do not apply to that portion of any
                                                                   ment or arrangement that are not in-                      plan which consists of a transfer of
                                                                   cludible in gross income under para-                      property described in section 83. For
                                                                                                                             this purpose, a transfer of property de-
                                                                   graph (a)(2) of this section are includ-
                                                                                                                             scribed in section 83 means a transfer
                                                                   ible in the gross income of the partici-
                                                                                                                             of property to which section 83 applies.
                                                                   pant or beneficiary only when paid or
                                                                                                                             Section 457(f) and paragraph (a) of this
                                                                   made available to the participant or
                                                                                                                             section do not apply if the date on
                                                                   beneficiary, provided that the interest
                                                                                                                             which there is no substantial risk of
                                                                   of the participant or beneficiary in any                  forfeiture with respect to compensa-
                                                                   assets (including amounts deferred                        tion deferred under an agreement or ar-
                                                                   under the plan) of the entity spon-                       rangement that is not an eligible plan
                                                                   soring the agreement or arrangement                       is on or after the date on which there
                                                                   is not senior to the entity’s general                     is a transfer of property to which sec-
                                                                   creditors; and                                            tion 83 applies. However, section 457(f)
                                                                     (4) Amounts paid or made available                      and paragraph (a) of this section apply
                                                                   to a participant or beneficiary under                     if the date on which there is no sub-
                                                                   the agreement or arrangement are in-                      stantial risk of forfeiture with respect
                                                                   cludible in the gross income of the par-                  to compensation deferred under an
                                                                   ticipant or beneficiary under section                     agreement or arrangement that is not
                                                                   72, relating to annuities.                                an eligible plan precedes the date on
                                                                     (b) Exceptions. Paragraph (a) of this                   which there is a transfer of property to
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                                                                   section does not apply with respect                       which section 83 applies. If deferred
                                                                   to—                                                       compensation payable in property is

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                                                                   § 1.457–12                                                              26 CFR Ch. I (4–1–12 Edition)

                                                                   includible in gross income under sec-                     substantial risk of forfeiture with respect to
                                                                   tion 457(f), then, as provided in section                 compensation deferred under the arrange-
                                                                   72, the amount includible in gross in-                    ment.
                                                                                                                               Example 3. (i) Facts. In 2004, Z, a tax-exempt
                                                                   come when that property is later trans-                   entity, grants an option to acquire property
                                                                   ferred or made available to the service                   to employee C. The option lacks a readily as-
                                                                   provider is the excess of the value of                    certainable fair market value, within the
                                                                   the property at that time over the                        meaning of section 83(e)(3), has a value on
                                                                   amount previously included in gross in-                   the date of grant equal to $100,000, and is not
                                                                   come under section 457(f).                                subject to a substantial risk of forfeiture
                                                                     (2) Examples. The provisions of this                    (within the meaning of section 457(f)(3)(B)
                                                                   paragraph (d) are illustrated in the fol-                 and within the meaning of section 83(c)(1)). Z
                                                                                                                             exercises the option in 2012 by paying an ex-
                                                                   lowing examples:                                          ercise price of $75,000 and receives property
                                                                     Example 1. (i) Facts. As part of an arrange-            that has a fair market value (for purposes of
                                                                   ment for the deferral of compensation, an el-             section 83) equal to $300,000.
                                                                   igible employer agrees on December 1, 2002 to               (ii) Conclusion. In this Example 3, under sec-
                                                                   pay an individual rendering services for the              tion 83(e)(3), section 83 does not apply to the
                                                                   eligible employer a specified dollar amount               grant of the option. Accordingly, C has in-
                                                                   on January 15, 2005. The arrangement pro-                 come of $100,000 in 2004 under section 457(f).
                                                                   vides for the payment to be made in the form              In 2012, C has income of $125,000, which is the
                                                                   of property having a fair market value equal              value of the property transferred in 2012,
                                                                   to the specified dollar amount. The individ-              minus the allocable portion of the basis that
                                                                   ual’s rights to the payment are not subject               results from the $100,000 of income in 2004
                                                                   to a substantial risk of forfeiture (within the           and the $75,000 exercise price.
                                                                   meaning of section 457(f)(3)(B)).                           Example 4. (i) Facts. In 2010, X, a tax-ex-
                                                                     (ii) Conclusion. In this Example 1, because             empt entity, agrees to pay deferred com-
                                                                   there is no substantial risk of forfeiture with           pensation to employee D. The amount pay-
                                                                   respect to the agreement to transfer prop-                able is $100,000 to be paid 10 years later in
                                                                   erty in 2005, the present value (as of Decem-             2020. The commitment to make the $100,000
                                                                   ber 1, 2002) of the payment is includible in              payment is not subject to a substantial risk
                                                                   the individual’s gross income for 2002. Under             of forfeiture. In 2010, the present value of the
                                                                   paragraph (a)(4) of this section, when the                $100,000 is $50,000. In 2018, X transfers to D
                                                                   payment is made on January 15, 2005, the                  property having a fair market value (for pur-
                                                                   amount includible in the individual’s gross               poses of section 83) equal to $70,000. The
                                                                   income is equal to the excess of the fair mar-            transfer is in partial settlement of the com-
                                                                   ket value of the property when paid, over the             mitment made in 2010 and, at the time of the
                                                                   amount that was includible in gross income                transfer in 2018, the present value of the
                                                                   for 2002 (which is the basis allocable to that            commitment is $80,000. In 2020, X pays D the
                                                                   payment).                                                 $12,500 that remains due.
                                                                     Example 2. (i) Facts. As part of an arrange-              (ii) Conclusion. In this Example 4, D has in-
                                                                   ment for the deferral of compensation, indi-              come of $50,000 in 2010. In 2018, D has income
                                                                   viduals A and B rendering services for a tax-             of $30,000, which is the amount transferred in