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									                                                                                               Bulletin No. 2005-47
                                                                                                November 21, 2005



HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.


INCOME TAX                                                          EMPLOYEE PLANS

T.D. 9228, page 972.                                                Notice 2005–72, page 976.
Final regulations under section 42 of the Code eliminate the        Weighted average interest rate update; corporate bond
requirement in regulations section 1.42–1(h) that a completed       indices; 30-year Treasury securities. The weighted aver-
Form 8609, Low-Income Housing Credit Allocation and Certifi-        age interest rate for November 2005 and the resulting permis-
cation, must be filed with an owner’s Federal income tax return     sible range of interest rates used to calculate current liability
for each of the 15 taxable years of the compliance period when      and to determine the required contribution are set forth.
the owner claims the low-income housing credit.

REG–105847–05, page 987.
Proposed regulations under section 199 of the Code relate to
                                                                    ESTATE TAX
the deduction for income attributable to domestic production
activities. Section 199 was enacted as part of the American         Rev. Proc. 2005–70, page 979.
Jobs Creation Act of 2004, and allows a deduction equal to          Cost-of-living adjustments for 2006. This procedure sets
3 percent (for 2005 and 2006) of the lesser of the qualified        forth the cost-of-living adjustments to certain items for 2006
production activities income of the taxpayer for the taxable        as required under various provisions of the Code.
year, or the taxable income of the taxpayer for the taxable
year, subject to certain limits. The applicable percentage rises
to 6 percent for 2007, 2008, and 2009, and 9 percent for
2010 and subsequent years. A public hearing is scheduled for
                                                                    GIFT TAX
January 11, 2006.
                                                                    Rev. Proc. 2005–70, page 979.
Rev. Proc. 2005–70, page 979.                                       Cost-of-living adjustments for 2006. This procedure sets
Cost-of-living adjustments for 2006. This procedure sets            forth the cost-of-living adjustments to certain items for 2006
forth the cost-of-living adjustments to certain items for 2006      as required under various provisions of the Code.
as required under various provisions of the Code.

Rev. Proc. 2005–71, page 985.
This procedure modifies Rev. Proc. 2004–59, 2004–2 C.B.             EXCISE TAX
678, to extend the sunset date for participation in the Voluntary
Compliance Program from December 31, 2005, to March 31,             Rev. Proc. 2005–70, page 979.
2006, and provides that no extensions will be granted beyond        Cost-of-living adjustments for 2006. This procedure sets
June 30, 2006. Rev. Proc. 2004–59 modified.                         forth the cost-of-living adjustments to certain items for 2006
                                                                    as required under various provisions of the Code.

                                                                                               (Continued on the next page)



Finding Lists begin on page ii.
ADMINISTRATIVE

Notice 2005–81, page 977.
This notice supplements Notice 2005–66, 2005–40 I.R.B.
620, which postponed until January 3, 2006, deadlines for
the IRS to perform certain acts under section 7508A of the
Code with respect to certain taxpayers affected by Hurricane
Katrina. This notice (1) expands the definition of “covered dis-
aster area” to include additional counties and parishes that the
Federal Emergency Management Agency (FEMA) determined
were eligible for federal assistance after the IRS issued Notice
2005–66; (2) extends the deadlines for the IRS to perform
certain acts to February 28, 2006, to match the deadlines
for affected taxpayers to file, pay, and perform certain acts;
(3) expands the definition of affected taxpayer to match the
definition of affected taxpayers in Notice 2005–73, 2005–42
I.R.B. 723; and (4) grants the IRS a postponement of time to
perform an act not previously identified in Notice 2005–66 –
issuing a Notice of Final Partnership Administrative Adjustment
(FPAA) under section 6223. Notice 2005–66 supplemented.

Notice 2005–82, page 978.
In Notice 2005–82, the IRS under section 7508A of the Code
extends the period for the government to take certain actions
until February 28, 2005, with respect to certain taxpayers af-
fected by Hurricane Rita. In response to Hurricane Rita, in News
Release IR-2005-110 of September 26, 2005, the IRS granted
relief for taxpayers affected by Hurricane Rita. News Release
IR-2005-110 provided that all counties and parishes in Texas
and Louisiana constitute a “covered disaster area” within the
meaning of regulations section 301.7508A–1(d)(2). Further,
News Release IR-2005-110 provided that taxpayers affected
by the disaster will have until February 28, 2006, to file tax
returns and submit payments, including, but not limited to, the
October 17, 2005, deadline for individuals who received a sec-
ond extension for filing their individual income tax returns. In
addition, News Release IR-2005-110 provided affected taxpay-
ers until February 28, 2006, to perform the acts listed in sec-
tion 301.7508A–1(c)(1) and Rev. Proc. 2005–27, 2005–20
I.R.B. 1050.

Rev. Proc. 2005–70, page 979.
Cost-of-living adjustments for 2006. This procedure sets
forth the cost-of-living adjustments to certain items for 2006
as required under various provisions of the Code.

Rev. Proc. 2005–71, page 985.
This procedure modifies Rev. Proc. 2004–59, 2004–2 C.B.
678, to extend the sunset date for participation in the Voluntary
Compliance Program from December 31, 2005, to March 31,
2006, and provides that no extensions will be granted beyond
June 30, 2006. Rev. Proc. 2004–59 modified.




November 21, 2005                                                   2005–47 I.R.B.
The IRS Mission
Provide America’s taxpayers top quality service by helping                        applying the tax law with integrity and fairness to all.
them understand and meet their tax responsibilities and by


Introduction
The Internal Revenue Bulletin is the authoritative instrument of                  court decisions, rulings, and procedures must be considered,
the Commissioner of Internal Revenue for announcing official                      and Service personnel and others concerned are cautioned
rulings and procedures of the Internal Revenue Service and for                    against reaching the same conclusions in other cases unless
publishing Treasury Decisions, Executive Orders, Tax Conven-                      the facts and circumstances are substantially the same.
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
                                                                                  The Bulletin is divided into four parts as follows:
Superintendent of Documents on a subscription basis. Bulletin
contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.                                            Part I.—1986 Code.
                                                                                  This part includes rulings and decisions based on provisions of
It is the policy of the Service to publish in the Bulletin all sub-               the Internal Revenue Code of 1986.
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-                  Part II.—Treaties and Tax Legislation.
ify, or amend any of those previously published in the Bulletin.                  This part is divided into two subparts as follows: Subpart A,
All published rulings apply retroactively unless otherwise indi-                  Tax Conventions and Other Related Items, and Subpart B, Leg-
cated. Procedures relating solely to matters of internal man-                     islation and Related Committee Reports.
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.                                                          Part III.—Administrative, Procedural, and Miscellaneous.
                                                                                  To the extent practicable, pertinent cross references to these
                                                                                  subjects are contained in the other Parts and Subparts. Also
Revenue rulings represent the conclusions of the Service on the                   included in this part are Bank Secrecy Act Administrative Rul-
application of the law to the pivotal facts stated in the revenue                 ings. Bank Secrecy Act Administrative Rulings are issued by
ruling. In those based on positions taken in rulings to taxpayers                 the Department of the Treasury’s Office of the Assistant Sec-
or technical advice to Service field offices, identifying details                 retary (Enforcement).
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.                                                                     Part IV.—Items of General Interest.
                                                                                  This part includes notices of proposed rulemakings, disbar-
                                                                                  ment and suspension lists, and announcements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be                        The last Bulletin for each month includes a cumulative index
relied on, used, or cited as precedents by Service personnel in                   for the matters published during the preceding months. These
the disposition of other cases. In applying published rulings and                 monthly indexes are cumulated on a semiannual basis, and are
procedures, the effect of subsequent legislation, regulations,                    published in the last Bulletin of each semiannual period.



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

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




2005–47 I.R.B.                                                                                                                November 21, 2005
Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 1.—Tax Imposed                                     ceiling used in determining the low-income housing    owner to include a third-party signature
                                                           credit for calendar year 2006. See Rev. Proc. 2005-   from an authorized State or local hous-
   The Service provides inflation adjustments to the       70, page 979.                                         ing credit agency (Agency) official when
tax rate tables for individuals, trusts, and estates for
taxable years beginning in 2006. In addition, the
                                                                                                                 filing the form with the owner’s Fed-
amounts of certain reductions allowed against the          26 CFR 1.42–1: Limitation on low-income housing       eral income tax return for each year of
                                                           credit allowed with respect to qualified low-income   the 15-year compliance period. Section
unearned income of minor children in computing
                                                           buildings receiving housing credit allocations from
the “kiddie tax” are adjusted. Also adjusted are the
                                                           State or local housing credit agency.
                                                                                                                 1.42–1(h) contains the filing requirement
amounts used to determine whether a parent may                                                                   for Form 8609 and no longer requires the
elect to report the “kiddie tax” on the parent’s return.                                                         third-party signature when filing the form
See Rev. Proc. 2005-70, page 979.                          T.D. 9228
                                                                                                                 with the owner’s Federal income tax re-
                                                           DEPARTMENT OF                                         turn.
Section 23.—Adoption                                       THE TREASURY
Expenses                                                                                                         Explanation of Provisions
                                                           Internal Revenue Service
   The Service provides inflation adjustments to the       26 CFR Part 1                                            Section 42 provides for a low-income
adoption credit allowed for the adoption of a child for                                                          housing credit that may be claimed as part
taxable years beginning in 2006. The Service also
                                                           Low-Income Housing Credit                             of the general business credit under sec-
provides inflation adjustments to the value used in                                                              tion 38. In general, the credit is allowable
calculating the modified adjusted gross income lim-        Allocation and Certification;                         only if the owner of a qualified low-in-
itations used to determine the amount of adoption          Revisions                                             come building receives a housing credit al-
credit that is allowed in taxable years beginning in
2006. See Rev. Proc. 2005-70, page 979.
                                                                                                                 location from an Agency of the jurisdiction
                                                           AGENCY: Internal Revenue Service
                                                                                                                 where the building is located.
                                                           (IRS), Treasury.
                                                                                                                    Section 1.42–1(h) provides that a com-
Section 24.—Child Tax                                      ACTION: Final regulations.                            pleted Form 8586, “Low-Income Housing
Credit                                                                                                           Credit,” must be filed with the owner’s
                                                           SUMMARY: This document contains reg-                  Federal income tax return for each taxable
   The Service provides inflation adjustments for the
value used in determining the amount of the credit         ulations that reduce the burden for taxpay-           year the owner of a qualified low-income
that may be refundable beginning in 2006. See Rev.         ers filing Form 8609, “Low-Income Hous-               building is claiming the low-income hous-
Proc. 2005-70, page 979.                                   ing Credit Allocation and Certification.”             ing credit under section 42(a). A com-
                                                           The regulations affect owners of low-in-              pleted Form 8609 must be filed with the
                                                           come housing projects who claim the low-              owner’s Federal income tax return for each
Section 25A.—Hope and                                      income housing credit.                                of the 15 taxable years of the compliance
Lifetime Learning Credits                                                                                        period. Failure to comply with the require-
    The Service provides inflation adjustments for the
                                                           DATES: Effective Date: These regulations              ment of the preceding sentence for any tax-
amount of qualified tuition and related expenses that      are effective November 7, 2005.                       able year after the first taxable year in the
are taken into account in determining the amount of           Date of Applicability: For date of appli-          credit period will be treated as a mathemat-
the Hope Scholarship Credit for taxable years begin-       cability, see §1.42–1(j).                             ical or clerical error for purposes of section
ning in 2006, and for the amount of a taxpayer’s mod-
                                                                                                                 6213(b)(1) and (g)(2).
ified adjusted gross income that is taken into account     FOR    FURTHER           INFORMATION
                                                                                                                    The IRS plans to reduce taxpayer bur-
in determining the reduction in the amount of the          CONTACT: Paul F. Handleman, (202)
Hope Scholarship and Lifetime Learning Credits oth-                                                              den by allowing taxpayers to file Form
                                                           622–3040 (not a toll-free number).
erwise available. See Rev. Proc. 2005-70, page 979.                                                              8609 one time, instead of filing the form
                                                           SUPPLEMENTARY INFORMATION:                            with the same information for 15 consec-
                                                                                                                 utive years. Taxpayers currently file the
Section 32.—Earned                                         Background                                            form as part of their return with the Inter-
Income                                                                                                           nal Revenue Service center that processes
                                                               On January 27, 2004, the Treasury                 their return. Planned revisions to the form
   The Service provides inflation adjustments to the
limitations on the earned income credit for taxable
                                                           Department and IRS published Treasury                 should improve administration of the low-
years beginning in 2006. See Rev. Proc. 2005-70,           Decision 9112, 2004–1 C.B. 523, in the                income housing credit program by requir-
page 979.                                                  Federal Register (69 FR 3826), which                  ing taxpayers to send completed forms to
                                                           removed impediments to the electronic                 the Philadelphia service center, where each
                                                           filing of Form 8609, “Low-Income Hous-
Section 42.—Low-Income                                     ing Credit Allocation and Certification,”
                                                                                                                 Agency currently sends Part I of the form.
Housing Credit                                             by revising former §1.42–1T(e)(1) and
                                                                                                                 The requirements for completing and fil-
                                                                                                                 ing Form 8609 will be addressed in the in-
  The Service provides inflation adjustments to the        (h)(2) and adding §1.42–1(h). Former                  structions to the form.
amounts used to calculate the State housing credit         §1.42–1T(e)(1) and (h)(2) required an


2005–47 I.R.B.                                                                   972                                             November 21, 2005
Special Analyses                                 the low-income housing credit under sec-                      standard deduction for the aged or blind) for taxable
                                                 tion 42(a). Unless otherwise provided in                      years beginning in 2006. See Rev. Proc. 2005-70,
    It has been determined that this Trea-       forms or instructions, a completed Form                       page 979.
sury decision is not a significant regula-       8609, “Low-Income Housing Credit Al-
tory action as defined in Executive Order        location and Certification,” (or any suc-
12866. Therefore, a regulatory assessment                                                                      Section 68.—Overall
                                                 cessor form) must be filed by the build-                      Limitation on Itemized
is not required. It also has been deter-         ing owner with the IRS. The requirements
mined that section 553(b) and (d) of the                                                                       Deductions
                                                 for completing and filing Forms 8586 and
Administrative Procedure Act (5 U.S.C.           8609 are addressed in the instructions to                       The Service provides inflation adjustments to the
chapter 5) does not apply to these regula-       the forms.                                                    overall limitation on itemized deductions for taxable
tions. Because no notice of proposed rule-                                                                     years beginning in 2006. See Rev. Proc. 2005-70,
making is required, the Regulatory Flex-         *****                                                         page 979.
ibility Act (5 U.S.C. chapter 6) does not            (j) Effective dates. Section 1.42–1(h)
apply. Pursuant to section 7805(f) of the        applies to forms filed on or after Novem-
Internal Revenue Code, these regulations         ber 7, 2005. The rules that apply for forms                   Section 132.—Certain
were submitted to the Chief Counsel for          filed before November 7, 2005 are con-                        Fringe Benefits
Advocacy of the Small Business Admin-            tained in §1.42–1T(h) and §1.42–1(h) (see
                                                                                                                  The Service provides inflation adjustments to the
istration for comment on their impact on         26 CFR part 1 revised as of April 1, 2003,                    limitations on the exclusion of income for a qualified
small business.                                  and April 1, 2005).                                           transportation fringe benefit for taxable years begin-
                                                                                                               ning in 2006. See Rev. Proc. 2005-70, page 979.
Drafting Information                                                        Mark E. Matthews,
                                                                      Deputy Commissioner for
   The principal author of these regula-                              Services and Enforcement.                Section 135.—Income
tions is Paul F. Handleman, Office of the                                                                      From United States Savings
Associate Chief Counsel (Passthroughs            Approved October 26, 2005.                                    Bonds Used to Pay Higher
and Special Industries), IRS. However,                                                                         Education Tuition and Fees
                                                                             Eric Solomon,
other personnel from the IRS and Treasury
                                                           Acting Deputy Assistant Secretary                      The Service provides inflation adjustments to the
Department participated in their develop-
                                                                            of the Treasury.                   limitation on the exclusion of income from United
ment.                                                                                                          States savings bonds for taxpayers who pay qualified
                   *****                         (Filed by the Office of the Federal Register on November 4,   higher education expenses for taxable years begin-
                                                 2005, 8:45 a.m., and published in the issue of the Federal
                                                 Register for November 7, 2005, 70 F.R. 67355)                 ning in 2006. See Rev. Proc. 2005-70, page 979.
Adoption of Amendments to the
Regulations
                                                                                                               Section 137.—Adoption
   Accordingly, 26 CFR part 1 is amended
                                                 Section 59.—Other                                             Assistance Programs
as follows:
                                                 Definitions and Special
                                                 Rules                                                            The Service provides inflation adjustments to the
PART 1—INCOME TAXES                                                                                            maximum amount that can be excluded from an em-
                                                    The Service provides an inflation adjustment to the        ployee’s gross income in connection with a qualified
                                                 exemption amount used in computing the alternative            adoption assistance program for taxable years begin-
   Paragraph 1. The authority citation for       minimum tax for a minor child subject to the “kiddie          ning in 2006. The Service also provides inflation ad-
part 1 continues to read, in part, as follows:   tax” for taxable years beginning in 2006. See Rev.            justments to the amount used to calculate the modi-
   Authority: 26 U.S.C. 7805 * * *               Proc. 2005-70, page 979.                                      fied adjusted gross income limitations used to deter-
   Par. 2. Section 1.42–1 is amended by                                                                        mine the amount that can be excluded from an em-
revising paragraphs (h) and (j) to read as                                                                     ployee’s gross income for taxable years beginning in
follows:                                         Section 62.—Adjusted                                          2006. See Rev. Proc. 2005-70, page 979.
                                                 Gross Income Defined
§1.42–1 Limitation on low-income
housing credit allowed with respect to              The Service provides inflation adjustments to the          Section 146.—Volume Cap
                                                 amounts an eligible employer may pay in 2006 to cer-
qualified low-income buildings receiving         tain welders and heavy equipment mechanics for rig-             The Service provides inflation adjustments to the
housing credit allocations from a State or       related expenses that are deemed substantiated under          amounts used to determine the State ceiling for the
local housing credit agency.                     an accountable plan when paid in accordance with              volume cap of private activity bonds for calendar year
                                                 Rev. Proc. 2002–41, 2002–1 C.B. 1098. See Rev.                2006. See Rev. Proc. 2005-70, page 979.
*****                                            Proc. 2005-70, page 979.
    (h) Filing of forms. Unless otherwise
provided in forms or instructions, a com-                                                                      Section 148.—Arbitrage
pleted Form 8586, “Low-Income Housing            Section 63.—Taxable
Credit,” (or any successor form) must be         Income Defined                                                26 CFR 1.148–5: Yield and valuation of investments.

filed with the owner’s Federal income tax           The Service provides inflation adjustments to the             The Service provides inflation adjustments for de-
return for each taxable year the owner of a      standard deduction amounts (including the limitation          termining in the calendar year 2006 whether a bro-
qualified low-income building is claiming        in the case of certain dependents, and the additional         ker’s commission or similar fee with respect to the



November 21, 2005                                                          973                                                             2005–47 I.R.B.
acquisition of a guaranteed investment contract or in-     years beginning in 2006. See Rev. Proc. 2005-70,           valuing the estate of a decedent dying in calendar year
vestments purchased for a yield restricted defeasance      page 979.                                                  2006. See Rev. Proc. 2005-70, page 979.
escrow is reasonable. See Rev. Proc. 2005-70, page
979.
                                                           Section 223.—Health                                        Section 2503.—Taxable
                                                           Savings Accounts                                           Gifts
Section 151.—Allowance
of Deductions for Personal                                    The Service provides inflation adjustments for cal-        The Service provides an inflation adjustment to the
Exemptions                                                 endar year 2006 to the monthly limitations on deduc-       amount of gifts that may be made to a person in a
                                                           tions under a high deductible plan and to the amounts      calendar year without including the amount in taxable
   The Service provides inflation adjustments to the       used in defining a high deductible plan. See Rev.          gifts for calendar year 2006. See Rev. Proc. 2005-70,
personal exemption and to the threshold amounts of         Proc. 2005-70, page 979.                                   page 979.
adjusted gross income above which the exemption
amount phases out for taxable years beginning in
2006. See Rev. Proc. 2005-70, page 979.                    Section 512.—Unrelated                                     Section 2523.—Gift to
                                                           Business Taxable Income                                    Spouse
Section 170.—Charitable,                                      The Service provides an inflation adjustment to the        The Service provides an inflation adjustment to the
etc., Contributions and Gifts                              maximum amount of annual dues that can be paid             amount of gifts that may be made in a calendar year
                                                           to certain agricultural or horticultural organizations     to a spouse who is not a citizen of the United States
   The Service provides inflation adjustments to the       without any portion being treated as unrelated trade       without including the amount in taxable gifts for cal-
“insubstantial benefit” guidelines for calendar year       or business income by reason of any benefits or priv-      endar year 2006. See Rev. Proc. 2005-70, page 979.
2006. Under the guidelines, a charitable contribu-         ileges available to members for taxable years begin-
tion is fully deductible even though the contributor re-   ning in 2006. See Rev. Proc. 2005-70, page 979.
ceives “insubstantial benefits” from the charity. See
                                                                                                                      Section 4161.—Imposition
Rev. Proc. 2005-70, page 979.                                                                                         of Tax
                                                           Section 513.—Unrelated
                                                           Trade or Business                                             The Service provides an inflation adjustment to the
Section 179.—Election                                                                                                 amount of excise tax imposed for calendar year 2006
to Expense Certain                                            The Service provides an inflation adjustment to         on the first sale by a manufacturer, producer, or im-
                                                                                                                      porter of any shaft of a type used in the manufacture
Depreciable Business                                       the maximum cost of a “low cost article” for tax-
                                                           able years beginning in 2006. Funds raised through         of certain arrows. See Rev. Proc. 2005-70, page 979.
Assets                                                     a charity’s distribution of “low cost articles” will not
                                                           be treated as unrelated business income to the charity.
   The Service provides inflation adjustments to the
                                                           See Rev. Proc. 2005-70, page 979.                          Section 4261.—Imposition
aggregate cost of section 179 property that a taxpayer
may elect to treat as an expense for taxable years be-
                                                                                                                      of Tax
ginning in 2006. See Rev. Proc. 2005-70, page 979.         Section 685.—Treatment                                        The Service provides inflation adjustments to the
                                                           of Funeral Trusts                                          amounts of the excise taxes on passenger air trans-
                                                                                                                      portation beginning or ending in the United States and
Section 213.—Medical,                                         The Service provides an inflation adjustment to the     for each domestic segment of air transportation for
Dental, etc., Expenses                                     maximum amount of contributions that may be made           calendar year 2006. See Rev. Proc. 2005-70, page
                                                           to a qualified funeral trust for contracts entered in      979.
   The Service provides inflation adjustments to the
                                                           calendar year 2006. See Rev. Proc. 2005-70, page
limitation on the amount of eligible long-term care
                                                           979.
premiums includible in the term “medical care” for                                                                    Section 6033.—Returns by
taxable years beginning in 2006. See Rev. Proc.
                                                                                                                      Exempt Organizations
2005-70, page 979.                                         Section 877.—Expatriation
                                                           to Avoid Tax                                                   The Service provides an inflation adjustment to
Section 220.—Archer MSAs                                                                                              the amount of dues certain exempt organizations with
                                                                                                                      nondeductible lobbying expenditures can charge and
                                                               The Service provides an inflation adjustment to
   The Service provides inflation adjustments to the       the amount used for calendar year 2006 to determine        still be excepted from reporting requirements for tax-
amounts used to determine whether a health plan is         whether an individual’s loss of United States citizen-     able years beginning in 2006. See Rev. Proc. 2005-
a “high deductible health plan” for purposes of de-        ship had the avoidance of United States tax as one of      70, page 979.
termining whether an individual is eligible for a de-      its principal purposes. See Rev. Proc. 2005-70, page
duction for cash paid to a medical savings account         979.
for taxable years beginning in 2006. See Rev. Proc.
                                                                                                                      Section 6039F.—Notice of
2005-70, page 979.                                                                                                    Large Gifts Received From
                                                           Section 2032A.—Valuation                                   Foreign Persons
                                                           of Certain Farm, etc.,
Section 221.—Interest on                                   Real Property                                                 The Service provides an inflation adjustment to the
Education Loans                                                                                                       amount of gifts received, in a taxable year from for-
                                                             The Service provides an inflation adjustment to the      eign persons, that triggers a reporting requirement for
   The Service provides inflation adjustments to the       maximum amount by which the value of certain farm          a United States person for taxable years beginning in
income limitations used to determine the allowable         and other qualified real property included in a dece-      2006. See Rev. Proc. 2005-70, page 979.
deduction for interest on education loans for taxable      dent’s gross estate may be deceased for purposes of




2005–47 I.R.B.                                                                     974                                                   November 21, 2005
Section 6323.—Validity                                   tools of a trade, business, or profession) for calendar   2006 that may be awarded in a judgment or settlement
and Priority Against                                     year 2006. See Rev. Proc. 2005-70, page 979.              of an administrative or judicial proceeding concern-
                                                                                                                   ing the determination, collection, or refund of tax, in-
Certain Persons                                                                                                    terest, or penalty. See Rev. Proc. 2005-70, page 979.
   The Service provides inflation adjustments for cal-
                                                         Section 6601.—Interest
                                                         on Underpayment,
                                                         Nonpayment, or Extensions Section 7702B.—Treatment
endar year 2006 to (1) the maximum amount of a ca-
sual sale of personal property below which a federal
tax lien will not be valid against a purchaser of the    of Time for Payment, of Tax of Qualified Long-Term
property and (2) the maximum amount of a contract                                    Care Insurance
for the repair or improvement of certain residential        The Service provides an inflation adjustment to
property at or below which a federal tax lien will not   the amount used to determine the amount of interest          The Service provides an inflation adjustment to the
be valid against a mechanic’s lienor. See Rev. Proc.     charged on a certain portion of the estate tax payable    stated dollar amount for calendar year 2006 of the per
2005-70, page 979.                                       in installments for the estate of a decedent dying in     diem limitation regarding periodic payments received
                                                         calendar year 2006. See Rev. Proc. 2005-70, page          under a qualified long-term care insurance contract
                                                         979.                                                      or periodic payments received under a life insurance
Section 6334.—Property                                                                                             contract that are treated as paid by reason of the death
Exempt From Levy                                                                                                   of a chronically ill individual. See Rev. Proc. 2005-
                                                         Section 7430.—Awarding                                    70, page 979.
   The Service provides inflation adjustments to the     of Costs and Certain Fees
value of certain property exempt from levy (fuel, pro-
visions, furniture, household personal effects, arms       The Service provides an inflation adjustment to the
for personal use, livestock, poultry, and books and      hourly limit on attorney fees incurred in calendar year




November 21, 2005                                                                975                                                            2005–47 I.R.B.
Part III. Administrative, Procedural, and Miscellaneous
Weighted Average Interest                      CORPORATE BOND WEIGHTED                          and the resulting permissible range of in-
Rate Update                                    AVERAGE INTEREST RATE                            terest rates used to calculate current liabil-
                                                                                                ity. That notice establishes that the corpo-
Notice 2005–72                                    Sections        412(b)(5)(B)(ii)       and    rate bond weighted average is based on the
                                               412(l)(7)(C)(i), as amended by the Pen-          monthly composite corporate bond rate de-
    This notice provides guidance as to the    sion Funding Equity Act of 2004, provide         rived from designated corporate bond in-
corporate bond weighted average interest       that the interest rates used to calculate cur-   dices.
rate and the permissible range of interest     rent liability and to determine the required         The composite corporate bond rate for
rates specified under § 412(b)(5)(B)(ii)(II)   contribution under § 412(l) for plan years       October 2005 is 5.68 percent. Pursuant
of the Internal Revenue Code. In ad-           beginning in 2004 or 2005 must be within         to Notice 2004–34, the Service has de-
dition, it provides guidance as to the         a permissible range based on the weighted        termined this rate as the average of the
interest rate on 30-year Treasury securi-      average of the rates of interest on amounts      monthly yields for the included corporate
ties under § 417(e)(3)(A)(ii)(II), and the     invested conservatively in long term in-         bond indices for that month.
weighted average interest rate and permis-     vestment grade corporate bonds during the            The following corporate bond weighted
sible ranges of interest rates based on the    4-year period ending on the last day before      average interest rate was determined for
30-year Treasury securities rate.              the beginning of the plan year.                  plan years beginning in the month shown
                                                  Notice 2004–34, 2004–1 C.B. 848, pro-         below.
                                               vides guidelines for determining the cor-
                                               porate bond weighted average interest rate


                                                                                  Corporate
                          For Plan Years                                            Bond                            90% to 110%
                           Beginning in:                                          Weighted                           Permissible
             Month                               Year                              Average                             Range
           November                              2005                                5.79                            5.21 to 5.79

30-YEAR TREASURY SECURITIES                    Tax Regulations provides that the applica-       imum amount of the deduction allowed
WEIGHTED AVERAGE INTEREST                      ble interest rate for a month is the annual      under § 404(a)(1).
RATE                                           interest rate on 30-year Treasury securi-           The rate of interest on 30-year Treasury
                                               ties as specified by the Commissioner for        securities for October 2005 is 4.68 percent.
   Section 417(e)(3)(A)(ii)(II) defines        that month in revenue rulings, notices or        Pursuant to Notice 2002–26, 2002–1 C.B.
the applicable interest rate, which must       other guidance published in the Internal         743, the Service has determined this rate
be used for purposes of determining the        Revenue Bulletin.                                as the monthly average of the daily deter-
minimum present value of a participant’s           Section 404(a)(1) of the Code, as            mination of yield on the 30-year Treasury
benefit under § 417(e)(1) and (2), as the      amended by the Pension Funding Eq-               bond maturing in February 2031.
annual rate of interest on 30-year Treasury    uity Act of 2004, permits an employer               The following 30-year Treasury rates
securities for the month before the date       to elect to disregard subclause (II) of          were determined for the plan years begin-
of distribution or such other time as the      § 412(b)(5)(B)(ii) to determine the max-         ning in the month shown below.
Secretary may by regulations prescribe.
Section 1.417(e)–1(d)(3) of the Income


                                                                30-Year
                   For Plan Years                               Treasury                    90% to 105%                90% to 110%
                    Beginning in:                               Weighted                     Permissible                Permissible
          Month                        Year                     Average                        Range                      Range
        November                      2005                         4.88                     4.39 to 5.12                4.39 to 5.37

Drafting Information                           please contact the Employee Plans’ tax-          1–202–283–9703. Mr. Montanaro may
                                               payer assistance telephone service at            be reached at 1–202–283–9714. The tele-
   The principal authors of this notice        1–877–829–5500 (a toll-free number),             phone numbers in the preceding sentences
are Paul Stern and Tony Montanaro of           between the hours of 8:00 a.m. and               are not toll-free.
the Employee Plans, Tax Exempt and             6:30 p.m. Eastern time, Monday through
Government Entities Division. For fur-         Friday. Mr. Stern may be reached at
ther information regarding this notice,


2005–47 I.R.B.                                                     976                                          November 21, 2005
Katrina — Supplemental                         otherwise due on or after September 6,         Hurricane Katrina and its aftermath: (1)
Government Acts Notice                         2005, and on or before February 28, 2006,      all workers assisting in the relief activi-
                                               applies to all the counties and parishes       ties in the covered disaster area, regardless
Notice 2005–81                                 listed in the Appendix to Notice 2005–73,      of whether they are affiliated with recog-
                                               and to counties and parishes that FEMA         nized government or philanthropic organi-
PURPOSE                                        later designates as eligible for Individual    zations; (2) any individual whose principal
                                               Assistance and/or Public Assistance as a       residence, and any business entity whose
    This notice supplements Notice             result of the devastation caused by Hurri-     principal place of business, is not located
2005–66, 2005–40 I.R.B. 620 (October           cane Katrina.                                  in the covered disaster area, but whose
3, 2005), which postponed until January                                                       tax professional/practitioner’s office is lo-
3, 2006, deadlines for the Internal Rev-       Extension of the postponement period           cated in the covered disaster area; and (3)
enue Service (IRS) to perform certain                                                         individuals, visiting the covered disaster
acts under section 7508A with respect to           By news releases issued on August
                                                                                              areas, who were killed or injured as a result
certain taxpayers affected by Hurricane        30, 2005, September 2, 2005, Septem-
                                                                                              of Hurricane Katrina and its aftermath. For
Katrina. This Notice (1) expands the defi-     ber 8, 2005, and September 14, 2005,
                                                                                              purposes of (3) above, the estate of an in-
nition of “covered disaster area” to include   the IRS granted affected taxpayers un-
                                                                                              dividual visiting the covered disaster who
additional counties and parishes that the      til January 3, 2006, to file certain re-
                                                                                              was killed as a result of the hurricane is
Federal Emergency Management Agency            turns, to pay certain taxes, and to per-
                                                                                              also considered to be an affected taxpayer.
(FEMA) determined were eligible for fed-       form certain time-sensitive acts listed
                                                                                              See Notice 2005–73. Thus, this notice sup-
eral assistance after the IRS issued Notice    in section 301.7508A–1(c)(1) and Rev.
                                                                                              plements Notice 2005–66 by extending the
2005–66; (2) extends the deadlines for the     Proc. 2005–27, 2005–20 I.R.B. 1050. See
                                                                                              period for the IRS to perform certain acts
IRS to perform certain acts to February        IR–2005–84; IR–2005–91; IR–2005–96;
                                                                                              related to affected taxpayers as defined in
28, 2006, to match the deadlines for af-       IR–2005–103. Notice 2005–73 and News
                                                                                              Notice 2005–73 otherwise due on or after
fected taxpayers to file, pay, and perform     Release IR–2005–109 summarize the re-
                                                                                              September 6, 2005, and on or before Feb-
certain acts; (3) expands the definition of    lief granted and the definitions of affected
                                                                                              ruary 28, 2006, to February 28, 2006.
affected taxpayer to match the definition      taxpayers and covered disaster area.
of affected taxpayers in Notice 2005–73,           On September 23, 2005, the President       Time for Issuing Notice of Final
2005–42 I.R.B. 723 (October 17, 2005);         signed the Katrina Emergency Tax Relief        Partnership Administrative Adjustment
and (4) grants the IRS a postponement          Act of 2005, Pub. L. 109–73 (KETRA).
of time to perform an act not previously       Section 403(b) of KETRA provides that in          In addition to the acts listed in Notice
identified in Notice 2005–66 — issuing a       the case of any taxpayer determined by the     2005–66, for affected taxpayers described
Notice of Final Partnership Administrative     Secretary of the Treasury to be affected by    in Notice 2005–66 (including taxpayers
Adjustment (FPAA) under section 6223.          the Presidentially declared disaster relat-    whose documents maintained by the IRS
                                               ing to Hurricane Katrina, any relief pro-      within the covered disaster area may have
ADDENDA TO NOTICE 2005–66                      vided under section 7508A should be for        been lost or destroyed as a result of Hurri-
                                               a period ending not earlier than February      cane Katrina, or remain in buildings that
Covered disaster area                          28, 2006. By News Release IR–2005–112          are inaccessible) and this notice, a post-
                                               of September 28, 2005, the IRS informed        ponement until February 28, 2006, is pro-
    Notice 2005–66 specifically identified
                                               affected taxpayers of the postponement of      vided under section 7508A for the IRS to
those counties and parishes FEMA had
                                               time to February 28, 2006, to file returns,    issue an FPAA to the Tax Matters Part-
designated at that time as eligible for Pub-
                                               pay taxes, and perform other time-sensi-       ner under section 6223 with respect to the
lic Assistance or Public Assistance and
                                               tive acts under the tax laws. In consid-       tax attributable to the partnership items of
Individual Assistance as constituting a
                                               eration of the additional time Congress        partners of any partnership that is an af-
“covered disaster area” within the mean-
                                               granted affected taxpayers to file, pay, and   fected taxpayer if the last date for issuance
ing of Treas. Reg. § 301.7508A–1(d)(2).
                                               perform certain acts, this notice supple-      of the FPAA is on or after November 7,
After the IRS issued Notice 2005–66,
                                               ments Notice 2005–66 by extending the          2005, and on or before February 28, 2006.
FEMA designated eight additional coun-
                                               period for the IRS to perform certain acts
ties in Florida, 16 additional counties in                                                    DRAFTING INFORMATION
                                               otherwise due on or after September 6,
Alabama, and 30 additional counties in
                                               2005, and on or before February 28, 2006,
Mississippi as eligible for Public Assis-                                                        The principal author of this notice is
                                               to February 28, 2006.
tance or Public Assistance and Individual                                                     Dillon Taylor of the Office of Associate
Assistance. All counties and parishes so       Affected taxpayers                             Chief Counsel, Procedure and Administra-
designated by FEMA constitute a “covered                                                      tion (Administrative Provisions and Judi-
disaster area” within the meaning of sec-         Under section 301.7508A–1(d)(1)(vii),       cial Practice Division). For further infor-
tion 301.7508A–1(d)(2). See Appendix           the IRS may determine that any other per-      mation regarding this notice, you may call
to Notice 2005–73 (complete list of coun-      son is affected by a Presidentially-declared   (202) 622–4940 (not a toll-free call).
ties and parishes designated by FEMA).         disaster and therefore eligible for relief.
The postponement of time for the IRS to        Accordingly, the IRS has determined that
perform the acts listed in Notice 2005–66,     the following persons are also affected by


November 21, 2005                                                   977                                              2005–47 I.R.B.
Rita — Government Act Notice                  a Presidentially declared disaster as de-        is not located in the covered disaster area,
                                              fined in section 1033(h)(3). Pursuant to         but whose tax professional/practitioner’s
Notice 2005–82                                section 7508A(a), a period of up to one          office is located in the covered disaster
                                              year may be disregarded in determining           area; and (3) individuals, visiting the
PURPOSE                                       whether the performance of certain acts by       covered disaster area, who were killed or
                                              affected taxpayers is timely under the in-       injured as a result of Hurricane Rita and its
    This notice under section 7508A post-     ternal revenue laws. Section 7508A(a)(1)         aftermath. For purposes of (3) above, the
pones the deadlines for certain acts per-     includes the acts listed in section 7508(a)      estate of an individual visiting the covered
formed by the Internal Revenue Service        as those that may be postponed. See also         disaster area who was killed as a result of
(IRS) with respect to certain taxpayers       § 301.7508A–1(c)(1). Section 7508(a) and         the hurricane is also considered to be an
affected by Hurricane Rita. In response       § 301.7508A–1(c)(1) include a number of          affected taxpayer. See IR–2005–110.
to Hurricane Rita, the President issued       acts performed by taxpayers for which sec-
disaster declarations on September 23,        tion 7508A relief may apply. These in-           ACTS PERFORMED BY THE
2005, covering Texas and Louisiana. The       clude, but are not limited to: the filing of     GOVERNMENT
Presidential declarations authorized, un-     certain tax returns; the payment of certain
der the Robert T. Stafford Disaster Relief    taxes; the filing of a Tax Court petition; the       In News Release IR–2005–110, the IRS
and Emergency Assistance Act, 42 U.S.C.       filing of a claim for credit or refund of tax;   granted affected taxpayers additional time
§§ 5121–5206 (Stafford Act), the Fed-         and the bringing of a lawsuit upon a claim       until February 28, 2006, to file tax re-
eral Emergency Management Agency              for credit or refund of tax.                     turns, to submit payments, and to perform
(FEMA) to provide Individual Assistance,          Section 301.7508A–1(d)(1) describes          certain time-sensitive acts listed in sec-
Public Assistance, and assistance under       several types of “affected taxpayers” el-        tion 301.7508A–1(c)(1) and in Rev. Proc.
the Hazard Mitigation Grant Program to        igible for certain postponements of up to        2005–27. In consideration of the addi-
counties and parishes in each state. Un-      one year. These affected taxpayers include       tional time that affected taxpayers have
der that authority, FEMA determined that      any individual whose principal residence,        been granted to perform certain acts, this
certain counties and parishes within those    and any business entity whose principal          notice extends the period for the govern-
states were eligible for both Individual      place of business, is located in the cov-        ment to take certain actions. Under the au-
Assistance and Public Assistance, that        ered disaster area; any individual who is a      thority of section 7508A(a)(1) and section
all counties in Texas and all parishes in     relief worker affiliated with a recognized       301.7508A–1(c)(2), for affected taxpayers
Louisiana were eligible for Public Assis-     government or philanthropic organiza-            covered by News Release IR–2005–110,
tance, and that all counties and parishes     tion and who is assisting in the covered         this notice provides a postponement until
could apply for assistance under the Haz-     disaster area; any individual whose prin-        February 28, 2006, under section 7508A
ard Mitigation Grant Program.                 cipal residence, and any business entity         for the following government acts if the
    By News Release IR–2005–110 of            whose principal place of business, is not        last date for performance of the act is on
September 26, 2005, the IRS granted re-       located in the covered disaster area, but        or after November 7, 2005, and on or be-
lief for taxpayers affected by Hurricane      whose records necessary to meet a filing         fore February 28, 2006: making an assess-
Rita. News Release IR–2005–110 pro-           or payment deadline are maintained in the        ment of any tax; issuing a statutory no-
vided that all counties and parishes in       covered disaster area; any estate or trust       tice of deficiency; allowing a credit or re-
Texas and Louisiana constitute a “cov-        that has tax records necessary to meet a         fund of any tax; collecting by the Secre-
ered disaster area” within the meaning of     filing or payment deadline in the covered        tary, by levy or otherwise, the amount of
§ 301.7508A–1(d)(2), of the Procedure         disaster area; and any spouse of an af-          any liability in respect of any tax; bring-
& Administration Regulations. Further,        fected taxpayer, solely with regard to a         ing suit by the United States, or any officer
News Release IR–2005–110 provided             joint return of the husband and wife.            on its behalf, in respect of any tax liabil-
that taxpayers affected by the disaster           Additionally,         under        section   ity; returning property under section 6343;
will have until February 28, 2006, to         301.7508A–1(d)(1)(vii), the IRS may              discharging an executor from personal lia-
file tax returns and submit payments. In      determine that any other person is affected      bility for a decedent’s taxes under section
addition, News Release IR–2005–110            by a Presidentially declared disaster and is     6905; and issuing a notice of Final Partner-
provided affected taxpayers until Febru-      therefore eligible for relief. Accordingly,      ship Administrative Adjustment (FPAA)
ary 28, 2006, to perform the acts listed in   as stated in News Release IR–2005–110,           to the Tax Matters Partner under section
section 301.7508A–1(c)(1) and Rev. Proc.      the IRS has determined that the following        6223 with respect to the tax attributable
2005–27, 2005–20 I.R.B. 1050 (May 16,         persons are also affected by Hurricane           to the partnership items of partners of any
2005).                                        Rita and its aftermath: (1) all workers          partnership subject to TEFRA proceedings
                                              assisting in the relief activities in the        that is an affected taxpayer.
BACKGROUND                                    covered disaster area, regardless of                 Documents maintained by the IRS
                                              whether they are affiliated with rec-            within the covered disaster area may have
   Section 7508A provides the Secretary       ognized government or philanthropic              been lost or destroyed as a result of Hur-
with authority to postpone the time for       organizations; (2) any individual whose          ricane Rita, or remain in buildings that
performing certain acts under the internal    principal residence, and any business            are inaccessible. The destruction, loss or
revenue laws for a taxpayer affected by       entity whose principal place of business,        inaccessibility of these documents will


2005–47 I.R.B.                                                    978                                          November 21, 2005
materially interfere with the IRS’s ability                             tax; collecting by the Secretary, by levy                                   defined under this paragraph, of the gov-
to timely administer the internal revenue                               or otherwise, the amount of any liability                                   ernment act or acts that will be postponed.
laws with respect to certain taxpayers. The                             in respect of any tax; bringing suit by the
taxpayers to whom these records relate are                              United States, or any office on its behalf,                                 DRAFTING INFORMATION
“affected taxpayers” for the limited pur-                               in respect of any tax liability; returning
                                                                                                                                                       The principal author of this notice is
poses set forth in this paragraph. In these                             property under section 6343; the discharge
                                                                                                                                                    Dillon Taylor of the Office of Associate
cases, a postponement until February 28,                                of an executor from personal liability for a
                                                                                                                                                    Chief Counsel, Procedure and Administra-
2006, is provided under section 7508A for                               decedent’s taxes under section 6905, and
                                                                                                                                                    tion (Administrative Provisions and Judi-
the following government acts if the last                               issuing an FPAA under section 6223 as
                                                                                                                                                    cial Practice Division). For further infor-
date for performance of the act is on or                                described above. The disregarding of time
                                                                                                                                                    mation regarding this notice, you may call
after November 7, 2005, and on or before                                under section 7508A results in a deadline
                                                                                                                                                    (202) 622–4940 (not a toll-free call).
February 28, 2006: making an assessment                                 of February 28, 2006, not in a suspension
of any tax; issuing a statutory notice of de-                           of a period. The IRS will notify as soon
ficiency; allowing a credit or refund of any                            as practicable any affected taxpayers, as

26 CFR 601.602: Tax forms and instructions.
(Also Part I, §§ 1, 23, 24, 25A, 32, 42, 59, 62, 63, 68, 132, 135, 137, 146, 148, 151, 170, 179, 213, 220, 221, 223, 512, 513, 685, 877, 2032A, 2503, 2523, 4161, 4261,
6033, 6039F, 6323, 6334, 6601, 7430, 7702B; 1.148–5.)


Rev. Proc. 2005–70

                                                                                      TABLE OF CONTENTS


 SECTION 1. PURPOSE
 SECTION 2. CHANGES
 SECTION 3. 2006 ADJUSTED ITEMS
                                                                                                                                                                                          Code Section
         .01 Tax Rate Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          1(a)–(e)
         .02 Unearned Income of Minor Children Taxed as if Parent’s Income (“Kiddie Tax”) . . . . . . . . . . . . . . . .                                                                 1(g)
         .03 Adoption Credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           23
         .04 Child Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           24
         .05 Hope and Lifetime Learning Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           25A
         .06 Earned Income Credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                32
         .07 Low-Income Housing Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        42(h)
         .08 Alternative Minimum Tax Exemption for a Child Subject to the “Kiddie Tax” . . . . . . . . . . . . . . . . . . .                                                              59(j)
         .09 Transportation Mainline Pipeline Construction Industry Optional Expense Substantiation Rules for
         Payments to Employees under Accountable Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                      62(c)
         .10 Standard Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               63
         .11 Overall Limitation on Itemized Deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                68
         .12 Qualified Transportation Fringe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      132(f)
         .13 Income from United States Savings Bonds for Taxpayers Who Pay Qualified Higher Education
         Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   135
         .14 Adoption Assistance Programs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        137
         .15 Private Activity Bonds Volume Cap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            146(d)
         .16 Safe Harbor Rules for Broker Commissions on Guaranteed Investment Contracts or Investments
         Purchased for a Yield Restricted Defeasance Escrow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                     148
         .17 Personal Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               151
         .18 Election to Expense Certain Depreciable Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                    179


November 21, 2005                                                                                      979                                                                                2005–47 I.R.B.
        .19 Eligible Long-Term Care Premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          213(d)(10)
        .20 Medical Savings Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  220
        .21 Interest on Education Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 221
        .22 Health Savings Accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                223
        .23 Treatment of Dues Paid to Agricultural or Horticultural Organizations . . . . . . . . . . . . . . . . . . . . . . . . . .                                                 512(d)
        .24 Insubstantial Benefit Limitations for Contributions Associated with Charitable Fund-Raising
        Campaigns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   513(h)
        .25 Funeral Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      685
        .26 Expatriation to Avoid Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               877
        .27 Valuation of Qualified Real Property in Decedent’s Gross Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                             2032A
        .28 Annual Exclusion for Gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                2503 & 2523
        .29 Tax on Arrow Shafts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            4161
        .30 Passenger Air Transportation Excise Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           4261
        .31 Reporting Exception for Certain Exempt Organizations with Nondeductible Lobbying
        Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    6033(e)(3)
        .32 Notice of Large Gifts Received from Foreign Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                       6039F
        .33 Persons Against Which a Federal Tax Lien Is Not Valid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                       6323
        .34 Property Exempt from Levy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                   6334
        .35 Interest on a Certain Portion of the Estate Tax Payable in Installments . . . . . . . . . . . . . . . . . . . . . . . . . .                                               6601(j)
        .36 Attorney Fee Awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             7430
        .37 Periodic Payments Received under Qualified Long-Term Care Insurance Contracts or under Certain
        Life Insurance Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            7702B(d)
 SECTION 4. EFFECTIVE DATE
 SECTION 5. DRAFTING INFORMATION

SECTION 1. PURPOSE                                                   SECTION 2. CHANGES                                                          SECTION 3. 2006 ADJUSTED ITEMS

   This revenue procedure sets forth infla-                             .01 The amount of tax imposed by                                            .01 Tax Rate Tables. For taxable years
tion adjusted items for 2006.                                        § 4161(b)(2)(A) on the first sale by the                                    beginning in 2006, the tax rate tables under
                                                                     manufacturer, producer, or importer of                                      § 1 are as follows:
                                                                     any shaft of a type used in the manu-
                                                                     facture of certain arrows is adjusted for
                                                                     inflation. (Section 3.29).


                         TABLE 1 — Section 1(a). — Married Individuals Filing Joint Returns and Surviving Spouses
 If Taxable Income Is:                                                               The Tax Is:
 Not Over $15,100                                                                    10% of the taxable income
 Over $15,100 but not over $61,300                                                   $1,510 plus 15% of the excess over $15,100
 Over $61,300 but not over $123,700                                                  $8,440 plus 25% of the excess over $61,300
 Over $123,700 but not over $188,450                                                 $24,040 plus 28% of the excess over $123,700
 Over $188,450 but not over $336,550                                                 $42,170 plus 33% of the excess over $188,450
 Over $336,550                                                                       $91,043 plus 35% of the excess over $336,550




2005–47 I.R.B.                                                                                       980                                                                  November 21, 2005
                                        TABLE 2 — Section 1(b). — Heads of Households
 If Taxable Income Is:                                  The Tax Is:
 Not Over $10,750                                       10% of the taxable income
 Over $10,750 but not over $41,050                      $1,075 plus 15% of the excess over $10,750
 Over $41,050 but not over $106,000                     $5,620 plus 25% of the excess over $41,050
 Over $106,000 but not over $171,650                    $21,857.50 plus 28% of the excess over $106,000
 Over $171,650 but not over $336,550                    $40,239.50 plus 33% of the excess over $171,650
 Over $336,550                                          $94,656.50 plus 35% of the excess over $336,550



          TABLE 3 — Section 1(c). — Unmarried Individuals (other than Surviving Spouse and Heads of Households).
 If Taxable Income Is:                                  The Tax Is:
 Not Over $7,550                                        10% of the taxable income
 Over $7,550 but not over $30,650                       $755 plus 15% of the excess over $7,550
 Over $30,650 but not over $74,200                      $4,220 plus 25% of the excess over $30,650
 Over $74,200 but not over $154,800                     $15,107.50 plus 28% of the excess over $74,200
 Over $154,800 but not over $336,550                    $37,675.50 plus 33% of the excess over $154,800
 Over $336,550                                          $97,653 plus 35% of the excess over $336,550



                            TABLE 4 — Section 1(d). — Married Individuals Filing Separate Returns
 If Taxable Income Is:                                  The Tax Is:
 Not Over $7,550                                        10% of the taxable income
 Over $7,550 but not over $30,650                       $755 plus 15% of the excess over $7,550
 Over $30,650 but not over $61,850                      $4,220 plus 25% of the excess over $30,650
 Over $61,850 but not over $94,225                      $12,020 plus 28% of the excess over $61,850
 Over $94,225 but not over $168,275                     $21,085 plus 33% of the excess over $94,225
 Over $168,275                                          $45,521.50 plus 35% of the excess over $168,275



                                          TABLE 5 — Section 1(e). — Estates and Trusts
 If Taxable Income Is:                                  The Tax Is:
 Not Over $2,050                                        15% of the taxable income
 Over $2,050 but not over $4,850                        $307.50 plus 25% of the excess over $2,050
 Over $4,850 but not over $7,400                        $1,007.50 plus 28% of the excess over $4,850
 Over $7,400 but not over $10,050                       $1,721.50 plus 33% of the excess over $7,400
 Over $10,050                                           $2,596 plus 35% of the excess over $10,050

   .02 Unearned Income of Minor Chil-          child’s return that is subject to the “kiddie   determining whether a parent may elect
dren Taxed as if Parent’s Income (the          tax,” is $850. (This amount is the same         to include a child’s gross income in the
“Kiddie Tax”).         For taxable years       as the $850 standard deduction amount           parent’s gross income and for calculating
beginning in 2006, the amount in               provided in section 3.10(2) of this revenue     the “kiddie tax”). For example, one of the
§ 1(g)(4)(A)(ii)(I), which is used to reduce   procedure.) The same $850 amount is             requirements for the parental election is
the net unearned income reported on the        used for purposes of § 1(g)(7) (that is, in     that a child’s gross income is more than the


November 21, 2005                                                  981                                                2005–47 I.R.B.
amount referenced in § 1(g)(4)(A)(ii)(I)            .04 Child Tax Credit. For taxable              .06 Earned Income Credit.
but less than 10 times such amount; thus,      years beginning in 2006, the value used             (1) In general. For taxable years be-
a child’s gross income for 2006 must be        in § 24(d)(1)(B)(i) in determining the           ginning in 2006, the following amounts
more than $850 but less than $8,500 to         amount of credit under § 24 that may be          are used to determine the earned income
satisfy that requirement.                      refundable is $11,300.                           credit under § 32(b). The “earned in-
   .03 Adoption Credit. For taxable years           .05 Hope and Lifetime Learning Cred-        come amount” is the amount of earned
beginning in 2006, under § 23(a)(3) the        its.                                             income at or above which the maximum
maximum credit allowed for an adoption              (1) For taxable years beginning in 2006,    amount of the earned income credit is al-
of a child with special needs is $10,960.      100 percent of qualified tuition and re-         lowed. The “threshold phaseout amount”
For taxable years beginning in 2006,           lated expenses not in excess of $1,100 and       is the amount of adjusted gross income
under § 23(b)(1) the maximum credit al-        50 percent of such expenses in excess of         (or, if greater, earned income) above which
lowed with regard to other adoptions is the    $1,100 are taken into account in determin-       the maximum amount of the credit begins
amount of qualified adoption expenses up       ing the amount of the Hope Scholarship           to phase out. The “completed phaseout
to $10,960. The available adoption credit      Credit under § 25A(b)(1).                        amount” is the amount of adjusted gross
begins to phase out under § 23(b)(2)(A)             (2) For taxable years beginning in          income (or if greater, earned income) at or
for taxpayers with modified adjusted           2006, a taxpayer’s modified adjusted             above which no credit is allowed.
gross income in excess of $164,410 and         gross income in excess of $45,000
is completely phased out for taxpayers         ($90,000 for a joint return) is taken into
with modified adjusted gross income of         account in determining the reduction un-
$204,410. (See section 3.14 of this rev-       der § 25A(d)(2)(A)(ii) in the amount of
enue procedure for the adjusted items          the Hope Scholarship and Lifetime Learn-
relating to adoption assistance programs.)     ing Credits otherwise allowable under
                                               § 25A(a).


                                                               Number of Qualifying Children
 Item                                                              One                         Two or More                      None
 Earned Income Amount                                            $ 8,080                         $11,340                    $ 5,380
 Maximum Amount of Credit                                        $ 2,747                         $ 4,536                    $    412
 Threshold Phaseout Amount                                       $14,810                         $14,810                    $ 6,740
 (Single, Surviving Spouse, or
 Head of Household)
 Completed Phaseout Amount                                       $32,001                         $36,348                    $12,120
 (Single, Surviving Spouse, or Head of
 Household)
 Threshold Phaseout Amount                                       $16,810                         $16,810                    $ 8,740
 (Married Filing Jointly)
 Completed Phaseout Amount                                       $34,001                         $38,348                    $14,120
 (Married Filing Jointly)

   The instructions for the Form 1040 se-      multiplied by the State population, or (ii)      calendar year 2006, an eligible employer
ries provide tables showing the amount of      $2,190,000.                                      may pay certain welders and heavy equip-
the earned income credit for each type of         .08 Alternative Minimum Tax Exemp-            ment mechanics an amount of up to $14
taxpayer.                                      tion for a Child Subject to the “Kiddie          per hour for rig-related expenses that is
   (2) Excessive investment income. For        Tax.” For taxable years beginning in 2006,       deemed substantiated under an account-
taxable years beginning in 2006, the           for a child to whom the § 1(g) “kiddie tax”      able plan when paid in accordance with
earned income tax credit is denied under       applies, the exemption amount under §§ 55        Rev. Proc. 2002–41, 2002–1 C.B. 1098.
§ 32(i) if the aggregate amount of certain     and 59(j) for purposes of the alternative        If the employer provides fuel or otherwise
investment income exceeds $2,800.              minimum tax under § 55 may not exceed            reimburses fuel expenses, up to $8 per hour
   .07 Low-Income Housing Credit. For          the sum of (i) such child’s earned income        is deemed substantiated when paid under
calendar year 2006, the amounts used un-       for the taxable year, plus (ii) $6,050.          Rev. Proc. 2002–41.
der § 42(h)(3)(C)(ii) to calculate the State      .09 Transportation Mainline Pipeline              .10 Standard Deduction.
housing credit ceiling for the low-income      Construction Industry Optional Expense               (1) In general. For taxable years be-
housing credit is the greater of (i) $1.90     Substantiation Rules for Payments to Em-         ginning in 2006, the standard deduction
                                               ployees under Accountable Plans. For             amounts under § 63(c)(2) are as follows:


2005–47 I.R.B.                                                     982                                         November 21, 2005
 Filing Status                                                                    Standard Deduction
 Married Individuals Filing Joint Returns and Surviving Spouses (§ 1(a))          $10,300
 Heads of Households (§ 1(b))                                                     $ 7,550
 Unmarried Individuals (other than Surviving Spouses and Heads of                 $ 5,150
 Households) (§ 1(c))
 Married Individuals Filing Separate Returns (§ 1(d))                             $ 5,150

    (2) Dependent. For taxable years be-       States savings bonds for taxpayers who        activity bonds is the greater of (i) $80
ginning in 2006, the standard deduction        pay qualified higher education expenses)      multiplied by the State population, or (ii)
amount under § 63(c)(5) for an individual      begins to phase out for modified adjusted     $246,610,000.
who may be claimed as a dependent by an-       gross income above $94,700 for joint re-         .16 Safe Harbor Rules for Broker
other taxpayer may not exceed the greater      turns and $63,100 for other returns. This     Commissions on Guaranteed Invest-
of (i) $850, or (ii) the sum of $300 and the   exclusion completely phases out for modi-     ment Contracts or Investments Purchased
individual’s earned income.                    fied adjusted gross income of $124,700 or     for a Yield Restricted Defeasance Es-
    (3) Aged and blind. For taxable years      more for joint returns and $78,100 or more    crow. For calendar year 2006, under
beginning in 2006, the additional standard     for other returns.                            § 1.148–5(e)(2)(iii)(B)(1), a broker’s
deduction amounts under § 63(f) for the            .14 Adoption Assistance Programs. For     commission or similar fee with respect
aged and for the blind are $1,000 for each.    taxable years beginning in 2006, under        to the acquisition of a guaranteed invest-
These amounts are increased to $1,250 if       § 137(a)(2) the maximum amount that can       ment contract or investments purchased
the individual is also unmarried and not a     be excluded from an employee’s gross          for a yield restricted defeasance escrow
surviving spouse.                              income in connection with the adoption        is reasonable to the extent that (i) the
    .11 Overall Limitation on Itemized De-     by the employee of a child with special       amount of the fee that the issuer treats as
ductions. For taxable years beginning in       needs is $10,960. For taxable years be-       a qualified administrative cost does not
2006, the “applicable amount” of adjusted      ginning in 2006, under § 137(b)(1) the        exceed the lesser of (A) $32,000, or (B)
gross income under § 68(b), above which        maximum amount that can be excluded           0.2 percent of the computational base (as
the amount of otherwise allowable item-        from an employee’s gross income for the       defined in § 1.148–5(e)(2)(iii)(B)(2)) or,
ized deductions is reduced under § 68, is      amounts paid or expenses incurred by the      if more, $3,000; and (ii) the issuer does
$150,500 (or $75,250 for a separate return     employer for qualified adoption expenses      not treat more than $90,000 in brokers’
filed by a married individual).                furnished pursuant to an adoption assis-      commissions or similar fees as qualified
    .12 Qualified Transportation Fringe.       tance program in connection with other        administrative costs with respect to all
For taxable years beginning in 2006, the       adoptions by the employee is $10,960. The     guaranteed investment contracts and in-
monthly limitation under § 132(f)(2)(A)        amount excludable from an employee’s          vestments for yield restricted defeasance
(regarding the aggregate fringe benefit        gross income begins to phase out under        escrows purchased with gross proceeds of
exclusion amount for transportation in a       § 137(b)(2)(A) for taxpayers with mod-        the issue.
commuter highway vehicle and any tran-         ified adjusted gross income in excess of         .17 Personal Exemption.
sit pass) is $105. The monthly limitation      $164,410 and is completely phased out for        (1) Exemption amount. For taxable
under § 132(f)(2)(B) (regarding the fringe     taxpayers with modified adjusted gross        years beginning in 2006, the personal ex-
benefit exclusion amount for qualified         income of $204,410. (See section 3.03         emption amount under § 151(d) is $3,300.
parking) is $205.                              of this revenue procedure for the adjusted       (2) Phase out. For taxable years be-
    .13 Income from United States Savings      items relating to the adoption credit.)       ginning in 2006, the personal exemption
Bonds for Taxpayers Who Pay Qualified              .15 Private Activity Bonds Volume Cap.    amount begins to phase out at, and is com-
Higher Education Expenses. For taxable         For calendar year 2006, the amounts used      pletely phased out after, the following ad-
years beginning in 2006, the exclusion un-     under § 146(d)(1) to calculate the State      justed gross income amounts:
der § 135 (regarding income from United        ceiling for the volume cap for private


 Filing Status                                                                    AGI – Beginning             AGI – Exemption
                                                                                  of Phaseout                 Fully Phased Out
 Married Individuals Filing Joint Returns and Surviving Spouses (§ 1(a))          $225,750                    $348,250
 Heads of Households (§ 1(b))                                                     $188,150                    $310,650
 Unmarried Individuals (other than Surviving Spouses and Heads of                 $150,500                    $273,000
 Households) (§ 1(c))
 Married Individuals Filing Separate Returns (§ 1(d))                             $112,875                    $174,125


November 21, 2005                                                983                                               2005–47 I.R.B.
   .18 Election to Expense Certain Depre-        limitation shall be reduced (but not below       the limitations under § 213(d)(10) (re-
ciable Assets. For taxable years beginning       zero) by the amount by which the cost of         garding eligible long-term care premiums
in 2006, under § 179(b)(1) the aggregate         § 179 property placed in service during the      includible in the term “medical care”) are
cost of any § 179 property a taxpayer may        2006 taxable year exceeds $430,000.              as follows:
elect to treat as an expense shall not exceed       .19 Eligible Long-Term Care Premi-
$108,000. Under § 179(b)(2) the $108,000         ums. For taxable years beginning in 2006,


 Attained Age Before the Close of the Taxable Year                                              Limitation on Premiums
 40 or less                                                                                                $ 280
 More than 40 but not more than 50                                                                         $ 530
 More than 50 but not more than 60                                                                         $1,060
 More than 60 but not more than 70                                                                         $2,830
 More than 70                                                                                              $3,530

    .20 Medical Savings Accounts.                high deductible plan as of the first day of      § 685, the trust may not accept aggregate
    (1) Self-only coverage. For taxable          such month is 1/12 of the lesser of (i) the      contributions by or for the benefit of an in-
years beginning in 2006, the term “high          annual deductible, or (ii) $5,450.               dividual in excess of $8,500.
deductible health plan” as defined in                (2) High deductible health plan. For             .26 Expatriation to Avoid Tax. For cal-
§ 220(c)(2)(A) means, for self-only cov-         calendar year 2006, a high deductible            endar year 2006, an individual with “av-
erage, a health plan that has an annual          health plan is defined under § 223(c)(2)(A)      erage annual net income tax” of more than
deductible that is not less than $1,800 and      as a health plan with an annual deductible       $131,000 for the 5 taxable years ending be-
not more than $2,700, and under which the        that is not less than $1,050 for self-only       fore the date of the loss of United States
annual out-of-pocket expenses required to        coverage or $2,100 for family coverage,          citizenship under § 877(a)(2)(A) is subject
be paid (other than for premiums) for cov-       and the annual out-of pocket expenses            to tax under § 877(b).
ered benefits does not exceed $3,650.            (deductibles, co-payments, and other                 .27 Valuation of Qualified Real Prop-
    (2) Family coverage. For taxable years       amounts, but not premiums) do not ex-            erty in Decedent’s Gross Estate. For an
beginning in 2006, the term “high de-            ceed $5,250 for self-only coverage or            estate of a decedent dying in calendar year
ductible health plan” means, for family          $10,500 for family coverage.                     2006, if the executor elects to use the spe-
coverage, a health plan that has an annual           .23 Treatment of Dues Paid to Agricul-       cial use valuation method under § 2032A
deductible that is not less than $3,650 and      tural or Horticultural Organizations. For        for qualified real property, the aggregate
not more than $5,450, and under which the        taxable years beginning in 2006, the limi-       decrease in the value of qualified real prop-
annual out-of-pocket expenses required to        tation under § 512(d)(1) (regarding the ex-      erty resulting from electing to use § 2032A
be paid (other than for premiums) for cov-       emption of annual dues required to be paid       that is taken into account for purposes of
ered benefits does not exceed $6,650.            by a member to an agricultural or horticul-      the estate tax may not exceed $900,000.
    .21 Interest on Education Loans. For         tural organization) is $131.                         .28 Annual Exclusion for Gifts.
taxable years beginning in 2006, the                 .24 Insubstantial Benefit Limitations            (1) For calendar year 2006, the first
$2,500 maximum deduction for interest            for Contributions Associated with Chari-         $12,000 of gifts to any person (other than
paid on qualified education loans under          table Fund-Raising Campaigns.                    gifts of future interests in property) are
§ 221 is reduced under § 221(b)(2)(B)                (1) Low cost article. For taxable years      not included in the total amount of taxable
when modified adjusted gross income ex-          beginning in 2006, the unrelated business        gifts under § 2503 made during that year.
ceeds $50,000 ($105,000 for joint returns),      income of certain exempt organizations               (2) For calendar year 2006, the first
and is completely eliminated when mod-           under § 513(h)(2) does not include a “low        $120,000 of gifts to a spouse who is not
ified adjusted gross income is $65,000           cost article” of $8.60 or less.                  a citizen of the United States (other than
($135,000 for joint returns).                        (2) Other insubstantial benefits. For        gifts of future interests in property) are
    .22 Health Savings Accounts.                 taxable years beginning in 2006, the $5,         not included in the total amount of taxable
    (1) Monthly contribution limitation.         $25, and $50 guidelines in section 3 of          gifts under §§ 2503 and 2523(i)(2) made
For calendar year 2006, the monthly limi-        Rev. Proc. 90–12, 1990–1 C.B. 471 (as            during that year.
tation on deductions under § 223(b)(2)(A)        amplified and modified), for disregarding            .29 Tax on Arrow Shafts. For calen-
for an individual with self-only coverage        the value of insubstantial benefits received     dar year 2006, the tax imposed under
under a high deductible plan as of the first     by a donor in return for a fully deductible      § 4161(b)(2)(A) on the first sale by the
day of such month is 1/12 of the lesser of (i)   charitable contribution under § 170, are         manufacturer, producer, or importer of
the annual deductible, or (ii) $2,700. For       $8.60, $43, and $86, respectively.               any shaft of a type used in the manufac-
calendar year 2006, the monthly limitation           .25 Funeral Trusts. For a contract en-       ture of certain arrows is $0.40 per shaft.
on deductions under § 223(b)(2)(B) for an        tered into during calendar year 2006 for             .30 Passenger Air Transportation Ex-
individual with family coverage under a          a “qualified funeral trust,” as defined in       cise Tax. For calendar year 2006, the tax


2005–47 I.R.B.                                                      984                                           November 21, 2005
under § 4261(b) on the amount paid for          estate tax extended as provided in § 6166      mation regarding this revenue procedure,
each domestic segment of taxable trans-         is $1,200,000.                                 contact Ms. Myers at (202) 622–4920 (not
portation by air is $3.30. For calendar             .36 Attorney Fee Awards. For fees          a toll-free call).
year 2006, the tax under § 4261(c) on any       incurred in calendar year 2006, the
amount paid (whether within or without          attorney fee award limitation under
                                                                                               26 CFR 1.1441–7: Extension of offer to resolve issues
the United States) for any transportation       § 7430(c)(1)(B)(iii) is $160 per hour.
                                                                                               arising from certain tax, withholding, and reporting
of any person by air, if such transportation        .37 Periodic Payments Received un-         obligations of U.S. withholding agents with respect to
begins or ends in the United States, gen-       der Qualified Long-Term Care Insurance         payments to foreign persons.
erally is $14.50. However, for a domes-         Contracts or under Certain Life Insur-
tic segment beginning or ending in Alaska       ance Contracts. For calendar year 2006,        Amendment to Sunset Date
or Hawaii as described in § 4261(c)(3), the     the stated dollar amount of the per diem       of Section 1441 Voluntary
tax only applies to departures and is at the    limitation under § 7702B(d)(4) (regarding
                                                                                               Compliance Program Under
rate of $7.30.                                  periodic payments received under a qual-
    .31 Reporting Exception for Certain         ified long-term care insurance contract or     Rev. Proc. 2004–59
Exempt Organizations with Nondeductible         periodic payments received under a life
Lobbying Expenditures. For taxable years        insurance contract that are treated as paid    Rev. Proc. 2005–71
beginning in 2006, the annual per per-          by reason of the death of a chronically ill
son, family, or entity dues limitation to       individual) is $250.                           SECTION 1. PURPOSE
qualify for the reporting exception under
§ 6033(e)(3) (and section 5.05 of Rev.          SECTION 4. EFFECTIVE DATE                         This revenue procedure modifies Rev.
Proc. 98–19, 1998–1 C.B. 547), regarding                                                       Proc. 2004–59, 2004–2 C.B. 678, to ex-
certain exempt organizations with nonde-            .01 General Rule. Except as provided       tend the sunset date of the Section 1441
ductible lobbying expenditures, is $91 or       in section 4.02, this revenue procedure ap-    Voluntary Compliance Program (“Section
less.                                           plies to taxable years beginning in 2006.      1441 VCP”) to March 31, 2006.
    .32 Notice of Large Gifts Received from         .02 Calendar Year Rule. This revenue
Foreign Persons. For taxable years begin-       procedure applies to transactions or events    SECTION 2. BACKGROUND
ning in 2006, recipients of gifts from cer-     occurring in calendar year 2006 for pur-
tain foreign persons may be required to re-     poses of sections 3.07 (low-income hous-          Rev. Proc. 2004–59 set forth the pro-
port these gifts under § 6039F if the ag-       ing credit), 3.09 (pipeline construction       visions of the Section 1441 VCP, a pro-
gregate value of gifts received in a taxable    industry optional expense substantiation       gram that is available to certain withhold-
year exceeds $12,760.                           rules), 3.15 (private activity bond volume     ing agents with respect to the withholding,
    .33 Persons Against Which a Federal         cap), 3.16 (safe harbor rules for broker       payment, and reporting of certain taxes due
Tax Lien Is Not Valid. For calendar year        commissions on guaranteed investment           on payments to foreign persons.
2006, a federal tax lien is not valid against   contracts or investments purchased for a          The IRS initiated the Section 1441 VCP
(i) certain purchasers under § 6323(b)(4)       yield restricted defeasance escrow), 3.22      as a temporary program. Section 6 of Rev.
who purchased personal property in a            (health savings accounts), 3.25 (funeral       Proc. 2004–59 provided that the Section
casual sale for less than $1,240, or (ii)       trusts), 3.26 (expatriation to avoid tax),     1441 VCP became effective September 29,
a mechanic’s lienor under § 6323(b)(7)          3.27 (valuation of qualified real property     2004, and would be available for submis-
that repaired or improved certain residen-      in decedent’s gross estate), 3.28 (annual      sions made on or before December 31,
tial property if the contract price with the    exclusion for gifts), 3.29 (tax on arrow       2005.
owner is not more than $6,210.                  shafts), 3.30 (passenger air transportation       The volume of Section 1441 VCP sub-
    .34 Property Exempt from Levy. For          excise tax), 3.33 (persons against which a     missions has increased steadily since the
calendar year 2006, the value of property       federal tax lien is not valid), 3.34 (prop-    inception of the program. Many withhold-
exempt from levy under § 6334(a)(2) (fuel,      erty exempt from levy), 3.35 (interest on a    ing agents that wish to participate in the
provisions, furniture, and other household      certain portion of the estate tax payable in   program will not be able to complete the
personal effects, as well as arms for per-      installments), 3.36 (attorney fee awards),     submission process before December 31,
sonal use, livestock, and poultry) may not      and 3.37 (periodic payments received un-       2005, and will be excluded from participa-
exceed $7,430. The value of property ex-        der qualified long-term care insurance         tion in the VCP without an extension. To
empt from levy under § 6334(a)(3) (books        contracts or under certain life insurance      enable such withholding agents to partic-
and tools necessary for the trade, business,    contracts).                                    ipate in the VCP, this revenue procedure
or profession of the taxpayer) may not ex-                                                     amends Section 6 of Rev. Proc. 2004–59
ceed $3,710.                                    SECTION 5. DRAFTING                            to extend the sunset date of the program
    .35 Interest on a Certain Portion of the    INFORMATION                                    for three months, to March 31, 2006. In
Estate Tax Payable in Installments. For an                                                     addition, this revenue procedure amends
estate of a decedent dying in calendar year        The principal author of this revenue        Section 5.01, which allows taxpayers to re-
2006, the dollar amount used to determine       procedure is Marnette M. Myers of the Of-      quest extensions to complete VCP submis-
the “2-percent portion” (for purposes of        fice of Associate Chief Counsel (Income        sions under certain circumstances. This
calculating interest under § 6601(j)) of the    Tax & Accounting). For further infor-          revenue procedure provides that, for sec-


November 21, 2005                                                  985                                                     2005–47 I.R.B.
tion 1441 VCP submissions made after          1042-S. A Section 1441 VCP submission        SECTION 5. EFFECT ON OTHER
December 31, 2005, no extensions will be      made after December 31, 2005, must in-       DOCUMENTS
granted beyond June 30, 2006.                 clude an executed Form 872, Consent to
                                              Extend the Time to Assess Tax, consenting      Rev. Proc. 2004–59 is modified.
SECTION 3. EXTENSION OF SUNSET                to extend for one additional year the time
DATE                                          to assess tax with respect to amounts re-    SECTION 6. EFFECTIVE DATE
                                              portable on Form 1042 for the 2002 year.
   Sections 5 and 6 of Rev. Proc. 2004–59     If the withholding agent has filed a Form      This revenue procedure is effective
are amended as follows.                       945 for the 2002 year, it should further     September 29, 2004, the effective date of
   In Section 5.01, the following sentence    include an executed Form SS–10, Consent      Rev. Proc. 2004–59.
is added after the existing text. “For sec-   to Extend the Time to Assess Employment
tion 1441 VCP submissions made after          Taxes, to extend the assessment period for   SECTION 7. DRAFTING
December 31, 2005, no extensions will be      income tax withholding for an additional     INFORMATION
granted beyond June 30, 2006.”                year.”
   In Section 6, the second sentence                                                           The principal author of this revenue
is amended by deleting “December 31,          SECTION 4. INQUIRIES                         procedure is Kathryn Holman of the
2005” and inserting in its place, “March                                                   Office of Associate Chief Counsel (In-
31, 2006.” A third, fourth, and fifth sen-       For further information regarding the     ternational). For further information re-
tence are added as follows: “A Section        Section 1441 VCP contact the Section         garding this revenue procedure, contact
1441 VCP submission may not be made           1441 VCP Coordinator at (212) 298–2698       Kathryn Holman at (202) 622–3840 (not a
for calendar year 2005 Forms 1042 and         (not a toll-free number).                    toll-free call).




2005–47 I.R.B.                                                  986                                      November 21, 2005
Part IV. Items of General Interest
Notice of Proposed                              Handleman or Lauren Ross Taylor,                 Estimates of capital or start-up costs
Rulemaking and Notice of                        (202) 622–3040; concerning §1.199–2,          and costs of operation, maintenance, and
Public Hearing                                  Alfred Kelley, (202) 622–6040; con-           purchase of service to provide information.
                                                cerning §1.199–4(c) and (d), Richard             The collection of information in these
                                                Chewning, (202) 622–3850; concerning          proposed regulations is in §1.199–6(b) in-
Income Attributable to                          all other provisions of §1.199–4, Scott       volving patrons of agricultural and horti-
Domestic Production Activities                  Rabinowitz, (202) 622–4970; concern-          cultural cooperatives. This information is
                                                ing §1.199–5, Martin Schaffer, (202)          required so that patrons of agricultural and
REG–105847–05                                   622–3080; concerning §1.199–7, Ken            horticultural cooperatives may claim the
                                                Cohen, (202) 622–7790; concerning sub-        section 199 deduction. The collections of
AGENCY: Internal Revenue Service
                                                mission of comments, the hearing, and/or      information is mandatory. The likely re-
(IRS), Treasury.
                                                to be placed on the building access list      spondents are business or other for-profit
ACTION: Notice of proposed rulemaking           to attend the hearing, LaNita Van Dyke,       institutions.
and notice of public hearing.                   (202) 622–7180 (not toll-free numbers).          Estimated total annual reporting bur-
                                                                                              den: 9,000 hours.
SUMMARY: This document contains pro-            SUPPLEMENTARY INFORMATION:                       Estimated average annual burden hours
posed regulations concerning the deduc-                                                       per respondent: 3 hours.
                                                Paperwork Reduction Act                          Estimated number of respondents:
tion for income attributable to domestic
production activities under section 199.                                                      3,000.
                                                   The collections of information con-
Section 199 was enacted as part of the                                                           Estimated annual frequency of re-
                                                tained in this notice of proposed rulemak-
American Jobs Creation Act of 2004, (the                                                      sponses: annually.
                                                ing have been submitted to the Office of
Act). The regulations will affect taxpayers                                                      An agency may not conduct or sponsor,
                                                Management and Budget for review in
engaged in certain domestic production                                                        and a person is not required to respond to, a
                                                accordance with the Paperwork Reduc-
activities. This document also provides a                                                     collection of information unless it displays
                                                tion Act of 1995 (44 U.S.C. 3507(d)).
notice of a public hearing on these pro-                                                      a valid control number assigned by the Of-
                                                Comments on the collections of infor-
posed regulations.                                                                            fice of Management and Budget.
                                                mation should be sent to the Office of
                                                                                                 Books or records relating to a collection
                                                Management and Budget, Attn: Desk
DATES: Written or electronic comments                                                         of information must be retained as long
                                                Officer for the Department of the Trea-
must be received by January 3, 2006. Out-                                                     as their contents may become material in
                                                sury, Office of Information and Regula-
lines of topics to be discussed at the public                                                 the administration of any internal revenue
                                                tory Affairs, Washington, DC 20503, with
hearing scheduled for Wednesday, January                                                      law. Generally, tax returns and tax return
                                                copies to the Internal Revenue Service,
11, 2006, must be received by December                                                        information are confidential, as required
                                                Attn: IRS Reports Clearance Officer,
21, 2005.                                                                                     by 26 U.S.C. 6103.
                                                SE:W:CAR:MP:T:T:SP, Washington, DC
ADDRESSES: Send submissions to:                 20224. Comments on the collection of          Background
CC:PA:LPD:PR            (REG–105847–05),        information should be received by January
room 5203, Internal Revenue Ser-                3, 2006.                                          This document contains proposed reg-
vice, POB 7604, Ben Franklin Sta-                  Comments are specifically requested        ulations relating to the deduction for in-
tion, Washington, DC 20044. Submis-             concerning:                                   come attributable to domestic production
sions may be hand delivered Monday                 Whether the proposed collection of in-     activities under section 199 of the Inter-
through Friday between the hours of 8           formation is necessary for the proper per-    nal Revenue Code (Code). Section 199
a.m. and 4 p.m. to: CC:PA:LPD:PR                formance of the functions of the IRS, in-     was added to the Code by section 102 of
(REG–105847–05), Courier’s Desk, In-            cluding whether the information will have     the Act (Public Law 108 357, 118 Stat.
ternal Revenue Service, 1111 Constitution       practical utility;                            1418). On January 19, 2005, the IRS
Avenue, NW, Washington, DC, or sent                The accuracy of the estimated burden       and Treasury Department issued Notice
electronically, via the IRS Internet site at    associated with the proposed collection of    2005–14, 2005–7 I.R.B. 498, providing in-
www.irs.gov/regs or via the Federal eRule-      information;                                  terim guidance on section 199 and invit-
making Portal at www.regulations.gov               How the quality, utility, and clarity of   ing comments on issues arising under sec-
(IRS-REG–105847–05). The public hear-           the information to be collected may be en-    tion 199. Written and electronic comments
ing will be held in the IRS Auditorium,         hanced;                                       responding to Notice 2005–14 were re-
Internal Revenue Building, 1111 Constitu-          How the burden of complying with the       ceived. The IRS and Treasury Department
tion Avenue, NW, Washington, DC.                proposed collections of information may       have reviewed and considered all the com-
                                                be minimized, including through the appli-    ments in the process of preparing these
FOR     FURTHER      INFORMATION                cation of automated collection techniques     proposed regulations. This preamble to
CONTACT: Concerning §§1.199–1,                  or other forms of information technology;     the proposed regulations describes many
1.199–3, 1.199–6, and 1.199–8, Paul             and                                           of the more significant comments received


November 21, 2005                                                  987                                               2005–47 I.R.B.
by the IRS and Treasury Department. Be-          be treated as acquired by purchase, and         merce, or are shipped or transported or are
cause of the large volume of comments re-        its cost shall be treated as not less than      intended for shipment or transportation in
ceived, however, the IRS and Treasury De-        its value immediately after it enters the       interstate or foreign commerce).
partment are not able to address all of the      United States. A similar rule applies in de-       Section 199(c)(7) provides that DPGR
comments in this preamble.                       termining the adjusted basis of leased or       does not include any gross receipts of the
                                                 rented property when the lease or rental        taxpayer derived from property leased, li-
General Overview                                 gives rise to DPGR. If the property has         censed, or rented by the taxpayer for use
                                                 been exported by the taxpayer for further       by any related person. A person is treated
    Section 199(a)(1) allows a deduction
                                                 manufacture, the increase in cost or ad-        as related to another person if both persons
equal to 9 percent (3 percent in the case of
                                                 justed basis must not exceed the difference     are treated as a single employer under ei-
taxable years beginning in 2005 or 2006,
                                                 between the value of the property when ex-      ther section 52(a) or (b) (without regard to
and 6 percent in the case of taxable years
                                                 ported and its value when imported back         section 1563(b)), or section 414(m) or (o).
beginning in 2007, 2008, or 2009) of the
                                                 into the United States after further manu-
lesser of: (a) the qualified production ac-
                                                 facture.                                        Pass-thru Entities
tivities income (QPAI) of the taxpayer for
                                                     Section 199(c)(4)(A) defines DPGR to
the taxable year; or (b) taxable income (de-
                                                 mean the taxpayer’s gross receipts that are         Section 199(d)(1) provides that, in the
termined without regard to section 199) for
                                                 derived from: (i) any lease, rental, license,   case of an S corporation, partnership, es-
the taxable year (or, in the case of an indi-
                                                 sale, exchange, or other disposition of         tate or trust, or other pass-thru entity, sec-
vidual, adjusted gross income (AGI)).
                                                 (I) qualifying production property (QPP)        tion 199 generally is applied at the share-
    Section 199(b)(1) limits the deduction
                                                 that was manufactured, produced, grown,         holder, partner, or similar level, except as
for a taxable year to 50 percent of the W–2
                                                 or extracted (MPGE) by the taxpayer in          otherwise provided in rules applicable to
wages paid by the taxpayer during the cal-
                                                 whole or in significant part within the         patrons of cooperatives. Section 199(d)(1)
endar year that ends in such taxable year.
                                                 United States; (II) any qualified film pro-     further provides that the Secretary shall
For this purpose, section 199(b)(2) defines
                                                 duced by the taxpayer; or (III) electricity,    prescribe rules for the application of sec-
the term W–2 wages to mean the sum of
                                                 natural gas, or potable water (collectively,    tion 199, including rules relating to: (a) re-
the aggregate amounts the taxpayer is re-
                                                 utilities) produced by the taxpayer in the      strictions on the allocation of the deduction
quired under section 6051(a)(3) and (8) to
                                                 United States; (ii) construction performed      to taxpayers at the partner or similar level;
include on the Forms W–2, “Wage and Tax
                                                 in the United States; or (iii) engineering      and (b) additional reporting requirements.
Statement,” of the taxpayer’s employees
                                                 or architectural services performed in the          The general rule is that section 199 is
during the calendar year ending during the
                                                 United States for construction projects in      applied at the shareholder, partner, or sim-
taxpayer’s taxable year. Section 199(b)(3)
                                                 the United States.                              ilar level. However, section 199(d)(1)(B)
provides that the Secretary shall prescribe
                                                     Section 199(c)(4)(B) excepts from           limits the amount of W–2 wages from a
rules for the application of section 199(b)
                                                 DPGR gross receipts of the taxpayer that        pass-thru entity that may be used by each
in the case of an acquisition or disposition
                                                 are derived from: (i) the sale of food and      shareholder, partner, or similar person
of a major portion of either a trade or busi-
                                                 beverages prepared by the taxpayer at a         to compute the section 199 deduction.
ness or a separate unit of a trade or business
                                                 retail establishment; and (ii) the transmis-    Specifically, section 199(d)(1)(B) pro-
during the taxable year.
                                                 sion or distribution of electricity, natural    vides that such person is treated as having
Qualified Production Activities Income           gas, or potable water.                          been allocated W–2 wages from such en-
                                                     Section 199(c)(5) defines QPP to mean:      tity in an amount equal to the lesser of:
   Under section 199(c)(1), QPAI is the          (A) tangible personal property; (B) any         (i) such person’s allocable share of such
excess of domestic production gross re-          computer software; and (C) any property         wages (without regard to this rule) from
ceipts (DPGR) over the sum of: (a) the cost      described in section 168(f)(4) (certain         such entity as determined under regula-
of goods sold (CGS) allocable to such re-        sound recordings).                              tions prescribed by the Secretary; or (ii) 2
ceipts; (b) other deductions, expenses, or           Section 199(c)(6) defines a qualified       times 9 percent (3 percent in the case of
losses directly allocable to such receipts;      film to mean any property described in sec-     taxable years beginning in 2005 or 2006,
and (c) a ratable portion of deductions, ex-     tion 168(f)(3) if not less than 50 percent      and 6 percent in the case of taxable years
penses, and losses not directly allocable to     of the total compensation relating to pro-      beginning in 2007, 2008, or 2009) of the
such receipts or another class of income.        duction of the property is compensation         QPAI of that entity allocated to such per-
   Section 199(c)(2) provides that the Sec-      for services performed in the United States     son for the taxable year.
retary shall prescribe rules for the proper      by actors, production personnel, directors,
allocation of items of income, deduction,        and producers. The term does not include        Individuals
expense, and loss for purposes of deter-         property with respect to which records are
mining QPAI.                                     required to be maintained under 18 U.S.C.          In the case of an individual, section
   Section 199(c)(3) provides special rules      2257 (generally, films, videotapes, or other    199(d)(2) provides that the deduction is
for determining costs in computing QPAI.         matter that depict actual sexually explicit     equal to the applicable percentage of the
Under these special rules, any item or ser-      conduct and are produced in whole or in         lesser of the taxpayer’s: (a) QPAI for the
vice imported into the United States with-       part with materials that have been mailed       taxable year; or (b) AGI for the taxable
out an arm’s length transfer price shall         or shipped in interstate or foreign com-        year determined after applying sections 86,


2005–47 I.R.B.                                                       988                                         November 21, 2005
135, 137, 219, 221, 222, and 469, and           member’s respective amount (if any) of           of advance payments, and the costs related
without regard to section 199.                  QPAI.                                            to those payments, for purposes of com-
                                                                                                 puting QPAI. Section 4.03(3) of Notice
Patrons of Certain Cooperatives                 Trade or Business Requirement                    2005–14 provides that, in the case of ad-
                                                                                                 vance payments (for goods, services, and
   Section 199(d)(3) provides special rules        Section 199(d)(5) provides that section       use of property) that are recognized under
under which a taxpayer receiving certain        199 is applied by taking into account only       the taxpayer’s method of accounting in
patronage dividends or certain qualified        items that are attributable to the actual con-   a taxable year earlier than that in which
per-unit retain allocations from a cooper-      duct of a trade or business.                     the property or services are delivered, per-
ative (to which subchapter T applies) en-
                                                                                                 formed, and provided, the taxpayer must
gaged in the MPGE, in whole or in sig-          Alternative Minimum Tax
                                                                                                 accurately identify, based on a reasonable
nificant part, or in the marketing of any
                                                   Section 199(d)(6) provides rules to co-       method, whether the receipts (and the cor-
agricultural or horticultural product is al-
                                                ordinate the deduction allowed under sec-        responding expenses) qualify as DPGR.
lowed a section 199 deduction with respect
                                                tion 199 with the alternative minimum tax        If a taxpayer recognizes an advance pay-
to the amount of the patronage dividends
                                                (AMT) imposed by section 55. Taking              ment in Year 1, and the CGS in Year 2, the
or qualified per-unit retain allocations that
                                                into account the provisions of the Congres-      commentator asks whether CGS must be
are: (a) allocable to the portion of the co-
                                                sional Letter, as described elsewhere, sec-      applied to reduce DPGR in Year 2, even
operative’s QPAI that would be deductible
                                                tion 199(d)(6) provides that for purposes        though the DPGR and CGS are recognized
by the cooperative; and (b) designated as
                                                of determining alternative minimum tax-          in different taxable years.
such by the cooperative in a written notice
                                                able income (AMTI) under section 55, the            The proposed regulations clarify that,
mailed to its patrons during the payment
                                                section 199 deduction shall be determined        in the example the commentator cites
period described in section 1382. Such an
                                                without regard to any adjustments under          involving advance payments, as well as
amount, however, does not reduce the tax-
                                                sections 56 through 59, except that in the       other circumstances (such as taxpayers
able income of the cooperative under sec-
                                                case of a corporation (including a corpora-      that use the cash receipts and disburse-
tion 1382.
                                                tion subject to tax under section 511), the      ments method) where gross receipts and
   In determining the portion of the coop-
                                                taxable income limitation is the corpora-        corresponding expenses are recognized
erative’s QPAI that would be deductible
                                                tion’s AMTI.                                     in different taxable years, taxpayers must
by the cooperative, the cooperative’s tax-
                                                                                                 take the receipts and expenses into account
able income is computed without taking
                                                Authority to Prescribe Regulations               for purposes of section 199 in the taxable
into account any deduction allowable un-
                                                                                                 year such items are recognized under their
der section 1382(b) or (c) (relating to            Section 199(d)(7) authorizes the Secre-       methods of accounting for Federal in-
patronage dividends, per-unit retain allo-      tary to prescribe such regulations as are        come tax purposes. The IRS and Treasury
cations, and nonpatronage distributions)        necessary to carry out the purposes of sec-      Department believe it would be unduly
and, in the case of a cooperative engaged       tion 199.                                        burdensome and complicated to create a
in marketing agricultural and horticultural
                                                                                                 separate set of timing rules for purposes of
products, the cooperative is treated as hav-    Congressional Letter                             section 199. Thus, gross receipts and costs
ing MPGE, in whole or in significant part,
                                                                                                 are taken into account for purposes of
any agricultural and horticultural products        On July 21, 2005, the Chairman and
                                                                                                 computing QPAI in the taxable year they
marketed by the cooperative that its pa-        Ranking Member of the Senate Finance
                                                                                                 are recognized for Federal income tax
trons have MPGE.                                Committee and the Chairman of the House
                                                                                                 purposes under the taxpayer’s methods of
                                                Ways and Means Committee introduced
Expanded Affiliated Groups                                                                       accounting, even if the related gross re-
                                                the Tax Technical Corrections Act of
                                                                                                 ceipts or costs, as applicable, are taken into
                                                2005, H.R. 3376 and S. 1447, 109th Cong.
    Section 199(d)(4)(A) provides that all                                                       account in different taxable years. If the
                                                (2005). In a letter on the same date to the
members of an expanded affiliated group                                                          gross receipts are recognized in an inter-
                                                Treasury Department (the Congressional
(EAG) are treated as a single corpora-                                                           company transaction within the meaning
                                                Letter), they provided clarification for sev-
tion for purposes of section 199. Taking                                                         of §1.1502–13, see also §1.199–7(d).
                                                eral issues so that appropriate regulatory
into account the provisions of the Con-                                                             A commentator requested clarification
                                                guidance may be issued reflecting their
gressional Letter, as described elsewhere,                                                       of how the advance payment rules would
                                                intention. These proposed regulations
section 199(d)(4)(B) provides that an EAG                                                        apply in the following scenario. In Year
                                                reflect the intent expressed in the Con-
is an affiliated group as defined in section                                                     1, a taxpayer sells for $100 a one-year
                                                gressional Letter with respect to section
1504(a), determined by substituting “more                                                        software maintenance agreement that pro-
                                                199.
than 50 percent” for “at least 80 percent”                                                       vides for software updates (that the tax-
each place it appears and without regard        Summary of Comments                              payer would MPGE in whole or in sig-
to section 1504(b)(2) and (4).                                                                   nificant part within the United States) and
    Section 199(d)(4)(C) provides that, ex-     Qualified Production Activities Income           customer support services. At the end
cept as provided in regulations, the sec-                                                        of Year 1, the taxpayer uses a reasonable
tion 199 deduction is allocated among the          One commentator requested that the            method to allocate 60 percent of the gross
members of the EAG in proportion to each        proposed regulations clarify the treatment       receipts ($60) to the software updates and


November 21, 2005                                                   989                                                  2005–47 I.R.B.
40 percent ($40) to the customer support          DPGR), commentators inquired whether             software that is MPGE by the taxpayer
services. The taxpayer treats the $60 as          they could allocate gross receipts to a com-     in whole or in significant part within the
DPGR in Year 1. In Year 2, no software            ponent of the product that did meet all          United States). This is the case even if
updates are provided. The commentator             of the requirements of section 199(c), and       the software is not offered for sale to cus-
asks whether the taxpayer in this scenario        thereby treat that portion of the gross re-      tomers separately from the router. Accord-
would be required to amend its Year 1 re-         ceipts as DPGR.                                  ingly, the gross receipts from the software
turn and reduce its DPGR by $60, reduce               H.R. Conf. Rep. No. 755, 108th               qualify as DPGR, but the gross receipts
DPGR by $60 in Year 2, or make no ad-             Cong., 2d Sess. 272 n. 27 (2004) (the            from the router do not qualify as DPGR.
justment for Year 1 or Year 2.                    Conference Report) indicates that a com-             Alternatively, assume that the taxpayer
    Consistent with the application of the        ponent may be treated as qualifying prop-        MPGE only software but that some of the
rules relating to advance payments, which         erty in the case of food and beverages.          content is MPGE within the United States
require that the taxpayer follow its meth-        Footnote 27 of the Conference Report ex-         and some content is MPGE outside the
ods of accounting for Federal income tax          plains that, in the context of food and bev-     United States. Assuming that the software
purposes, the taxpayer should make no ad-         erages prepared at a retail establishment,       does not meet the requirements of section
justment in Year 1 (by amended return) or         although a cup of coffee prepared at a re-       199(c), that portion of the software that is
in Year 2 for the $60 that was appropriately      tail establishment does not qualify under        MPGE within the United States must be
treated as DPGR in Year 1, even though no         section 199(c), a portion of the cup of cof-     treated as the item. Accordingly, gross re-
software updates were provided in Year 2.         fee, that is, the coffee beans (roasted at       ceipts from the sale of the software must be
    A commentator suggested that the pro-         a facility separate from the retail estab-       allocated (using any reasonable method)
posed regulations clarify how a taxpayer          lishment) that meet the requirements un-         between that portion that is MPGE within
that uses a long-term contract method de-         der section 199(c), does qualify under sec-      the United States (which is DPGR if all
termines the portion of the percentage of         tion 199. The Joint Committee on Taxation        other requirements of section 199(c) are
completion revenue reported for each con-         Staff, General Explanation of Tax Legisla-       met) and that portion that is MPGE outside
tract for the taxable year that is allocated to   tion Enacted in the 108th Congress, 109th        the United States (which is non-DPGR).
DPGR. The proposed regulations provide            Cong., 1st Sess. 172 (2005) (the Blue                In the case of construction and architec-
that taxpayers using a long-term contract         Book), indicates Congressional intent that       tural and engineering services, commen-
method (for example, under section 460)           this treatment is not limited to food and        tators asked that the proposed regulations
may use any reasonable method of allocat-         beverages, but rather, is permitted with re-     clarify whether the item is the construction
ing gross receipts under such a contract be-      spect to section 199 in general. Accord-         project itself, or whether the item can con-
tween DPGR and non-DPGR.                          ingly, in the case of QPP, qualified films,      stitute a task or sub-task that is performed
    A number of comments were received            and utilities, the proposed regulations de-      as part of the construction project. The
regarding the rule in section 4.03(1) of No-      fine an item as the property offered for sale    IRS and Treasury Department believe that
tice 2005–14 that requires that section 199       to customers that meets all of the require-      the determination of what constitutes the
be applied on an item-by-item basis. Some         ments under section 199(c). If the prop-         item for purposes of construction and ar-
commentators stated that applying section         erty offered for sale does not meet all of       chitectural or engineering services should
199 on an item-by-item basis is unduly            the requirements under section 199(c), a         be made on a case-by-case basis taking
burdensome, and that the proposed regula-         taxpayer must treat as the item any portion      into account all of the facts and circum-
tions should permit taxpayers to determine        of the property offered for sale that meets      stances. Taxpayers may use any reason-
QPAI on a division or product-line basis          all of these requirements. However, in no        able method of determining the item for
instead. The IRS and Treasury Depart-             case shall the portion of the property of-       this purpose.
ment, however, continue to believe that ap-       fered for sale that is treated as the item ex-       A commentator requested that the pro-
plying section 199 on a basis other than          clude any other portion that meets all of        posed regulations clarify how the rules for
item-by-item would allow taxpayers to re-         the requirements under section 199(c). For       determining DPGR apply in the case of a
ceive the benefits of section 199 with re-        example, assume that the taxpayer MPGE           taxpayer that repairs or rebuilds property
spect to gross receipts that should not qual-     software entirely within the United States,      for a customer. The commentator sug-
ify as DPGR. Accordingly, the proposed            attaches the software to a router that it        gested the IRS and Treasury Department
regulations retain the requirement that sec-      MPGE entirely outside the United States,         distinguish between “repair” activities and
tion 199 be applied on an item-by-item ba-        and then sells the combined property. As-        “rebuild” activities. In the case of a re-
sis.                                              sume further that if the combined property       pair contract where the customer retains
    Many commentators requested clarifi-          is treated as the item, the gross receipts       the benefits and burdens of the property
cation of what constitutes an item. Com-          from the sale will not qualify as DPGR be-       while it is being repaired, the commen-
mentators asked whether an item is a final        cause the combined property does not sat-        tator suggests that the contractor should
product or whether one or more compo-             isfy the in whole or in significant part re-     be permitted to treat as DPGR the gross
nent parts of the final product may qualify       quirement. The proposed regulations re-          receipts attributable to parts that the con-
as an item. For example, if a final product       quire the taxpayer to treat the software as      tractor MPGE in whole or in significant
does not meet the in whole or in significant      an item; separate from the router, because       part within the United States, as well as
part requirement (so that gross receipts          the software meets all of the requirements       the gross receipts attributable to the in-
from the sale of the final product are non-       of section 199(c) (that is, it is computer       stallation of those parts. Gross receipts


2005–47 I.R.B.                                                        990                                          November 21, 2005
attributable to the parts MPGE by the tax-     ship, estate, trust, or other pass-thru entity,   income when determining the amount of
payer in whole or in significant part within   the determination of whether less than            the NOL carryback and carryover under
the United States are DPGR (assuming all       5 percent of the pass-thru entity’s total         section 172(b)(2). Thus, except as oth-
the other requirements of section 199(c)       gross receipts are non-DPGR is made at            erwise provided in §1.199–7(c)(2) of the
are met). Consistent with the general          the pass-thru entity level. In the case of        proposed regulations (concerning the por-
rule for installation (discussed below),       an owner of a pass-thru entity, the deter-        tion of a section 199 deduction allocated to
the installation activity will be considered   mination of whether less than 5 percent           a member of an EAG), the section 199 de-
an MPGE activity only if the contractor        of the owner’s total gross receipts are           duction can neither create an NOL carry-
retains the benefits and burdens of own-       non-DPGR is made at the owner level,              back or carryover nor increase the amount
ership with respect to the parts while the     taking into account the owner’s share of          of an NOL carryback or carryover.
parts are being installed. In addition, the    any of the pass-thru entity’s gross receipts
gross receipts attributable to the instal-     as well as all other gross receipts of the        Wage Limitation
lation of parts that the contractor MPGE       owner. In addition, the 5 percent de min-
may qualify as DPGR if the exception           imis exception in §1.199–3(h)(4)(ii)(E)              A commentator requested that the IRS
for embedded installation described in         applies at the entity level to each item that     and Treasury Department clarify whether
§1.199–3(h)(4)(ii)(D) of the proposed reg-     qualifies.                                        self-employment income of self-employed
ulations applies. The contractor is not            Commentators also observed that,              individuals as reported on the individuals’
permitted to treat as DPGR gross receipts      in determining whether the taxpayer’s             Schedule SE, “Self-Employment Tax,” of
attributable to purchased parts, or the in-    method of allocating gross receipts and           Form 1040 and/or payments for nonem-
stallation of purchased parts.                 CGS between DPGR and non-DPGR is                  ployee compensation reported by the
    The commentator suggested that the         reasonable, the list of factors cited in          taxpayer on Form 1099-MISC, “Miscella-
proposed regulations provide a special         section 4.03(2) of Notice 2005–14 with            neous Income,” are included in determin-
rule for “rebuild” contracts, which the        respect to gross receipts is inconsistent         ing the amount of the W–2 wages of the
commentator suggested be defined as any        with the list of factors cited in section         taxpayer. A commentator also requested
contract where the value of the rebuild        4.05(2)(b) of the notice with respect to          that the IRS clarify whether guaranteed
work performed exceeds 25 percent of the       CGS. The list of factors was intended to          payments to partners are included in W–2
value of the preexisting property immedi-      be as consistent as possible for both gross       wages for purposes of section 199.
ately before the rebuild. The commentator      receipts and CGS, and appropriate changes            The statutory language in section
further suggested that if more than 50         to the lists have been incorporated into the      199(b) refers to the amounts a taxpayer
percent of the contractor’s costs of per-      proposed regulations as necessary.                is required to report as wages on Form
forming the rebuild is attributable to the                                                       W–2 pursuant to section 6051 with respect
cost of parts that the contractor MPGE,        Taxable Income                                    to the employment of employees of the
the contractor should not be required to                                                         taxpayer. Neither self-employment in-
allocate its gross receipts between parts          In the Congressional Letter, the Trea-        come nor guaranteed payments to partners
that it MPGE and any parts that it pur-        sury Department was advised that unre-            are required to be reported under section
chased. The commentator’s suggested            lated business taxable income, rather than        6051. In addition, section 4.02(1)(a) of
rule would effectively create for rebuild      taxable income, applies for purposes of           Notice 2005–14 and §1.199–2(a)(1) of the
contracts a separate de minimis exception      section 199(a)(1) in computing the unre-          proposed regulations define employees as
to the general allocation requirement. The     lated business income tax under section           including only common law employees of
IRS and Treasury Department believe that       511. Accordingly, the proposed regula-            the taxpayer and officers of a corporate
the de minimis exceptions provided in the      tions in §1.199–1(b) provide that, for pur-       taxpayer. Consistent with the statutory
proposed regulations (for example, the 5       poses of determining the tax imposed by           intent, this definition does not include in-
percent de minimis exception discussed         section 511, section 199(a)(1)(B) is ap-          dependent contractors or partners. Thus,
later generally applicable to embedded         plied using unrelated business taxable in-        payments to independent contractors and
services and embedded nonqualifying            come.                                             self-employment income, including guar-
property) are appropriate. Accordingly,            The Congressional Letter also indicates       anteed payments made to partners, are not
the proposed regulations do not adopt this     that the section 199 deduction is not taken       included in determining W–2 wages.
suggestion.                                    into account for purposes of computing               The proposed regulations provide for
    Section 4.03(2) of Notice 2005–14 pro-     taxable income under the rules relating           the same three methods of calculating W–2
vides that, if the amount of the taxpayer’s    to the carryover of a net operating loss          wages as contained in Notice 2005–14.
gross receipts that do not qualify as DPGR     (NOL). Accordingly, the proposed regu-            It is anticipated that when final regula-
equals or exceeds 5 percent of the total       lations provide that for purposes of com-         tions are issued, these three methods will
gross receipts, the taxpayer is required to    puting the section 199 deduction, the def-        be published in a notice rather than as
allocate all gross receipts between DPGR       inition of taxable income under section           part of the final regulations. It is antic-
and non-DPGR. For purposes of this 5           63 applies, but without regard to section         ipated that this notice will be published
percent de minimis rule, the proposed reg-     199. The proposed regulations also pro-           at the same time as the final regulations.
ulations in §1.199–1(d)(2) provide that,       vide that the section 199 deduction is not        The methods will be included in a notice
in the case of an S corporation, partner-      taken into account in computing taxable           rather than the final regulations so that if


November 21, 2005                                                  991                                                  2005–47 I.R.B.
changes are made to the box numbers on           the gross receipts that constitute DPGR.        ple, utilities may hedge to manage the risk
Form W–2, “Wage and Tax Statement,” a            If a taxpayer can, without undue burden         of changes in prices of ordinary inputs
new notice can be issued reflecting those        or expense, specifically identify where an      into the production process. For purposes
changes more promptly than an amend-             item was manufactured, or if the taxpayer       of section 199 only, the proposed regu-
ment to final regulations.                       uses a specific identification method for       lations include a rule in §1.199–3(h)(3)
   The       non-duplication   rule     in       other purposes, then the taxpayer must use      concerning hedges (within the meaning of
§1.199–2(e) continues to provide that            that specific identification method to de-      section 1221(b)(2) and §1.1221–2(b)) of
amounts that are treated as W–2 wages            termine DPGR. If a taxpayer does not use        inventory that is QPP and supplies con-
for any taxable year under any method            a specific identification method for other      sumed in activities giving rise to DPGR.
may not be treated as W–2 wages for any          purposes and cannot, without undue bur-         The proposed regulations require gain or
other taxable year. Additional language          den or expense, use a specific identifica-      loss on the hedging transaction to be taken
has been added to the non-duplication rule       tion method, the taxpayer is not required       into account in determining DPGR. The
to clarify that the same W–2 wages cannot        to use a specific identification method to      proposed rule applies to hedges that man-
be claimed by more than one taxpayer for         determine DPGR.                                 age the risk of currency fluctuations but
purposes of section 199.                                                                         only to the extent that the hedges are not
                                                 Related Persons                                 integrated with an underlying transaction
Domestic Production Gross Receipts                                                               under §1.988–5(b).
                                                     Section 199(c)(7) provides that DPGR
                                                                                                     Commentators suggested that the pro-
                                                 does not include any gross receipts of the
    DPGR includes the gross receipts of the                                                      posed regulations treat gross receipts
                                                 taxpayer derived from property leased, li-
taxpayer that are derived from any lease,                                                        attributable to the distribution or delivery
                                                 censed, or rented by the taxpayer for use
rental, license, sale, exchange, or other dis-                                                   of QPP as derived from the lease, rental,
                                                 by any related person. A person is treated
position of property described in section                                                        license, sale, exchange, or other disposi-
                                                 as related to another person if both persons
199(c)(4)(A)(i). Commentators specifi-                                                           tion of that property. The commentators
                                                 are treated as a single employer under ei-
cally asked whether fees such as cotton or                                                       stated that section 199(c)(4)(B)(ii), which
                                                 ther section 52(a) or (b) (without regard
real estate broker’s fees are DPGR. These                                                        specifically provides that DPGR does not
                                                 to section 1563(b)), or section 414(m) or
fees are non-DPGR because they are not                                                           include gross receipts derived from the
                                                 (o). However, footnote 29 in the Confer-
derived from any lease, rental, license,                                                         transmission and distribution of utilities,
                                                 ence Report indicates that this provision is
sale, exchange, or other disposition of                                                          indicates (by negative implication) that
                                                 not intended to apply to property leased by
property under section 199(c)(4)(A)(i).                                                          gross receipts attributable to the distribu-
                                                 the taxpayer to a related person if the prop-
    Commentators asked for clarification of                                                      tion or delivery of QPP is intended to be
                                                 erty is held for sublease or is subleased to
whether DPGR includes gross receipts de-                                                         considered DPGR. Moreover, some com-
                                                 an unrelated person for the ultimate use
rived by a taxpayer from the subsequent                                                          mentators interpreted language in section
                                                 of such unrelated person, or to a license
sale or lease of QPP MPGE within the                                                             3.04(10)(c) of Notice 2005–14, stating
                                                 to a related person for reproduction and
United States by the taxpayer, sold, and                                                         that bottled water is treated as QPP and
                                                 sale, exchange, lease, rental or sublicense
then reacquired by the taxpayer. The pro-                                                        that DPGR may include gross receipts at-
                                                 to an unrelated person for the ultimate use
posed regulations in §1.199–3(h)(2) pro-                                                         tributable to distribution of bottled water,
                                                 of such unrelated person. Accordingly, the
vide an example to illustrate the rule that                                                      as suggesting that gross receipts attribut-
                                                 proposed regulations include these excep-
gross receipts from the subsequent sale or                                                       able to distribution and delivery of QPP
                                                 tions from the general rule of exclusion un-
lease of QPP are DPGR to the taxpayer                                                            are considered DPGR.
                                                 der section 199(c)(7).
that originally MPGE the QPP within the                                                              In general, the IRS and Treasury De-
                                                     One commentator stated that if a televi-
United States. Any interest component of                                                         partment believe that gross receipts at-
                                                 sion network licenses programming to an
the lease payment also qualifies as DPGR                                                         tributable to distribution and delivery of
                                                 affiliate station, applying section 199(c)(7)
because section 199(c)(4)(A)(i) provides                                                         QPP are not DPGR because distribution
                                                 to treat the royalty payment received from
that DPGR means gross receipts derived                                                           and delivery are properly regarded as
                                                 the affiliate as non-DPGR places these
by the taxpayer from any lease.                                                                  services, regardless of whether the tax-
                                                 vertically integrated companies at a com-
    Commentators pointed out that the rule                                                       payer retains the benefits and burdens of
                                                 petitive disadvantage. The commentator
for allocating gross receipts for purposes                                                       ownership of the property at the time it
                                                 therefore suggested that the proposed reg-
of identifying DPGR under section 3.04(1)                                                        is delivered. No inference to the con-
                                                 ulations provide an exception for networks
of Notice 2005–14 appears to adopt a spe-                                                        trary in Notice 2005–14 was intended.
                                                 and affiliate stations. The proposed regu-
cific identification standard, whereas sec-                                                      Thus, the proposed regulations clarify that
                                                 lations do not adopt this suggestion, which
tion 4.03(2) appears to provide a reason-                                                        taxpayers generally must allocate gross
                                                 is not consistent with section 199(c)(7).
able basis standard. The proposed regu-                                                          receipts between the lease, rental, license,
lations provide in §1.199–1(d)(1) that the       Derived from a Lease, Rental, License,          sale, exchange, or other disposition of the
taxpayer must allocate its gross receipts        Sale, Exchange, or Other Disposition            property itself and the delivery compo-
from all transactions based on a reason-                                                         nent. The IRS and Treasury Department,
able method that is satisfactory to the Sec-        Commentators asked whether gains             however, believe that, because distribu-
retary based on all of the facts and cir-        and losses associated with hedging trans-       tion and delivery are service components
cumstances and that accurately identifies        actions are included in DPGR. For exam-         common to QPP, it is appropriate, as a


2005–47 I.R.B.                                                       992                                        November 21, 2005
matter of administrative convenience, to             A number of commentators suggested              The IRS and Treasury Department fur-
treat embedded distribution and delivery         that the IRS and Treasury Department ex-        ther believe that the reference to section
services similar to the qualified warranty       pand the exception to the allocation re-        482 principles in footnote 27 of the Con-
exception in section 4.04(7)(b) of Notice        quirement for a qualified warranty to in-       ference Report reflects an intent to apply
2005–14. Thus, the taxpayer must include         clude all services (including training, tech-   section 482 principles consistently with
in DPGR gross receipts attributable to the       nical and customer support, and regular         the general intent and purpose of section
distribution and delivery of QPP if (1) in       maintenance of the property), as well as        199. The IRS and Treasury Department
the normal course of business, the charge        all nonqualifying property (including pur-      continue to believe that the statutory lan-
for the delivery or distribution service is      chased spare parts), the charge for which       guage and legislative history require that
included in the price charged for the sale of    is embedded in the contract price of the        transactions be bifurcated into qualify-
the QPP, and (2) the charge for the delivery     lease, rental, license, sale, exchange, or      ing and nonqualifying elements and that
or distribution service is neither separately    other disposition of QPP, qualified films,      gross receipts be allocated accordingly
offered nor separately bargained for with        and utilities. Other commentators stated        for purposes of section 199. The IRS
the customer.                                    that the proposed regulations should adopt      and Treasury Department further believe
    For similar reasons, the proposed regu-      principles similar to §1.482–2(b), so that      that the exceptions to this general rule
lations also treat embedded qualified oper-      services that are ancillary and incidental      should be limited. Expanding the special
ating manuals provided in connection with        to the sale of QPP, qualified films, and        exceptions to include all, or ancillary or
the sale or disposition of QPP, qualified        utilities would not be treated as embed-        incidental, embedded services and embed-
films, and utilities similar to embedded         ded services and no allocation of gross re-     ded nonqualifying property would result
qualified warranties.                            ceipts to those services would be required.     in the inclusion in DPGR of gross receipts
    The proposed regulations also provide        These commentators believe that footnote        that the IRS and Treasury Department do
special rules for installation activities. The   27 in the Conference Report supports such       not believe were intended to be within
IRS and Treasury Department believe that,        a position in stating that the conferees in-    the scope of section 199. The legislative
in some circumstances, installation is ap-       tend that the Secretary provide guidance        history also does not support adopting
propriately viewed as an MPGE activity,          regarding the allocation of gross receipts      principles applicable to other Code sec-
and in others it is appropriately viewed as a    that draws on the principles of section 482.    tions under which a single predominant
service. For example, installation is prop-      Other commentators stated that, elsewhere       nature character is assigned to a trans-
erly viewed as an MPGE activity if the tax-      in the Code and regulations, transactions       action, or characterizing transactions for
payer MPGE QPP within the United States          are given a single characterization based       purposes of section 199 according to their
and installs the QPP while the taxpayer re-      on their predominant nature and that sec-       treatment for financial reporting purposes.
tains the benefits and burdens of owner-         tion 199 should be applied in the same          Accordingly, the proposed regulations do
ship of the QPP. In that case, gross receipts    manner. For example, if the predominant         not adopt these suggestions.
attributable to the installation, whether or     nature of a transaction is the sale of prop-        One commentator requested that the
not embedded, are derived from the lease,        erty, all gross receipts from the transaction   proposed regulations clarify whether the
rental, license, sale, exchange, or other dis-   should be treated as proceeds from the sale.    embedded services rule is intended to
position of the QPP. If, however, the bene-      Finally, some commentators stated that a        require taxpayers to treat certain ser-
fits and burdens of ownership pass to the        taxpayer’s treatment of a transaction for       vice-type activities that take place as part
customer prior to the installation of the        financial reporting purposes should gov-        of the MPGE process as embedded ser-
QPP, the taxpayer is performing a service        ern its characterization for section 199 pur-   vices. The proposed regulations clarify
by installing the customer’s property. In        poses.                                          that embedded services do not include
that case, gross receipts attributable to in-        The IRS and Treasury Department in-         service-type activities that take place as
stallation are not derived from the lease,       fer that the commentators are referring         part of the MPGE process (that is, while
rental, license, sale, exchange, or other dis-   to §1.482–2(b)(8), which provides that,         the taxpayer is engaged in an MPGE ac-
position of the property, and the taxpayer       in general, no separate allocation will be      tivity with respect to the property and
generally is required under the proposed         made in connection with ancillary and           retains the benefits and burdens of owner-
regulations to allocate gross receipts be-       subsidiary services provided with a trans-      ship of the property). For example, with
tween the proceeds of sale or disposition        fer of property. Services ancillary and         respect to QPP, activities such as non-con-
of the property (DPGR) and the installa-         subsidiary to another transaction may be        struction engineering, materials analysis
tion service (non-DPGR). However, the            referred to, outside the section 199 con-       and selection, subcontractor inspections
IRS and Treasury Department believe that,        text, as embedded services. The IRS and         and approval, routine production inspec-
because installation is a service component      Treasury Department do not intend that          tions, product testing and documentation,
common to sales or dispositions of QPP,          services defined as embedded services un-       and assistance with certain regulatory ap-
if the benefits and burdens of ownership         der section 199 will be treated in the same     provals, if undertaken in connection with a
pass to the customer prior to the installa-      manner provided in §1.482–2(b)(8) be-           qualifying MPGE activity, are considered
tion, it is appropriate to treat embedded in-    cause such treatment would be generally         part of the MPGE of the QPP and are not
stallation similar to an embedded qualified      inconsistent with the intent and purpose of     considered embedded services. No sep-
warranty, qualified delivery, and a quali-       section 199.                                    arate allocation of gross receipts to such
fied operating manual.                                                                           activities is required.


November 21, 2005                                                    993                                                2005–47 I.R.B.
    Services and nonqualifying property          2005–14 cites Rev. Rul. 88–65, 1988–2           cess services, and other services are not
are not considered embedded if they are          C.B. 32, and describes that revenue rul-        derived from a lease, rental, license, sale,
either separately offered or separately          ing as treating a short-term rental as a ser-   exchange, or other disposition of the soft-
bargained for, or a charge for the service       vice. Many commentators asked that the          ware. Consistent with the notice, the
or nonqualifying property is separately          proposed regulations clarify that not all       proposed regulations reflect the position
stated. Thus, for example, if a charge for       short-term rentals will be regarded as ser-     that the use of online computer software
freight or delivery is separately stated on      vices for purposes of section 199. They         does not rise to the level of a lease, rental,
an invoice for the sale of an item of QPP,       observed that Rev. Rul. 88–65 involves          license, sale, exchange, or other disposi-
the delivery service is not embedded and         the lease of automobiles and trucks on a        tion as required under section 199 but is
gross receipts attributable to that service      daily basis (normally for not more than one     instead a service. This is the case even
are non-DPGR, even if the purchaser does         week), and that the taxpayer performs sig-      if the customer must agree to terms and
not have the option of refusing the service.     nificant services in connection with the ve-    conditions (which may be termed a license
Further, separately stated or bargained for      hicle, including maintenance and repairs,       by the software provider) before using
amounts will not be respected unless they        and pays all taxes and insurance on the ve-     the software online, or receive enabling
reflect the fair market value of the service     hicle. The IRS and Treasury Department          software to facilitate the customer’s use
or nonqualifying property. For example,          acknowledge that the short-term nature of       of the primary software on the customer’s
if a taxpayer offers contracts to customers      a transaction does not, by itself, render the   hardware.
that include a cellular phone priced on the      transaction a service for purposes of sec-          If gross receipts attributable to the use
invoice at $595 and three years of cellular      tion 199 and that many transactions in-         of online software were permitted to qual-
telephone service priced on the invoice at       clude both service and property rental el-      ify as DPGR because the same or simi-
$5, the $5 stated amount for the service         ements. Therefore, the proposed regula-         lar software also is available to customers
will only be respected if it represents an       tions clarify that, in such cases, taxpay-      on disk or by download, different items of
allocation of gross receipts consistent with     ers must allocate gross receipts between        software available online would be subject
the principles of section 482.                   the qualifying rental of QPP or qualified       to disparate treatment under section 199.
    Gross receipts attributable to embedded      films (DPGR) and the non-qualifying ser-        In addition, if online software were per-
services, embedded nonqualifying prop-           vices (non-DPGR). The allocation must be        mitted to qualify as DPGR, it would be
erty, or any other embedded element (other       based on the facts and circumstances of         difficult to distinguish this online software
than a qualified warranty, qualified de-         each transaction. Generally, in the case of     from software that is used to facilitate a
livery, qualified installation, and a quali-     short-term transactions, such as those de-      service. The IRS and Treasury Department
fied operating manual) may be considered         scribed in Rev. Rul. 88–65, in which sig-       are requesting comments in the Request
DPGR under the 5 percent de minimis ex-          nificant services are provided in connec-       for Comments section on this issue.
ception. The proposed regulations clarify        tion with the property, the transaction will        One commentator suggested that the
that, with respect to the de minimis ex-         consist mostly of services.                     term lease, rental, license, sale, exchange,
ception, taxpayers should apply the 5 per-           Not every transaction in which prop-        or other disposition, especially the term
cent against the total amount of the gross       erty is used in connection with provid-         other disposition, was intended to be in-
receipts derived from the lease, rental, li-     ing a service to customers, however, con-       terpreted broadly to include gross receipts
cense, sale, exchange, or other disposi-         stitutes a mixture of services and rental       from any means of commercialization of
tion of the item of QPP, qualified films,        for which allocation of gross receipts is       property, whether or not an actual transfer
or utilities. The total amount of DPGR in-       appropriate. For example, assume that           of the property occurs. Another com-
cludes gross receipts attributable to a qual-    a taxpayer operates a video game arcade         mentator noted that section 3.04(7)(d) of
ified warranty, qualified delivery, qualified    that features video game machines that the      Notice 2005–14 states that gross receipts
installation, and/or a qualified operating       taxpayer MPGE. The machines remain in           derived by a taxpayer from software that
manual that are treated as DPGR with re-         the taxpayer’s possession during the cus-       is merely offered for use to customers
spect to that item. In the case of a lease       tomers’ use. Gross receipts derived from        online for a fee are non-DPGR, and sug-
or an installment sale, the de minimis ex-       customers’ use of the machines at the tax-      gested that if the software is also offered
ception is applied by taking into account        payer’s arcade are not derived from the         to customers on disk or by download, then
the total amount of gross receipts under the     lease, rental, license, sale, exchange, or      gross receipts for online use of otherwise
lease or installment sale that are attribut-     other disposition of the machines. Rather,      qualifying software would be DPGR. The
able to the item of QPP, qualified films, or     the machines are used to provide a ser-         commentator also noted that the same
utilities.                                       vice and, thus, the gross receipts are non-     section provides that a “service provided
    Under the proposed regulations, as un-       DPGR.                                           using computer software that does not in-
der Notice 2005–14, applicable Federal               A number of commentators objected           volve a transfer of the computer software
income tax principles apply in determin-         to the position taken in section 4.04(7)(d)     does not result in [DPGR],” and suggested
ing whether a transaction (or any part of        of Notice 2005–14 that gross receipts           that this language implies that if the soft-
a transaction) is, in substance, a lease,        from Internet access services, online ser-      ware is not used in providing a service, no
rental, license, sale, exchange, or other dis-   vices, customer support, telephone ser-         transfer is required for purposes of section
position, or whether it is a service. For        vices, games played through a website,          199. The IRS and Treasury Department
this purpose, section 3.04(7)(a) of Notice       provider-controlled software online ac-         did not intend the results suggested by the


2005–47 I.R.B.                                                       994                                         November 21, 2005
commentators and the proposed regula-           linked to (and therefore should be treated        Treasury believe that the commentators’
tions have been clarified as necessary.         as derived from) the qualified film. The          interpretations are inconsistent with sec-
    A number of commentators requested          proposed regulations do not adopt this            tion 199(c)(4)(A)(i)(I).
clarification and expansion of the rule         comment.        Section 199(c)(4)(A)(i)(II)          Commentators requested that the IRS
in Notice 2005–14 that treats advertising       clearly requires that receipts must be de-        and Treasury Department clarify whether
receipts attributable to the sale or other      rived from a lease, rental, license, sale,        gross receipts from mineral royalties and
disposition of newspapers and magazines         exchange, or other disposition of a qual-         net profits interests are properly treated as
as DPGR. Notice 2005–14 explains that           ified film to be DPGR. Receipts derived           DPGR. Mineral royalties, including net
advertising receipts in this context are        from the licensing of related intangibles,        profits interests, are returns on passive
inextricably linked to the gross receipts       including film characters, trademarks, and        interests in mineral properties, the owner
derived from the lease, rental, license,        trade names, do not meet this requirement.        of which makes no expenditure for oper-
sale, exchange, or other disposition of the     Further, the IRS and Treasury Department          ation or development. The courts and the
newspapers and magazines. In response           do not agree that receipts derived from           IRS have long considered these types of
to comments, the proposed regulations           licensing of film-related intangibles are         income to be in the nature of rent (see, for
clarify that this rule also applies, under      inextricably linked to the gross receipts         example, Kirby Petroleum Co. v. Comm’r,
the same rationale, to advertising receipts     derived from a qualified film.                    326 U.S. 599 (1946)). Accordingly, the
relating to telephone directories and pe-           Some commentators objected to the             proposed regulations in §1.199–3(h)(9)
riodicals, whereby a taxpayer’s gross           rule in section 4.04(7)(a) of Notice              provide that gross receipts from mineral
receipts derived from the lease, rental, li-    2005–14 that provides that if a taxpayer          interests and net profits interests other
cense, sale, exchange, or other disposition     exchanges QPP MPGE by the taxpayer                than operating or working interests are not
of the telephone directories or periodicals     in whole or in significant part within            treated as DPGR.
that are MPGE in whole or in significant        the United States for other property in a
part within the United States includes          taxable exchange, the value of the prop-          Definition of Manufactured, Produced,
advertising income from advertisements          erty received by the taxpayer is DPGR;            Grown, or Extracted
placed in those media, but only to the ex-      whereas any gross receipts derived from
tent the gross receipts, if any, derived from   a subsequent sale by the taxpayer of the              Section 4.04(3)(b) of Notice 2005–14
the lease, rental, license, sale, exchange,     acquired property are non-DPGR because            provides that a taxpayer that MPGE QPP
or other disposition of the telephone di-       the taxpayer did not MPGE the acquired            for the taxable year should treat itself as
rectories or periodicals are DPGR. The          property. The commentators noted that             a producer under section 263A with re-
proposed regulations clarify that adver-        in their industry, fungible commodities           spect to the QPP for the taxable year un-
tising revenue for advertising in online        held for sale to customers are exchanged          less the taxpayer is not subject to section
newspapers and periodicals is non-DPGR,         routinely between producers as a practi-          263A. In response, commentators ques-
because any underlying receipts from the        cal means of avoiding logistical problems         tioned whether all taxpayers that are sub-
property itself are non-DPGR, as there is       in meeting customers’ needs and reduc-            ject to section 263A are considered to have
no lease, rental, license, sale, exchange,      ing transportation and storage costs. The         MPGE QPP for purposes of section 199.
or other disposition of such property.          commentators noted that these exchanges           Taxpayers who do not MPGE QPP may
The proposed regulations provide similar        typically are not treated as taxable ex-          nevertheless be subject to section 263A.
treatment for gross receipts attributable       changes on the parties’ financial records.        For example, a taxpayer that has property
to product placements in a qualified film.      The commentators requested that the pro-          produced for it under a contract is con-
The gross receipts attributable to product      posed regulations instead provide that if         sidered a producer of property under sec-
placements will be treated as DPGR, but         the property relinquished in the exchange         tion 263A, but may not be considered as
(as with newspapers) only if the gross          is QPP, qualified films, or utilities, then the   having MPGE property for purposes of
receipts derived from the lease, rental, li-    property received in the exchange should          section 199 if it does not have the bene-
cense, sale, exchange, or other disposition     be treated as QPP, qualified films, or util-      fits and burdens of ownership of the prop-
of the qualified film are DPGR. Thus, for       ities and gross receipts derived from the         erty while it is being produced. Addition-
product placement revenue to be derived         subsequent sale of that property should be        ally, in some circumstances a taxpayer that
from a qualified film, there must be a          treated as DPGR. Another commentator              manufactures property for a customer pur-
lease, rental, license, sale, exchange, or      suggested that this treatment be applied          suant to a contract may be considered the
other disposition of the qualified film.        only to nontaxable exchanges.                     producer of the property for purposes of
    Section 3.04(9)(a) of Notice 2005–14            The proposed regulations do not adopt         section 263A and not to have MPGE the
provides that revenue from the licensing        these suggestions. The IRS and Treasury           property for purposes of section 199. Ac-
of film characters is not derived from the      Department believe that the character of          cordingly, not all taxpayers that are sub-
lease, rental, license, sale, exchange, or      property as having been MPGE in whole             ject to section 263A are considered to have
other disposition of a qualified film. One      or in significant part by the taxpayer within     MPGE QPP for purposes of section 199.
commentator stated that this treatment          the United States is not an attribute of the          Commentators also have questioned
is inconsistent with the income forecast        property, like basis and holding periods,         whether a taxpayer that engages in cer-
method, and that revenue from licensing         that may be substituted with the transfer         tain production activities that are exempt
of film-related intangibles is inextricably     of the property. The IRS and Department           from section 263A (for example, develop-


November 21, 2005                                                   995                                                  2005–47 I.R.B.
ing computer software under Rev. Proc.         certain government contracts described in       ple, Suzy’s Zoo v. Comm’r, 114 T.C. 1
2000–50, 2000–2 C.B. 601, producing            §1.199–3(e)(2), only one taxpayer may           (2000), aff’d 273 F.3d 875 (9th Cir. 2001)
property pursuant to a long-term contract      claim the section 199 deduction with            and Golden Gate Litho v. Comm’r, T.C.
under section 460, or farming exempt un-       respect to the MPGE of QPP. If one tax-         Memo (1998–184).
der section 263A(d)) must treat itself as      payer MPGE QPP pursuant to a contract               The IRS and Treasury Department
a producer under section 263A if the tax-      with another person, then only the tax-         continue to believe that the requirement
payer wants to be treated as MPGE QPP          payer that has the benefits and burdens         of section 199(c)(4)(A)(i) that property
for purposes of section 199. The proposed      of ownership of the property under Fed-         be MPGE by the taxpayer means that
regulations in §1.199–3(d)(4) provide that     eral income tax principles during the time      only one taxpayer may claim the section
a taxpayer that has MPGE QPP for the           the property is MPGE will be consid-            199 deduction with respect to the same
taxable year should treat itself as a pro-     ered to have MPGE the QPP. In con-              function performed with respect to the
ducer under section 263A with respect to       trast, §1.263A–2(a)(1)(ii)(B) provides that     same property. Therefore, it would be
the QPP for the taxable year unless the        property produced for the taxpayer under        inappropriate to adopt the standard under
taxpayer is not subject to section 263A.       a contract is considered as produced by the     the section 263A regulations. In addi-
A taxpayer whose MPGE activity is ex-          taxpayer to the extent the taxpayer makes       tion, this interpretation is supported by
empt from section 263A is not required         payments or otherwise incurs costs with         the Congressional Letter that states the
to change its method of accounting under       respect to the property, even if the taxpayer   Treasury Department has the authority to
section 263A to treat itself as engaged in     is not the owner of the property while the      prescribe rules to prevent the section 199
the MPGE of QPP for purposes of section        property is being produced. Commenta-           deduction from being claimed by more
199.                                           tors questioned why a similar rule does not     than one taxpayer with respect to the same
   Commentators requested clarification        apply in the context of section 199. The        economic activity described in section
as to whether a reseller that engages in de    rule provided by §1.263A–2(a)(1)(ii)(B)         199(c)(4)(A)(i). Thus, consistent with
minimis production activities or that has      is derived from section 263A(g)(2). That        Notice 2005–14, the proposed regulations
property produced for it under contract,       section specifically provides that a tax-       in §1.199–3(e)(1) provide that only one
which constitutes the MPGE of QPP un-          payer is treated as producing property          taxpayer may claim the section 199 deduc-
der section 199, is precluded from using       produced for it under a contract to the ex-     tion with respect to any MPGE activity.
the simplified resale method provided by       tent that it has made payments or incurred          Commentators also proposed other
§1.263A–3(d). Section 1.263A–3(a)(4)(ii)       costs with respect to the contract. In con-     alternatives to the benefits and burdens
provides that a reseller with de minimis       trast, section 199(c)(4)(A)(i) provides that    standard, such as looking to the person
production activities is permitted to use      DPGR only includes gross receipts of the        that has the economic risks and benefits,
the simplified resale method. Likewise,        taxpayer that are derived from any lease,       adopting the qualified research rules un-
§1.263A–3(a)(4)(iii) provides that a re-       rental, license, sale, exchange, or other       der §1.41–2(e)(2), providing safe harbors
seller otherwise permitted to use the sim-     disposition of QPP MPGE by the taxpayer         based on contract terms, treating the per-
plified resale method is permitted to use      in whole in significant part within the         son that arranges for the acquisition of
the method if it has personal property         United States. Accordingly, the proposed        the property as the owner, and looking
produced for it under a contract if the con-   regulations do not contain a provision that     to the person that controls the process by
tract is entered into incident to its resale   is analogous to §1.263A–2(a)(1)(ii)(B).         which the property is MPGE. The pro-
activities and the property is sold to its         While sections 199, 263A, and 936           posed regulations do not adopt any of
customers. The section 263A consistency        all have benefits and burdens standards,        these suggestions because the IRS and
rule provided in §1.199–3(d)(4) of the pro-    the standard under section 199 is not the       Treasury Department believe that there is
posed regulations does not affect the rules    same as those under sections 263A and           considerable variation in the types of con-
provided in §1.263A–3. Accordingly, a          936. Commentators suggested that the            tract manufacturing situations. Therefore,
reseller with de minimis production or         proposed regulations adopt the broader          the proposed regulations contain the same
that has property produced for it under a      standard under §1.263A–2(a)(1)(ii)(A)           benefits and burdens standard used in No-
contract that is considered the MPGE of        that provides that a taxpayer is not con-       tice 2005–14 because it is a standard that
QPP for purposes of section 199 is not         sidered to be producing property unless         the IRS and Treasury Department believe
precluded from using the simplified resale     the taxpayer is considered the owner of         covers all of the varied factual situations.
method if the taxpayer meets the require-      the property produced under Federal in-             Commentators requested that the pro-
ments of §1.263A–3(a)(4)(ii) or (iii).         come tax principles. The determination          posed regulations provide examples of
                                               of whether a taxpayer is considered an          how to apply the benefits and burdens
Definition of By the Taxpayer                  owner is based on all of the facts and cir-     standard. The proposed regulations con-
                                               cumstances, including the various benefits      tain examples illustrating contract manu-
   Section 1.199–3(e)(1) of the proposed       and burdens of ownership vested with            facturing situations in which the taxpayer
regulations provides that, with the ex-        the taxpayer. Because the standard under        with the benefits and burdens of owner-
ception of rules that are applicable to an     the section 263A regulations is broad, it       ship under Federal income tax principles
EAG, certain oil and gas partnerships          has been interpreted to allow two tax-          is treated as manufacturing the QPP.
described in §1.199–3(h)(7), EAG part-         payers to be considered the producer of             In the Congressional Letter, the Trea-
nerships described in §1.199–3(h)(8), and      the same property. Compare, for exam-           sury Department was advised that gross


2005–47 I.R.B.                                                     996                                        November 21, 2005
receipts derived from certain contracts          cluded from total CGS for purposes of the         section 168(i)(2)(B)(iv) apply to computer
to manufacture or produce property for           safe harbor.                                      software under section 199. In response
the Federal government are derived from             A commentator suggested that a tax-            to this comment, the proposed regulations
the sale of such property and, therefore,        payer’s activity within the United States         provide in §1.199–3(i)(3)(i) that these
are DPGR. The proposed regulations in            that is critical to the functionality or nature   exceptions do not apply for purposes of
§1.199–3(e)(2) provide that a taxpayer           of property should be considered to meet          section 199 and computer software also
will be treated as meeting the by the tax-       the in significant part requirement under         includes the machine-readable code for
payer requirement if the QPP, qualified          section 199(c)(4)(A)(i)(I) even if the activ-     video games and similar programs, for
films, or utilities are MPGE or other-           ity is not substantial in nature. The pro-        equipment that is an integral part of other
wise produced in the United States by the        posed regulations do not adopt this sugges-       property, and for typewriters, calculators,
taxpayer pursuant to a contract with the         tion because the IRS and Treasury Depart-         adding and accounting machines, copiers,
Federal government and the Federal Ac-           ment do not believe that this is an accurate      duplicating equipment, and similar equip-
quisition Regulation requires that title or      measurement of the degree of activity re-         ment, regardless of whether the code is
risk of loss with respect to the QPP, quali-     quired to satisfy the in whole or in signifi-     designed to operate on a computer (as de-
fied films, or utilities be transferred to the   cant part requirement.                            fined in section 168(i)(2)(B)). Computer
Federal government before the MPGE or                                                              programs of all classes, for example, op-
production of the QPP, qualified films, or       Qualifying Production Property                    erating systems, executive systems, mon-
utilities is complete.                                                                             itors, compilers and translators, assembly
                                                     Commentators requested that the IRS
                                                                                                   routines, and utility programs as well as
In Whole or In Significant Part                  and Treasury Department reconsider the
                                                                                                   application programs, are included.
                                                 rule under section 4.04(8)(c) and (d) of
                                                                                                       A commentator requested that the pro-
   Under section 199(c)(4)(A)(i)(I), QPP         Notice 2005–14 which provides that, if the
                                                                                                   posed regulations provide that the creation
must be MPGE in whole or in signif-              medium in which computer software or
                                                                                                   and licensing of copyrighted business in-
icant part by the taxpayer within the            sound recordings are contained is tangible,
                                                                                                   formation reports constitutes the MPGE
United States. The proposed regulations          then such medium is considered tangible
                                                                                                   of QPP. Formerly distributed in hard copy,
in §1.199–3(f)(1) clarify that the in whole      personal property for purposes of section
                                                                                                   this information is now generally dis-
or in significant part requirement applies       199. This rule has been removed and the
                                                                                                   tributed electronically. Customers are re-
to both the by the taxpayer requirement          proposed regulations in §1.199–3(i)(5)
                                                                                                   quired to use the information only for their
and the within the United States require-        provide that if a taxpayer MPGE com-
                                                                                                   own use, and no copyright is transferred
ment.                                            puter software or sound recordings that
                                                                                                   to them. The commentator contends that,
   Section 4.04(5)(b) of Notice 2005–14          the taxpayer fixed on, or added to, tan-
                                                                                                   while the activity of creating the business
provides that QPP will be treated as hav-        gible personal property (for example, a
                                                                                                   information reports provided to customers
ing been MPGE in significant part by the         computer diskette or an appliance), then
                                                                                                   is not a production activity in the tradi-
taxpayer within the United States if the         the tangible medium with the computer
                                                                                                   tional sense, the definition of MPGE is
MPGE of the QPP performed within the             software or sound recordings may be
                                                                                                   broad enough to encompass this activity.
United States is substantial in nature. De-      treated by the taxpayer as computer soft-
                                                                                                   The IRS and Treasury Department do not
sign and development costs do not qual-          ware or sound recordings, as applicable.
                                                                                                   agree with this comment because creating
ify as substantial in nature for any QPP         However, the proposed regulations pro-
                                                                                                   a database of business information is not
other than computer software and sound           vide that, if a taxpayer treats the tangible
                                                                                                   MPGE, the database is not QPP, and the
recordings. The proposed regulations in          medium as computer software or sound
                                                                                                   business information reports are not QPP
§1.199–3(f)(2) substitute research and ex-       recordings, any costs under section 174
                                                                                                   MPGE by the taxpayer.
perimental expenditures under section 174        attributable to the tangible medium are
for design and development costs.                not considered in determining whether the         Qualified Films
   Section 4.04(5)(c) of Notice 2005–14          taxpayer’s activity is substantial in nature
provides that a taxpayer will be treated as      under §1.199–3(f)(2) or conversion costs             Similar to the rules for computer
having MPGE property in whole or in sig-         under §1.199–3(f)(3). In addition, because        software, section 4.04(9)(a) of Notice
nificant part within the United States if, in    a taxpayer may MPGE tangible personal             2005–14 provides that if a medium on
connection with the property, conversion         property, but not computer software or            which a qualified film is fixed is tangible
costs (direct labor and related factory bur-     sound recordings that the taxpayers fixes         (such as a DVD), the property consists of
den) to MPGE the property are incurred by        on, or adds to, the tangible personal prop-       both a qualified film and tangible personal
the taxpayer within the United States and        erty MPGE by the taxpayer, the proposed           property. The notice contains examples
the costs account for 20 percent or more         regulations provide that the computer soft-       in which taxpayers that either produce a
of the total CGS of the property. The pro-       ware or sound recordings may be treated           qualified film and purchase the tangible
posed regulations in §1.199–3(f)(3) pro-         by the taxpayer as tangible personal prop-        medium, or MPGE the tangible medium
vide that, in the case of tangible personal      erty.                                             and license the qualified film, must allo-
property, research and experimental ex-              Commentators requested that the pro-          cate gross receipts between the tangible
penditures under section 174 and any other       posed regulations clarify whether the             medium and the qualified film. For the
costs of creating intangibles may be ex-         exceptions from computer software under           reasons stated under the discussion of



November 21, 2005                                                    997                                                  2005–47 I.R.B.
computer software, the proposed regu-           the gross receipts derived by the taxpayer           Section 4.04(11)(a) of Notice 2005–14
lations allow certain taxpayers to treat        from the sale of the building would not be       contains a safe harbor rule for determin-
such combined property as either tangible       DPGR because the taxpayer did not con-           ing when tangible personal property that
personal property or a qualified film, as       struct the building. The proposed regula-        is sold as part of a construction project
applicable.                                     tions provide an example to illustrate this      may be considered real property. If more
    One commentator requested that the          rule.                                            than 95 percent of the total gross receipts
proposed regulations clarify the require-           Commentators also asked that the             derived by a taxpayer from a construc-
ment that 50 percent of the total compen-       proposed regulations clarify whether             tion project are derived from real property
sation relating to the production of the        eligible construction activities are lim-        (as defined in §1.263A–8(c)), then the to-
film be compensation for services per-          ited to a specific NAICS code. Section           tal gross receipts derived by the taxpayer
formed in the United States by actors,          1.199–3(l)(1)(i) provides that a trade or        from the project are DPGR from construc-
production personnel, directors, and pro-       business that is considered construction         tion. Commentators stated that it was un-
ducers. Specifically, the commentator           for purposes of the NAICS codes means            clear what items of tangible personal prop-
requested that the phrase “total compensa-      a construction activity under the two-digit      erty are included in this rule (for exam-
tion relating to the production of the film”    NAICS code of 23 and any other construc-         ple, small or major appliances, home the-
be interpreted to mean compensation for         tion activity in any other NAICS code            aters, and fixtures installed by a builder)
services performed only by actors, produc-      relating to the construction of real prop-       and whether it was intended that land be
tion personnel, directors, and producers.       erty. For example, a construction activity       included for purposes of this safe harbor.
The commentator further requested that          relating to the construction of real prop-       Consequently, this rule has been replaced
the term “compensation” be interpreted to       erty that is not under the two-digit NAICS       in the proposed regulations with a de min-
include all compensation (not just W–2          code of 23 but which qualifies as an eli-        imis exception in §1.199–3(l)(1)(ii). Ac-
wages) that is paid to these individuals        gible construction activity would include        cordingly, if less than 5 percent of the total
and that is required to be capitalized by       the construction of oil and gas wells for        gross receipts derived by a taxpayer from
film producers under section 263A and           NAICS code 213111 (drilling oil and gas          a construction project are derived from ac-
§1.263A–1(e)(2) and (3). These sugges-          wells) and 213112 (support activities for        tivities other than the construction of real
tions have been adopted in the proposed         oil and gas operations). Commentators            property in the United States (for exam-
regulations.                                    also asked that the proposed regulations         ple, from non-construction activities, the
                                                include a listing of construction activities     sale of tangible personal property, or land)
Definition of Construction Performed in         relating to oil and gas wells. In response to    then the total gross receipts derived by the
the United States                               this request, the proposed regulations pro-      taxpayer from the project are DPGR from
                                                vide, as a matter of administrative grace,       construction.
    Section 4.04(11)(a) of Notice 2005–14       that qualifying construction activities also         Many commentators suggested that the
defines the term “construction” to mean         include activities relating to drilling an oil   proposed regulations treat gross receipts
the construction or erection of real prop-      well and mining, and include any activi-         attributable to the sale or other disposition
erty by a taxpayer that is in a trade or        ties treated by the taxpayer as intangible       of land as DPGR derived from construc-
business that is considered construction for    drilling and development costs under sec-        tion of real property. Commentators also
purposes of the North American Industry         tion 263(c) and §1.612–4 and development         suggested that construction begins as soon
Classification System (NAICS). Commen-          expenditures for a mine or natural deposit       as production activities begin, that is,
tators asked how a taxpayer in multiple         under section 616.                               when land is acquired and the entitlement
trades or businesses determines if it is in a       Commentators contend that gross re-          process, such as obtaining proper zoning
construction NAICS code. The proposed           ceipts attributable to the leasing or rental     and permits, commences in connection
regulations clarify that in order for a tax-    of constructed real property qualify as          with construction of real property. The
payer to be considered in a construction        DPGR because the right to use constructed        proposed regulations do not adopt these
NAICS code, it must be engaged in a con-        property represents one right in the bundle      suggestions. The IRS and Treasury De-
struction trade or business (but not neces-     of rights derived from the construction of       partment continue to believe that Congress
sarily its primary trade or business) on a      real property. The proposed regulations do       intended the benefit under section 199 only
regular and ongoing basis. The determi-         not adopt this interpretation because gross      for construction services performed in the
nation of whether an entity is in a NAICS       receipts derived from the rental of real         United States. Taxpayers do not construct
code is generally tested on an entity-by-en-    property that a taxpayer constructs are not      land and thus any gain attributable to
tity basis. Under this rule, a member of        derived from construction, but are instead       the disposition of land (including zoning,
an EAG must perform the construction            compensation for the use or forbearance          planning, entitlement costs and other costs
activity in order for its gross receipts to     of the property. Similarly, gross receipts       capitalized to the land such as the demo-
qualify as DPGR from construction. See          derived from renting or leasing equipment        lition of structures under section 280B) is
§1.199–7(a)(3). In addition, the taxpayer       such as bulldozers and generators to con-        not eligible for the section 199 deduction.
must actually perform the construction ac-      tractors for use in the construction of real     Commentators also argue that the land
tivity. For example, if a taxpayer in a con-    property are non-DPGR (assuming the              exclusion creates an administrative and
struction NAICS code hired an unrelated         rental companies do not manufacture the          financial burden because a valuation will
general contractor to construct a building,     equipment).                                      be necessary for any sale of real property


2005–47 I.R.B.                                                      998                                          November 21, 2005
that includes land. To address the admin-        to the land and any entitlements attribut-     for the construction of real property in
istrative burden in identifying and valuing      able to the land. The proposed regulations     the United States. In addition, the IRS
the gross receipts attributable to land in       provide examples in §1.199–3(l)(5)(iii) to     and Treasury Department believe that,
connection with qualifying construction          illustrate this rule.                          consistent with the rules for construction
activities, the proposed regulations pro-            Commentators suggested that the pro-       activities, a taxpayer performing engi-
vide a safe harbor in §1.199–3(l)(5)(ii).        posed regulations extend the embedded          neering and architectural services must
Under this safe harbor, a taxpayer may al-       services exception for qualified warranties    be in a trade or business described in
locate gross receipts between the proceeds       in connection with the sale of property        an engineering or architectural NAICS
from the sale, exchange, or other dispo-         to construction warranties. The IRS and        code. Accordingly, the proposed regula-
sition of real property constructed by the       Treasury Department agree with this sug-       tions require that, at the time the taxpayer
taxpayer and the gross receipts attributable     gestion. Accordingly, §1.199–3(l)(5)(i)        performs the engineering or architectural
to the sale, exchange, or other disposition      provides DPGR derived from the con-            services, the taxpayer must be in a trade
of land by reducing its costs related to         struction of real property includes gross      or business on a regular and ongoing basis
DPGR in §1.199–4 by costs of the land            receipts from any warranty that is provided    (but not necessarily its primary trade or
and any other costs capitalized to the land      in connection with the construction of the     business) that is considered engineering or
(collectively, land costs) (including land       real property if, in the normal course of      architectural services for purposes of the
costs in any common improvements as de-          the taxpayer’s business, the charge for the    NAICS codes, for example NAICS codes
fined in section 2.01 of Rev. Proc. 92–29,       construction warranty is included in the       541330 (engineering services) or 541310
1992–1 C.B. 748), and by reducing its            price for the construction project and the     (architectural services).
DPGR from qualifying construction activ-         construction warranty is neither separately        A commentator also requested clari-
ities by those land costs plus a specified       offered by the taxpayer nor separately bar-    fication of whether a structure enclosing
percentage. The percentage is based on           gained for with the customer (that is, the     an electric generation station as described
the number of years that elapse between          customer cannot purchase the constructed       in Rev. Rul. 69–412, 1969–2 C.B. 2,
the date the taxpayer acquires the land,         real property without the construction         would be considered real property for
including the date the taxpayer enters into      warranty).                                     purposes of section 199(c)(4)(A)(iii). In
the first option to acquire all or a portion                                                    that revenue ruling, the structure quali-
of the land, and ends on the date the tax-       Engineering and Architectural Services         fied as section 38 property for investment
payer sells each item of real property on                                                       credit purposes. The revenue ruling does
the land. The percentage is 5 percent for           Section 4.04(12)(a) of Notice 2005–14       not determine whether the property was
years zero through 5; 10 percent for years       provides that DPGR includes gross re-          real or personal property. Under section
6 through 10; and 15 percent for years 11        ceipts derived from engineering or ar-         4.04(11)(a) of Notice 2005–14, real prop-
through 15. Land held by a taxpayer for          chitectural services performed in the          erty includes residential and commercial
16 or more years is not eligible for the         United States for real property construc-      buildings including items that are struc-
safe harbor and the taxpayer must allocate       tion projects in the United States. Com-       tural components of such buildings and
gross receipts between the land and the          mentators stated that the definition of en-    inherently permanent structures other than
qualifying real property. For example, if        gineering and architectural services should    tangible personal property in the nature
a taxpayer acquires land in 2001 and con-        not be limited to real property because this   of machinery. The proposed regulations
structs houses that it sells in 2005, 2008,      limitation is inconsistent with the rules      in §1.199–3(l)(1)(i) retain this language.
and 2012, the houses sold in 2005 are sub-       for engineering and architectural services     Thus, a structure enclosing an electric
ject to the 5 percent reduction; the houses      under the domestic international sales cor-    generation station as described in Rev.
sold in 2008 are subject to the 10 percent       poration, foreign sales corporation, and       Rul. 69–412 is treated as real property for
reduction; and the houses sold in 2012 are       extraterritorial income exclusion provi-       purposes of section 199(c)(4)(A)(iii).
subject to the 15 percent reduction.             sions. The IRS and Treasury Department             In addition, similar to the rules for con-
    Commentators suggested that develop-         continue to believe that the statutory lan-    struction, the determination of whether an
ers of raw land should be entitled to a sec-     guage in section 199(c)(4)(A)(iii) requires    entity is in an engineering or architectural
tion 199 deduction for improvements to           that only engineering and architectural        NAICS code is made on an entity-by-en-
land such as building roads, sidewalks, and      services relating to real property qualify     tity basis. Under this rule, a member of
installing utilities. In addition, they sug-     for the section 199 deduction and that the     an EAG must perform the engineering
gested that entitlements such as zoning,         same rules relating to construction of real    or architectural services in order for its
permits, and surveys that add value to the       property apply for engineering or architec-    gross receipts to qualify as DPGR from
land should be included in DPGR similar          tural services. In addition, the Blue Book     engineering or architectural services. See
to the treatment of design and development       at page 172 n. 292, states that DPGR           §1.199–7(a)(3). In addition, the taxpayer
costs for software and sound recordings.         includes gross receipts derived from the       must actually perform the engineering or
The proposed regulations provide that a          engineering or architectural services per-     architectural services.
taxpayer in a construction NAICS code            formed with respect to real property only.         One commentator pointed out that the
that sells developed land will have DPGR         Thus, DPGR only includes gross receipts        requirement in section 4.04(12)(a) of No-
to the extent the receipts are attributable to   derived from engineering or architectural      tice 2005–14 that a taxpayer must substan-
real property such as infrastructure but not     services performed in the United States        tiate that the engineering or architectural


November 21, 2005                                                   999                                                 2005–47 I.R.B.
services relate to a construction project in   trade). Accordingly, the proposed regula-         produced on the bonded premises of the
the United States is unnecessary because       tions do not adopt this suggestion, and the       winery. Accordingly, the sales of such
taxpayers are already required to identify     term “retail establishment” is clarified to       wine will be treated as DPGR for purposes
and allocate gross receipts attributable to    include both real and personal property.          of section 199 (assuming all the other re-
DPGR based upon a reasonable method            In addition, a facility at which food and         quirements of section 199(c) are met). A
satisfactory to the Secretary for purposes     beverages are prepared solely for take out        similar result applies to the sale of taxpaid
of determining QPAI. Because there was         service or delivery is a retail establishment     distilled spirits from the general (taxpaid)
no intention on the part of the IRS and        (for example, a caterer).                         premises of a distilled spirits plant, and to
Treasury Department to create an addi-             Consistent with Notice 2005–14, the           the sale of taxpaid beer from the tavern
tional substantiation requirement for engi-    proposed regulations provide that if a tax-       portion of a brewery.
neering and architectural services, this ad-   payer’s facility is a retail establishment,           A commentator suggested that the pro-
ditional substantiation requirement is not     then, as a matter of administrative grace, a      posed regulations interpret the term food
required under the proposed regulations.       taxpayer is permitted to allocate its gross       and beverages to mean only items pre-
    Commentators requested clarification       receipts between gross receipts derived           pared by the taxpayer in a single serving
of whether gross receipts attributable to      from the wholesale sale of the food and           size for immediate consumption by the
feasibility studies, for example, planning     beverages prepared at the retail establish-       purchaser. The commentator believes
possible road or building configurations       ment (which are DPGR, assuming all the            that the Conference Report in footnote 27
for a potential real property develop-         other requirements of section 199(c) are          supports this interpretation because these
ment project, is a qualifying activity.        met) and the gross receipts derived from          characteristics are common to the exam-
The commentators state that engineering        the retail sale of the food and beverages         ples that the footnote provides (that is,
and architectural firms are often hired        prepared and sold at the retail establish-        brewed coffee and venison sausage pre-
for these studies to determine a project’s     ment (which are non-DPGR). For this               pared at a restaurant). The commentator
practicability. Accordingly, the proposed      purpose, wholesale sales are defined as           further contends that this interpretation
regulations provide in §1.199–3(m)(1)          sales of food and beverages to be resold          eliminates the distinction between food
that DPGR includes gross receipts derived      by the purchaser.                                 and beverages prepared off-site (gross re-
from engineering or architectural services,        One commentator requested clarifica-          ceipts from the retail sale of which may be
including feasibility studies for a con-       tion how the retail establishment excep-          DPGR) and those prepared on-site (gross
struction project in the United States, even   tion applies in the case of wineries. While       receipts from the retail sale of which are
if the planned construction project is not     producers of distilled spirits, wines, and        non-DPGR), a distinction that the com-
undertaken or is not completed.                beer may conduct retail sales of their prod-      mentator believes Congress did not intend.
                                               ucts on their premises, such sales do not             The IRS and Treasury Department do
Food and Beverages                             transform the entire premises of the dis-         not believe that the statute or Conference
                                               tilled spirits plant, bonded wine cellar (or      Report supports the commentator’s inter-
   Section 199(c)(4)(B)(i) provides that       bonded winery), or brewery into a retail es-      pretation. If the commentator’s interpreta-
DPGR does not include gross receipts of        tablishment. Chapter 51 of Title 26 of the        tion was correct, then gross receipts from
the taxpayer that are derived from the sale    United States Code, and the implementing          the retail sale of the roasted coffee beans
of food and beverages prepared by the          regulations found in 27 CFR Parts 19, 24,         in footnote 27 would have qualified as
taxpayer at a retail establishment. Sec-       and 25, create clear distinctions between         DPGR even if the taxpayer had roasted
tion 4.04(13) of Notice 2005–14 defines        that portion of a distilled spirits plant, win-   the beans at its retail establishment be-
a “retail establishment” as real property      ery, or brewery devoted to production ac-         cause the beans are not sold in single serv-
leased, occupied, or otherwise used by the     tivities and the portion devoted to other         ings for immediate consumption. How-
taxpayer in its trade or business of selling   activities, such as retail sales. Consis-         ever, footnote 27 makes clear that the gross
food or beverages to the public at which       tent with the treatment of such facilities        receipts attributable to the beans only qual-
retail sales are made. One commentator         for purposes of Chapter 51 of Title 26 of         ify because the beans were roasted at a
stated that food carts and portable food       the United States Code and the regulations        facility separate from the retail establish-
stands should not be considered retail         thereunder, the proposed regulations pro-         ment. Thus, the statute and legislative his-
establishments because they do not consti-     vide that the portion of a distilled spirits      tory clearly provide different treatment for
tute real property. The IRS and Treasury       plant, bonded winery, or brewery that is          gross receipts attributable to the retail sale
Department believe that the term “retail       restricted to production activities, includ-      of food and beverages prepared at a retail
establishment” is intended to be inter-        ing the processing and blending of distilled      establishment and food and beverages pre-
preted broadly to include any facility at      spirits, wine, and beer products, will not        pared elsewhere.
which the taxpayer prepares food or bev-       be treated as a retail establishment for pur-         The same commentator requested clar-
erages and makes retail sales of the food or   poses of section 199(c)(4)(B)(i). Thus, for       ification of how the food and beverages
beverages to the public. See Conference        example, for purposes of section 199, tax-        exception applies to in-store bakeries.
Report at page 272 (footnote 27) (retail es-   paid wine sold from the taxpaid premises          Footnote 27 of the Conference Report
tablishment not limited to establishments      of a bonded winery is not considered to           provides an example of a taxpayer that
at which customers dine on premises or         have been produced at a retail establish-         operates a supermarket that includes an
to those engaged primarily in the dining       ment because it is considered to have been        in-store bakery, and provides that the


2005–47 I.R.B.                                                    1000                                           November 21, 2005
taxpayer may allocate its gross receipts        a reasonable allocation method to allocate    The proposed regulations provide that a
between DPGR and non-DPGR. The com-             CGS between DPGR and non-DPGR. The            taxpayer that uses the LIFO method to
mentator believes that the example could        Notice further provides that, if a taxpayer   account for its inventory may use any rea-
be interpreted to mean that all gross re-       uses a method to allocate gross receipts      sonable method to allocate CGS between
ceipts allocable to sales (both retail and      between DPGR and non-DPGR, then the           DPGR and non-DPGR. In addition, the
wholesale) of items prepared in the bakery      taxpayer may not use a different method       regulations provide simplified methods
are non-DPGR. Section 4.04(13) of Notice        for purposes of allocating CGS.               that a taxpayer may use to allocate CGS
2005–14 however, as a matter of adminis-            Commentators suggested that a tax-        when a taxpayer uses the LIFO method to
trative grace, permits gross receipts from      payer should be permitted to allocate CGS     account for its inventories.
wholesale sales of food and beverages           using a reasonable method separate from          The IRS and Treasury Department also
produced at a retail establishment to qual-     the method used to allocate gross receipts    received comments requesting clarifica-
ify as DPGR (if all other requirements of       because using the same allocation method      tion of the types of costs that are required
section 199(c) are met), and the proposed       for gross receipts and CGS may not be         to be allocated as CGS allocable to DPGR.
regulations retain this rule. Thus, gross       possible or may distort income. For exam-     In particular, commentators stated that
receipts from wholesale sales of items pro-     ple, a taxpayer that can identify from its    section 263A only requires taxpayers to
duced at the in-store bakery (for example,      books and records gross receipts allocable    capitalize costs with respect to inventory
items sold to restaurants) may qualify as       to DPGR may not be able to specifically       on hand at the end of the taxable year
DPGR (if all other requirements of section      identify CGS allocable to DPGR. Com-          and that as a result taxpayers generally
199(c) are met). The commentator further        mentators also questioned whether a tax-      do not include indirect costs in CGS, but
stated, consistent with the first comment,      payer that can identify from its books and    instead deduct the amount not allocated to
that gross receipts from retail sales of        records CGS allocable to DPGR must al-        ending inventory. Section 263A requires
bakery products that require further pro-       locate CGS on such basis when it allocates    a taxpayer that produces inventory to in-
cessing by the consumer to be suitable for      gross receipts using a different method.      clude in inventory costs the direct costs of
individual consumption (such as unsliced        The proposed regulations clarify that if      producing the property and the property’s
cakes and unsliced loaves of bread) should      a taxpayer does, or can without undue         properly allocable share of indirect costs
not be excluded from DPGR under section         burden or expense, specifically identify      for purposes of determining both ending
199(c)(4)(B)(i). For the reasons stated         from its books and records CGS alloca-        inventory and CGS. Consistent with No-
above, the IRS and Treasury Department          ble to DPGR, CGS allocable to DPGR is         tice 2005–14, the proposed regulations
believe that retail sales of these items are    that amount irrespective of whether the       provide that, for purposes of determining
subject to that exclusion. Receipts allo-       taxpayer uses another allocation method       CGS allocable to DPGR, CGS includes
cable to wholesale sales of these items,        to allocate gross receipts between DPGR       the costs that would have been included
however, may qualify as DPGR under the          and other gross receipts. The proposed        in ending inventory under the principles
administrative exception, assuming all the      regulations also clarify that if a taxpayer   of sections 263A, 471, and 472 if the
other requirements of section 199(c) are        cannot, without undue burden or expense,      goods sold during the taxable year were
met.                                            use a specific identification method to       on hand at the end of the taxable year.
                                                determine CGS allocable to DPGR, the          However, a taxpayer is permitted to use
Determining Costs                               taxpayer is not required to use a specific    any reasonable method to allocate indirect
                                                identification method to determine CGS        costs properly included in CGS between
   To determine its QPAI for the taxable
                                                allocable to DPGR, but may use some           DPGR and non-DPGR if the taxpayer’s
year, a taxpayer must subtract from its
                                                other reasonable method. A taxpayer’s         books and records do not, or cannot with-
DPGR the amount of CGS allocable to
                                                use of a method for purposes of allocat-      out undue burden or expense, specifically
DPGR, the other deductions, expenses,
                                                ing CGS between DPGR and non-DPGR             identify CGS allocable to DPGR.
and losses (deductions) directly allocable
                                                that is different from its method for allo-      Comments also were received concern-
to DPGR, and a ratable portion of other
                                                cating gross receipts between DPGR and        ing whether a taxpayer is permitted to use
deductions that are not directly allocable
                                                non-DPGR will ordinarily not be con-          a reasonable allocation method to allocate
to DPGR or another class of income. A
                                                sidered reasonable unless the method for      CGS if it uses the simplified production
taxpayer’s costs must be determined using
                                                allocating CGS is demonstrably more ac-       method or simplified resale method for
the taxpayer’s methods of accounting for
                                                curate than the method used to allocate       additional section 263A costs. The pro-
Federal income tax purposes.
                                                gross receipts.                               posed regulations clarify that a taxpayer
Allocation of Cost of Goods Sold                    Commentators also suggested that          that uses either the simplified production
                                                CGS allocable to DPGR may not be read-        method or the simplified resale method for
   Notice 2005–14 provides that if a tax-       ily ascertainable when a taxpayer uses the    additional section 263A costs may use a
payer can identify from its books and           last-in, first-out (LIFO) method to account   reasonable allocation method to allocate
records CGS allocable to DPGR, CGS al-          for its inventory. Therefore, commenta-       both section 471 costs and additional sec-
locable to DPGR is that amount. The No-         tors requested that a simplified method be    tion 263A costs included in CGS. The pro-
tice also provides that if a taxpayer’s books   provided to allocate CGS between DPGR         posed regulations further provide that if
and records do not allow it to identify CGS     and non-DPGR when a taxpayer uses the         a taxpayer uses the simplified production
allocable to DPGR, the taxpayer may use         LIFO method to account for its inventory.     method or the simplified resale method to


November 21, 2005                                                 1001                                               2005–47 I.R.B.
allocate additional section 263A costs to     receipts in excess of $25,000,000. Many           large taxpayers to circumvent the require-
ending inventory, additional section 263A     of these comments were from taxpayers             ments to allocate and apportion deductions
costs ordinarily should be allocated in the   that have not in the past been required to        using the section 861 method. As a re-
same proportion as section 471 costs are      allocate and apportion deductions under           sult, a deduction limitation has been added
allocated.                                    the section 861 regulations. Some com-            to this method. In addition, commentators
                                              mentators suggested that the simplified           requested that the definition of qualifying
Allocation and Apportionment of               deduction method be used for all costs,           small taxpayer for purposes of the small
Deductions                                    except for limited identified costs such as       business simplified overall method be ex-
                                              interest, for which the section 861 method        panded to include farmers that are not re-
   Consistent with Notice 2005–14, the        would continue to apply. Still other com-         quired to use the accrual method under sec-
proposed regulations provide three meth-      mentators suggested that taxpayers be             tion 447. The proposed regulations incor-
ods for allocating and apportioning de-       allowed to use other existing cost alloca-        porate this suggestion. Accordingly, the
ductions. However, as described below,        tion methods, such as those under section         proposed regulations provide that a quali-
modifications have been made in these         263A or under other government regula-            fying small taxpayer is a taxpayer that; (1)
proposed regulations to the qualification     tory procedures.                                  has both average annual gross receipts of
requirements of the simplified deduction          In response to these comments, the IRS        $5,000,000 or less, and CGS and deduc-
method and the small business simplified      and Treasury Department have modified             tions (excluding NOL deductions and de-
overall method.                               the eligibility requirements for the simpli-      ductions not attributable to the conduct of
   The first method, the “section 861         fied deduction method. Under the pro-             a trade or business) for the current taxable
method,” is required to be used by a          posed regulations, a taxpayer may use the         year of $5,000,000 or less; (2) is engaged
taxpayer, unless the taxpayer is eligible     simplified deduction method if it has aver-       in the trade or business of farming that is
and chooses to use either the simpli-         age annual gross receipts of $25,000,000          not required to use the accrual method un-
fied deduction method or the small busi-      or less, or total assets at the end of the tax-   der section 447; or (3) is eligible to use
ness simplified overall method. Under         able year of $10,000,000 or less. However,        the cash method as provided in Rev. Proc.
the section 861 method, section 199 is        the IRS and Treasury Department still be-         2002–28.
treated as an operative section described     lieve that for taxpayers above this thresh-           Notice 2005–14 specifically requested
in §1.861–8(f). Accordingly, a taxpayer       old the section 861 method is the appro-          comments on whether taxpayers should be
determines the deductions allocated and       priate method of allocating and apportion-        able to change between the three cost allo-
apportioned to DPGR by applying the           ing deductions for purposes of determining        cation methods of section 199 on amended
allocation and apportionment rules pro-       QPAI. Furthermore, the alternative alloca-        returns and whether there should be re-
vided by §§1.861–8 through 1.861–17           tion methods suggested by commentators            strictions on a taxpayer’s ability to change
and §§1.861–8T through 1.861–14T (the         would each require additional rules and           from one method to another. Several com-
section 861 regulations), subject to cer-     guidance to address the interaction of the        mentators suggested that a taxpayer should
tain special rules. The IRS and Treasury      suggested methods with other Federal in-          be allowed to change its cost allocation
Department recognize that the allocation      come tax rules and would result in admin-         method on an amended return and that a
and apportionment rules of the section        istrative complexity and inefficiency. The        taxpayer should be able to annually choose
861 method may be burdensome to certain       IRS and Treasury Department believe that          to use any of the three methods. The
taxpayers, particularly smaller taxpayers,    use of the section 861 method will result in      IRS and Treasury Department agree that
that otherwise would not be required to       an appropriate cost allocation and appor-         a taxpayer that qualifies to use a particu-
use these rules. Accordingly, the pro-        tionment for purposes of section 199 and          lar allocation and apportionment method
posed regulations provide two alternative     will be easier administratively for both tax-     should be able to change to that method
methods, the simplified deduction method      payers and the IRS than any new, equally          at any time. Accordingly, the proposed
and the small business simplified overall     comprehensive cost allocation and appor-          regulations generally provide that a tax-
method, with a goal of minimizing the         tionment rules that might be created.             payer eligible to use the simplified deduc-
need for smaller taxpayers to devote addi-        Section 1.199–4(f) of the proposed reg-       tion method may choose at any time to
tional resources to compliance.               ulations provides that a qualifying small         use the simplified deduction method or the
   Under the “simplified deduction            taxpayer may use the “small business sim-         section 861 method for a taxable year. A
method,” a taxpayer’s deductions are          plified overall method” to apportion CGS          taxpayer eligible to use the small business
apportioned between DPGR and other            and deductions to DPGR. Under Notice              simplified overall method may choose at
receipts based on relative gross receipts.    2005–14, a qualifying small taxpayer is a         any time to use the small business sim-
The simplified deduction method does          taxpayer that has average annual gross re-        plified overall method, the simplified de-
not apply to the allocation of CGS. Notice    ceipts of $5,000,000 or less or a taxpayer        duction method, or the section 861 method
2005–14 permits only taxpayers with aver-     that is eligible to use the cash method as        for a taxable year. This rule does not
age annual gross receipts of $25,000,000      provided in Rev. Proc. 2002–28, 2002–1            affect, however, any restrictions or limi-
or less to use the simplified deduction       C.B. 815. The IRS and Treasury Depart-            tations that apply within the section 861
method. Several commentators requested        ment are concerned that the $5,000,000 av-        method.
that the simplified deduction method also     erage annual gross receipts threshold with-
be made available to taxpayers with gross     out further modification could be used by


2005–47 I.R.B.                                                   1002                                          November 21, 2005
Pass-thru Entities                                This rule applies to all partnerships, in-       cated to that partner, provided the partner
                                                  cluding partnerships that have elected out       derives gross receipts from the distributed
    Section 199 applies at the owner level        of subchapter K under section 761(a). In         property during the taxable year of the
in a manner consistent with the economic          addition, attribution of activities does not     partner with or within which the partner-
arrangement of the owners of the pass-thru        apply for purposes of the construction of        ship’s taxable year (in which the distribu-
entity. Under the proposed regulations,           real property and the performance of engi-       tion occurs) ends. Costs included in the ad-
each owner computes its section 199 de-           neering and architectural services.              justed basis of the distributed property and
duction by taking into account its distribu-          The proposed regulations, pursuant to        any other relevant deductions are taken
tive or proportionate share of the pass-thru      the Congressional Letter, provide a lim-         into account in computing the partner’s
entity’s items (including items of income         ited exception for certain partnerships in       QPAI. The proposed regulations provide
and gain, as well as items of loss and de-        which all of the capital and profits inter-      that the small business simplified overall
duction not otherwise disallowed by the           ests are owned by members of a single            method is not available to EAG partner-
Code), CGS allocated to such items of in-         EAG at all times during the taxable year         ships.
come, and gross receipts included in such         of the partnership (EAG partnership). For            Another commentator asked whether
items of income. In response to a commen-         purposes of determining the DPGR of a            the owner of a pass-thru entity might
tator’s inquiry, the proposed regulations         partnership and its partners, an EAG part-       have to perform multiple QPAI calcula-
make it clear that the owner of a pass-thru       nership and all members of the EAG in            tions, distinguishing between pass-thru
entity need not be engaged directly in the        which the partners of the EAG partner-           and non-pass-thru production activities.
entity’s trade or business in order to claim      ship are members are treated as a single         The proposed regulations make it clear
a section 199 deduction on the basis of           taxpayer during the taxable year for pur-        that, when determining its section 199
that owner’s share of the pass-thru entity’s      poses of section 199(c)(4). Thus, if an          deduction, an owner of a pass-thru entity
items.                                            EAG partnership MPGE or produces prop-           aggregates items of income and expense
    Some commentators recommended that            erty and distributes, leases, rents, licenses,   from the entity (including W–2 wages)
section 199 be applied to partnerships by         sells, exchanges, or otherwise disposes of       with its own items of income and expense
using an aggregate approach in situations         that property to a member of an EAG in           (including W–2 wages) for purposes of
where the qualified production activities         which the partners of the EAG partnership        allocating and apportioning deductions to
are conducted by the partnership, which           are members, then the MPGE or produc-            DPGR. As noted above, the amount of
distributes or sells the QPP, qualified films,    tion activity conducted by the EAG part-         W–2 wages of a pass-thru entity taken into
or utilities to a partner who then leases,        nership will be treated as having been con-      account by an owner in applying the wage
rents, licenses, sells, exchanges, or oth-        ducted by the members of the EAG. Sim-           limitation of section 199(b) is determined
erwise disposes of the property, or where         ilarly, if one or more members of an EAG         under section 199(d)(1)(B). The proposed
the qualified production activities are con-      in which the partners of an EAG part-            regulations provide that in determining an
ducted by a partner which contributes or          nership are members MPGE or produces             owner’s allocable share of wages under
sells the QPP, qualified films, or utilities to   property, and contributes, leases, rents, li-    section 199(d)(1)(B)(i), W–2 wages are
the partnership, which then leases, rents,        censes, sells, exchanges, or otherwise dis-      deemed to be allocated in the same way
licenses, sells, exchanges, or otherwise          poses of that property to the EAG partner-       as wage expense is allocated. In the case
disposes of the property. The commenta-           ship, then the MPGE or production activity       of a non-grantor trust or estate, the W–2
tors maintained that the income derived           conducted by the EAG member (or mem-             wages are deemed to be allocated among
by the partners and the partnerships from         bers) will be treated as having been con-        the trust or estate and the various bene-
the lease, rental, license, sale, exchange,       ducted by the EAG partnership.                   ficiaries in the same manner as QPAI, as
or other disposition of the property in               Except as otherwise provided, an EAG         described below. Although a pass-thru
these situations should be treated as QPAI        partnership is generally treated the same        entity’s QPAI is computed by deducting
and qualify for the section 199 deduction.        as other partnerships for purposes of sec-       wages paid by the entity during its entire
The proposed regulations do not follow            tion 199. Accordingly, the proposed regu-        taxable year, generally it is the pass-thru
the commentators’ recommendation be-              lations provide that an EAG partnership is       entity’s W–2 wages (as shown on the
cause section 199(c)(4)(A) requires that          subject to the rules of §1.199–5 regarding       Forms W–2 for the calendar year ending
the gross receipts must be derived from           the application of section 199 to pass-thru      within that taxable year) that are used to
the taxpayer’s own qualified production           entities, and the application of the sec-        compute the wage limitation under section
activities to qualify as DPGR. Accord-            tion 199(d)(1)(B) wage limitation under          199(b) and an owner’s allocable share of
ingly, except for; (i) certain qualifying oil     §1.199–5(a)(3). Under the proposed reg-          wages under section 199(d)(1)(B)(i). If
and gas partnerships; and (ii) EAG part-          ulations, if an EAG partnership distributes      QPAI, computed by taking into account
nerships, discussed below, the proposed           property to a partner, then, solely for pur-     only the items of the pass-thru entity al-
regulations provide that the owner of a           poses of section 199(d)(1)(B)(ii), the EAG       located to the owner, is not greater than
pass-thru entity is not treated as directly       partnership is treated as having gross re-       zero, the owner may not take into account
conducting the qualified production activ-        ceipts in the taxable year of the distribution   the W–2 wages of the entity in computing
ities of the pass-thru entity, and vice versa,    equal to the fair market value of the prop-      the section 199(b) wage limitation.
with respect to the property transferred be-      erty at the time of distribution to the part-        A commentator requested that the pro-
tween the pass-thru entity and the owner.         ner and the deemed gross receipts are allo-      posed regulations clarify and illustrate


November 21, 2005                                                    1003                                                 2005–47 I.R.B.
by example how the section 199(d)(1)(B)          trust or estate has no DNI in a particular       vide the same information to their part-
wage limitation applies in a tiered partner-     taxable year, any QPAI and W–2 wages are         ners as other partnerships for purposes of
ship structure. In particular, the commen-       allocated to the trust or estate, and not to     computing the section 199 deduction. The
tator suggested that the W–2 wages of a          any beneficiary.                                 IRS and the Treasury Department intend
lower-tier partnership with positive QPAI            Section 199(d)(1)(A)(i) provides that,       to provide information reporting rules for
are properly allocable to the partner of the     in the case of an estate or trust (or other      pass-thru entities in the relevant forms and
upper-tier partnership even if the QPAI          pass-thru entity), section 199 shall apply       instructions.
allocated to the partner from the upper-tier     at the beneficiary (or similar) level. Pur-
partnership is less than zero. The proposed      suant to this provision, as clarified by the     Agricultural and Horticultural
regulations do not adopt this suggestion.        Congressional Letter, the proposed regu-         Cooperatives
The proposed regulations provide that            lations provide that a trust or estate may
the section 199(d)(1)(B) wage limitation         claim the section 199 deduction to the ex-           A commentator suggested that the pro-
must be applied at each level in a tiered        tent that QPAI is allocated to it.               posed regulations provide that patrons
structure. Thus, in a tiered structure, the          Solely for purposes of determining the       cannot include patronage dividends and
owner of a pass-thru entity (including           section 199 deduction for the taxable year,      per-unit retain certificates in the computa-
an owner that itself is a pass-thru en-          the QPAI of a trust or estate must be com-       tion of the QPAI from the patron’s other
tity) calculates the amounts described in        puted by allocating the expenses described       farming operations to the extent that those
section 199(d)(1)(B)(i) (allocable share)        in section 199(d)(5) under §1.652(b)–3           amounts were taken into account by a co-
and (d)(1)(B)(ii) (twice the applicable          with respect to directly attributable ex-        operative in determining the cooperative’s
percentage of the QPAI from the entity)          penses. With respect to other expenses           section 199 deduction. The commentator
separately with regard to its interest in that   described in section 199(d)(5), a trust or       stated that in many cases, both the coop-
pass-thru entity. The proposed regulations       estate that qualifies for the simplified de-     erative and its patrons will be engaged in
provide rules regarding the treatment of         duction method described in §1.199–4(e)          qualifying activities. For example, gross
W–2 wages when a pass-thru entity (up-           must use that method, and any other trust        receipts from crops raised by a farmer
per-tier entity) owns an interest in one or      or estate must use the section 861 method        in the United States may be eligible for
more other pass-thru entities (lower-tier        described in §1.199–4(d). The small              the section 199 deduction as well as the
entities). An example in the proposed reg-       business simplified overall method is not        receipts the cooperative derives from the
ulations illustrates the application of these    available to a trust or estate.                  marketing of the crop. To avoid duplica-
rules.                                               Because the sale of an interest in a pass-   tion of section 199 benefits, the proposed
    The proposed regulations contain spe-        thru entity does not reflect the realization     regulations clarify that under §1.199–6(h)
cial rules for trusts and estates. To the        of DPGR by that entity, DPGR generally           patronage dividends and per-unit alloca-
extent that a grantor or another person is       does not include gain or loss recognized on      tions a patron receives from a cooperative
treated as owning all or part of a trust under   the sale, exchange or other disposition of       that are taken into account as part of the
sections 671 through 679 (grantor trust),        an interest in the entity. However, consis-      cooperative’s computation of QPAI may
the owner will compute its QPAI with re-         tent with Notice 2005–14, if section 751(a)      not be taken into account in computing the
spect to the owned portion of the trust as       or (b) applies, then gain or loss attribut-      patron’s QPAI from its own qualifying ac-
if that QPAI had been generated by activ-        able to partnership assets giving rise to or-    tivities. In addition, patronage dividends
ities performed directly by the owner. In        dinary income under section 751(a) or (b),       and per-unit retain allocations include any
the case of a non-grantor trust or estate, the   the sale, exchange, or other disposition of      advances on patronage or per-unit retains
DPGR and expenses needed to compute              which would give rise to an item of DPGR,        paid in money made during the taxable
the QPAI, as well as the W–2 wages rele-         is taken into account in computing the part-     year. Examples are provided to illustrate
vant to the computation of the wage limita-      ner’s section 199 deduction.                     this rule.
tion, must be allocated among the trust or           Section 199 applies to taxable years be-         A commentator suggested that the pro-
estate and its various beneficiaries. Each       ginning after December 31, 2004. Ac-             posed regulations clarify the amount of the
beneficiary’s share of the trust’s or estate’s   cordingly, these proposed regulations ap-        section 199 deduction a cooperative is re-
QPAI (which will be less than zero if the        ply to taxable years of pass-thru entities       quired to pass through to its patrons. Ac-
CGS and the deductions allocated and ap-         that begin on or after January 1, 2005. The      cordingly, the proposed regulations clarify
portioned to DPGR exceed the trust’s or          IRS and Treasury Department recognize            in §1.199–6(d) that the cooperative may,
estate’s DPGR) and W–2 wages will be             that a pass-thru entity will need to provide     at its discretion, pass through all, some, or
determined based on the proportion of the        certain information to its owners to allow       none of the allowable section 199 deduc-
trust’s or estate’s distributable net income     those persons to compute the section 199         tion to its patrons.
(DNI), as defined by section 643(a), that        deduction. No special provision with re-             A commentator suggested that it would
is deemed to be distributed to that ben-         gard to information reporting is made for        be useful if the proposed regulations ad-
eficiary for that taxable year. Similarly,       electing large partnerships (ELPs) as de-        dress whether a cooperative member of a
the proportion of the entity’s DNI that is       fined by section 775, which are subject to       federated cooperative may pass through
not deemed distributed by the trust or es-       the same methods for allocating and ap-          to its patrons the section 199 deduction
tate will determine the entity’s share of the    portioning deductions as are other partner-      it receives as a patron cooperative. Ac-
QPAI and W–2 wages. In addition, if the          ships. Thus, ELPs are required to pro-           cordingly, the proposed regulations in


2005–47 I.R.B.                                                      1004                                          November 21, 2005
§1.199–6(d) provide that a cooperative          itation at the patron level to the extent the   should be eligible for the section 199 de-
patron of a federated cooperative may           section 199 deduction is passed through         duction if the activities to produce QPP,
pass through the section 199 deduction it       to its patrons. The proposed regulations        qualified films, and utilities are done by
receives to its member patrons.                 provide in §1.199–6(e) that the W–2 wage        one or more members of the EAG other
   A commentator requested that the             limitation shall be applied only at the co-     than the member who leases, rents, li-
proposed regulations address the form,          operative level whether or not the cooper-      censes, sells, exchanges, or otherwise
content, and timing of the patron notifi-       ative chooses to pass through some or all of    disposes of the QPP, qualified films, and
cation requirements. The commentator            the section 199 deduction. In addition, the     utilities. Accordingly, the proposed regu-
stated that the notice should not have to       proposed regulations in §1.199–6(d) pro-        lations provide generally that if a member
accompany the patronage distribution. For       vide that patrons may claim the section 199     of an EAG (the disposing member) de-
instance, a cooperative should be permit-       deduction without regard to the taxable in-     rives gross receipts from the lease, rental,
ted to send out a notice passing through        come limitation.                                license, sale, exchange, or other disposi-
an estimated amount of the section 199              A commentator suggested that the pro-       tion of QPP, qualified films, and utilities
deduction at the time patronage dividends       posed regulations address what happens          MPGE or otherwise produced by another
are paid and a second notice (when the          when an audit determination results in a        member or members of the same EAG,
Federal income tax return is completed          decrease in the amount of a cooperative’s       the disposing member is treated as con-
and the section 199 deduction is actually       section 199 deduction passed through to         ducting the activities conducted by each
determined) covering anything that was          its patrons. The proposed regulations pro-      other member of the EAG with respect to
not passed through by the first notice, pro-    vide in §1.199–6(f) that, if an audit deter-    the QPP, qualified films, and utilities in
vided the notice is sent during the payment     mines or an amended return reports that the     determining whether its gross receipts are
period in section 1382(d). The proposed         amount of the section 199 deduction that        DPGR. However, in general, attribution
regulations provide in §1.199–6(b) that,        was passed through to patrons exceeded          of activities does not apply for purposes
in order for a patron to qualify for the        the amount determined to be allowable by        of the construction of real property un-
section 199 deduction, the cooperative          the audit or on the amended return, recap-      der §1.199–3(l)(1) or the performance
must designate the patron’s portion of the      ture of the audit adjustment amount or ex-      of engineering and architectural services
section 199 deduction in a written notice       cess amended return amount will occur at        under §1.199–3(m)(1). A member of
mailed by the cooperative to its patrons no     the cooperative level.                          an EAG must engage in a construction
later than the 15th day of the ninth month                                                      activity under §1.199–3(l)(2), provide en-
following the close of the cooperative’s        Expanded Affiliated Groups                      gineering services under §1.199–3(m)(2),
taxable year. The cooperative may use                                                           or provide architectural services under
the same written notice, if any, that it uses       Section 199(d)(4)(A) provides that all      §1.199–3(m)(3) in order for the mem-
to notify patrons of their respective allo-     members of an EAG are treated as a single       ber’s gross receipts to be derived from
cations of patronage dividends, or may          corporation for purposes of section 199.        construction, engineering, or architectural
use a separate timely written notice(s) to          The single corporation language in sec-     services. Notwithstanding the above, attri-
comply with this section. The cooperative       tion 199(d)(4)(A) has created confusion         bution of activities in the construction of
must report the amount of the patron’s sec-     among commentators and the proposed             real property and the performance of en-
tion 199 deduction on Form 1099-PATR,           regulations clarify the meaning of this lan-    gineering and architectural services does
“Taxable Distributions Received From            guage. The proposed regulations provide         apply for members of the same consoli-
Cooperatives,” issued to the patron.            that except as otherwise provided in the        dated group. For example, if X and Y are
   A commentator suggested that the             Code and regulations (see, for example,         members of the same EAG, but are not
proposed regulations clarify that patrons       sections 199(c)(7) and 267, §§1.199–3(b)        members of the same consolidated group,
(whether they use the cash or accrual           and 1.199–7(a)(3), and the consolidated         and X constructs a commercial building
method of accounting) are entitled to           return regulations), each member of an          and sells the building to Y, and Y, who
claim the section 199 deduction passed          EAG is a separate taxpayer that computes        performs no construction activities with
through from the cooperative on the re-         its own taxable income or loss, QPAI, and       respect to the building, sells the building
turn for the taxable year in which they         W–2 wages, which are then aggregated at         to an unrelated person, Y is not attributed
receive written notification from the coop-     the EAG level. For example, if corpora-         the construction activities of X and Y’s
erative. The proposed regulations provide       tions X and Y are members of the same           receipts from the sale of the building will
in §1.199–6(d) that patrons may claim the       EAG, but are not members of the same            not be DPGR. However, if X and Y are
section 199 deduction for the taxable year      consolidated group, and X sells QPP it          members of the same consolidated group,
they receive the written notice informing       MPGE within the United States to Y, the         Y is attributed the construction activities
them of the section 199 deduction amount.       transaction is taken into account in deter-     of X and, assuming all the requirements of
   A commentator suggested that the pro-        mining the EAG’s section 199 deduction.         section 199(c) are met, Y’s receipts will
posed regulations clarify that the section      If X and Y are members of the same con-         be DPGR.
199 deduction of a cooperative is subject       solidated group, see the section entitled           Some commentators suggested that the
to the W–2 wage limitation under section        Consolidated Groups, below.                     proposed regulations provide a special
199(b) at the cooperative level and that it         The IRS and Treasury Department be-         rule excluding finance companies from an
is not subject to a second W–2 wage lim-        lieve that Congress intended that an EAG        EAG. Section 199(d)(4)(A) specifically


November 21, 2005                                                  1005                                                2005–47 I.R.B.
states that all members of an EAG shall         cash method as provided in Rev. Proc.           Consolidated Groups
be treated as a single corporation. Nei-        2002–28, and is thus eligible to use the
ther the statute nor the legislative history    small business simplified overall method,           The section 199 deduction of a consol-
provide any exceptions that would allow         is determined by taking into account the        idated group (or the section 199 deduction
taxpayers to exclude certain types of com-      activities of all the members of the EAG.       allocated to a consolidated group that is
panies, including finance companies, from           Commentators requested that the rule        a member of an EAG) is allocated to the
the EAG. Accordingly, the commentators’         in Notice 2005–14 that requires all mem-        members of the consolidated group in pro-
suggestion has not been adopted.                bers of the same EAG to use the same            portion to each consolidated group mem-
   Notwithstanding that a transaction be-       cost allocation method be changed to al-        ber’s QPAI, regardless of whether the con-
tween members of the same EAG (an intra-        low members to use different cost allo-         solidated group member has separate tax-
group transaction) generally is taken into      cation methods. In response to the com-         able income or loss or W–2 wages for
account in determining the section 199 de-      ments received, the IRS and Treasury De-        the taxable year. Further, if two or more
duction, the IRS and Treasury Department        partment agree that if an EAG is eligible       members of a consolidated group engage
recognize that taxpayers may engage in an       to use the simplified deduction method,         in an intercompany transaction, as defined
intragroup transaction in an attempt to ob-     each member of the EAG may individu-            in §1.1502–13(b)(1), the proposed regu-
tain a section 199 deduction when none          ally determine whether it wants to use the      lations clarify that if an item of income,
should be available. Accordingly, the pro-      section 861 method or the simplified de-        gain, deduction, or loss is not yet taken into
posed regulations retain the anti-avoidance     duction method, notwithstanding that an-        account under §1.1502–13, the intercom-
rule contained in Notice 2005–14. Thus,         other member of the EAG uses a different        pany transaction that gave rise to the item
if a transaction between members of the         method. Similarly, if the EAG is eligible       is not taken into account in computing the
same EAG is engaged in or structured with       to use the small business simplified over-      section 199 deduction until the time and in
a principal purpose of qualifying for, or in-   all method, each member of the EAG may          the same proportion that the item is taken
creasing the amount of, the section 199 de-     individually determine whether it wants to      into account under §1.1502–13. For ex-
duction of the EAG or the portion of the        use the section 861 method, the simplified      ample, if corporations X and Y file a con-
section 199 deduction allocated to one or       deduction method, or the small business         solidated Federal income tax return and
more members of the EAG, adjustments            simplified overall method, notwithstand-        X sells QPP it MPGE within the United
must be made to eliminate the effect of the     ing that another member of the EAG uses a       States to Y, the transaction is not taken into
transaction on the computation of the sec-      different method. However, if the EAG is        account until the time (and in the same pro-
tion 199 deduction.                             not eligible to use either the simplified de-   portion) provided in the matching rule of
   Some commentators asked whether              duction method or the small business sim-       §1.1502–13(c) or the acceleration rule of
the $25,000,000 and $5,000,000 aver-            plified overall method, then all members of     §1.1502–13(d). The proposed regulations
age annual gross receipts thresholds for        the EAG must use the section 861 method.        provide examples to illustrate these princi-
using the simplified deduction method           Notwithstanding that the members of an          ples.
and the small business simplified over-         EAG generally are not required to use the           Some commentators suggested that if
all method, respectively, are applied at        same cost allocation method, each member        X’s receipts from an intercompany trans-
the EAG level, the consolidated group           of a consolidated group must use the same       action with consolidated group member Y
level, or at the member level. If the EAG       cost allocation method. Examples are pro-       are non-DPGR (for example, X licenses
was a single corporation, the $25,000,000       vided to illustrate these provisions.           non-QPP to Y) and Y’s CGS and other de-
and $5,000,000 average annual gross re-             A commentator also asked at what            ductions from the intercompany transac-
ceipts thresholds would take into account       level the de minimis rule described             tion are taken into account in determining
the activities of all the members of the        in §1.199–1(d)(2) is tested.         Section    the consolidated group’s QPAI, the con-
EAG. Accordingly, the $25,000,000 and           1.199–1(d)(2) treats all of a taxpayer’s        solidated group’s QPAI could be different
$5,000,000 average annual gross receipts        gross receipts as DPGR if less than 5           than if X and Y were divisions of a sin-
thresholds are applied at the EAG level.        percent of the taxpayer’s total gross re-       gle corporation, contrary to the general in-
Similarly, the new $10,000,000 total as-        ceipts are non-DPGR. The de minimis             tent of §1.1502–13. The consolidated re-
sets threshold for using the simplified         rule is intended to eliminate the burden        turn regulations already prevent this result.
deduction method and the new $5,000,000         to a taxpayer of allocating gross receipts      Under §1.1502–13(c)(1)(i) and (c)(4), X’s,
current year CGS and deductions thresh-         between DPGR and non-DPGR when less             Y’s, or both X’s and Y’s separate entity at-
old for using the small business simplified     than 5 percent of its total gross receipts      tributes must be redetermined to the extent
overall method also are applied at the          are non-DPGR. When considering the              necessary to treat X and Y as if they were
EAG level. The determination of whether         purpose of the de minimis rule, the IRS         divisions of a single corporation. Thus,
a taxpayer is engaged in the trade or busi-     and Treasury Department believe that it is      X’s income may be redetermined to be
ness of farming that is not required to use     appropriate that the 5 percent threshold be     DPGR (notwithstanding section 199(c)(7)
the accrual method of accounting under          determined at the corporation level, rather     or that the item licensed by X in the in-
section 447 is determined by taking into        than at the EAG or consolidated group           tercompany transaction does not otherwise
account the activities of all the members       level.                                          meet the requirements of section 199(c))
of the EAG. Similarly, the determination                                                        or Y’s CGS and other deductions from
of whether a taxpayer is eligible to use the                                                    the intercompany transaction may be re-


2005–47 I.R.B.                                                     1006                                         November 21, 2005
determined to be not allocable to DPGR,         idated group (the A consolidated group),        sale or exchange. Any section 631(a) elec-
whichever produces the effect as though X       then the A consolidated group is treated as     tion for a taxable year ending on or before
and Y were divisions of a single corpora-       one member of the EAG. Thus, the EAG            October 22, 2004, may be revoked under
tion. Similarly, if X MPGE QPP within           is considered to have three members, the        section 102(c) of the Act for any taxable
the United States and sells the QPP to Y,       A consolidated group, B, and C.                 year ending after that date. In addition, any
but Y does not use the QPP in creating                                                          election under section 631(a) for a taxable
DPGR, in order to produce the effect as         Alternative Minimum Tax                         year ending on or before October 22, 2004
though X and Y were divisions of a sin-                                                         (and any revocation of the election under
                                                   Section 199(d)(6), as clarified by the
gle corporation, X’s gross receipts from                                                        section 102(c) of the Act), is disregarded
                                                Congressional Letter, provides that for
the sale of the QPP may be redetermined                                                         for purposes of determining whether the
                                                purposes of determining AMTI under sec-
to be non-DPGR or Y’s CGS and other de-                                                         taxpayer is eligible to make a subsequent
                                                tion 55, the section 199 deduction must
ductions may be redetermined to be alloca-                                                      election under section 631(a). A revoca-
                                                be computed in the same manner as for
ble to DPGR. In addition, if X MPGE QPP                                                         tion under section 102(c) of the Act will
                                                regular tax, except that in the case of a
within the United States and sells the QPP                                                      remain in effect until the first taxable year
                                                corporation, the taxable income limitation
to Y, and Y sells the QPP to an unrelated                                                       for which the taxpayer makes a new elec-
                                                is the corporation’s AMTI. Accordingly,
person, X’s gross receipts may be redeter-                                                      tion under section 631(a).
                                                the proposed regulations provide that for
mined to be non-DPGR (and non-receipts)                                                             Commentators suggested that, if a
                                                purposes of determining AMTI under sec-
and Y’s CGS and other deductions may be                                                         taxpayer makes an election under sec-
                                                tion 55, a taxpayer that is not a corporation
redetermined to be not allocable to DPGR,                                                       tion 631(a), section 199 should apply to
                                                may deduct an amount equal to 9 percent
to the extent necessary to produce the ef-                                                      any resulting section 1231 gain. A tax-
                                                (3 percent in the case of taxable years
fect as though X and Y were divisions of                                                        payer that makes an election under section
                                                beginning in 2005 or 2006, and 6 percent
a single corporation. The proposed regula-                                                      631(a) reports the difference between the
                                                in the case of taxable years beginning in
tions provide examples to illustrate the sit-                                                   fair market value of the timber cut and
                                                2007, 2008, or 2009) of the lesser of the
uations described above.                                                                        its actual cost as section 1231 gain. The
                                                taxpayer’s QPAI for the taxable year, or
    Some commentators asked whether the                                                         proposed regulations do not adopt the sug-
                                                the taxpayer’s taxable income for the tax-
section 199 deduction results in a down-                                                        gestion because timber is real property,
                                                able year, determined without regard to
ward basis adjustment under §1.1502–32                                                          not tangible personal property, and the
                                                the section 199 deduction (or in the case of
if the deduction is allocated to a sub-                                                         cutting of timber does not qualify under
                                                an individual, AGI). In the case of a cor-
sidiary member (S) of a consolidated                                                            section 199(c)(4)(A)(i)(I). In the case of a
                                                poration (including a corporation subject
group.     Section 1.1502–32(b)(3)(ii)(B)                                                       taxpayer who does not make an election
                                                to tax under section 511(a)), a taxpayer
already addresses this situation.        Al-                                                    under section 631(a), or a taxpayer who
                                                may deduct an amount equal to 9 percent
though the section 199 deduction is taken                                                       revokes an election under section 631(a)
                                                (3 percent in the case of taxable years
into account under the general operating                                                        pursuant to section 102(c) of the Act, the
                                                beginning in 2005 or 2006, and 6 percent
rules of §1.1502–32(b)(3)(i), paragraph                                                         cutting and sawing of timber produces
                                                in the case of taxable years beginning in
(b)(3)(ii)(B) of that section provides that                                                     lumber which qualifies as tangible per-
                                                2007, 2008, or 2009) of the lesser of the
not only is S’s income taken into ac-                                                           sonal property. The gross receipts derived
                                                taxpayer’s QPAI for the taxable year, or
count under the general operating rules of                                                      by a taxpayer from the sale of lumber it
                                                the taxpayer’s AMTI (as defined in section
§1.1502–32(b)(3)(i), but an amount of S’s                                                       produces qualify as DPGR (assuming all
                                                55(b)(2)) for the taxable year, determined
income equivalent to the section 199 de-                                                        the other requirements of section 199(c)
                                                without regard to the section 199 deduc-
duction is also treated as being tax-exempt                                                     are met).
                                                tion. For purposes of computing AMTI,
income under §1.1502–32(b)(3)(ii)(A).
                                                QPAI is determined without regard to any
The net result is that the basis that P (S’s                                                    Proposed Effective Date
                                                adjustments under sections 56 through 59.
parent) has in its S stock is not reduced on
                                                In the case of an individual or a trust, AGI
account of the section 199 deduction. For                                                           The regulations are proposed to be ap-
                                                and taxable income are also determined
example, if S earns $100 and is entitled                                                        plicable to taxable years beginning after
                                                without regard to any adjustments under
to a $9 section 199 deduction, P’s basis                                                        December 31, 2004. Section 199 applies
                                                sections 56 through 59. The amount of the
in S increases by $100 because the $100                                                         to taxable years of pass-thru entities be-
                                                deduction allowable for purposes of com-
income and the $9 deduction are taken                                                           ginning after December 31, 2004. Accord-
                                                puting AMTI for any taxable year cannot
into account under §1.1502–32(b)(3)(i)                                                          ingly, section 199 does not apply to taxable
                                                exceed 50 percent of the W–2 wages of
(resulting in $91 of the increase) and $9 of                                                    years of pass-thru entities beginning be-
                                                the employer for the taxable year (as de-
the income also is taken into account un-                                                       fore January 1, 2005. For example, assume
                                                termined under §1.199–2).
der §1.1502–32(b)(3)(ii)(A) as tax-exempt                                                       a pass-thru entity has a taxable year be-
income (resulting in $9 of the increase).       Revocation of Election under Section            ginning July 1, 2004, and ending June 30,
    The proposed regulations treat a con-       631(a)                                          2005, and the owners of the pass-thru en-
solidated group as a single member of the                                                       tity have calendar taxable years. Because
EAG. For example, if A, B, C, S1, and S2           Section 102(c) of the Act allows a tax-      section 199 first applies to the pass-thru
are members of the same EAG, and A, S1,         payer to revoke an election under section       entity for its taxable year beginning July
and S2 are members of the same consol-          631(a) to treat the cutting of timber as a      1, 2005, the first taxable year in which an


November 21, 2005                                                  1007                                                2005–47 I.R.B.
owner of the pass-thru entity will be eli-     Request for Comments                            cerning such an automatic consent proce-
gible to claim a section 199 deduction for                                                     dure, including which elections should be
the owner’s allocable or pro rata share of         The IRS and Treasury Department in-         included and the appropriate time period
items allocated or apportioned to the qual-    vite taxpayers to submit comments on is-        during which the automatic consent should
ified production activities of the pass-thru   sues relating to section 199. The IRS and       apply.
entity will be the calendar year 2006. Con-    Treasury Department intend to finalize the         3. The IRS and Treasury Depart-
versely, assume that a pass-thru entity has    proposed regulations as soon as possible        ment note that there are special rules
a calendar taxable year beginning January      so taxpayers will have the final regulations    regarding the application of the sec-
1, 2005, and has a short taxable year end-     as they begin to prepare their 2005 Federal     tion 861 method in the case of affiliated
ing on June 30, 2005, due to the termina-      income tax returns. Accordingly, the IRS        groups. See section 864(e)(5) and (6); see
tion of the entity. Assume the owners of       and Treasury Department encourage tax-          also §§1.861–11(d)(7), 1.861–11T(d)(6),
that pass-thru entity have taxable years be-   payers to submit their comments by Jan-         1.861–14(d) and 1.861–14T. Comments
ginning July 1, 2004, and ending June 30,      uary 3, 2006, so they can be given proper       are requested regarding whether addi-
2005. Because section 199 first applies to     consideration. In particular, the IRS and       tional guidance is needed to clarify how
the owners for their taxable years begin-      Treasury Department encourage taxpayers         the rules under §§1.861–11T(c) and (g)
ning July 1, 2005, under §1.199–8(g), the      to submit comments on the following is-         and 1.861–14T(c) apply under the section
owners of the pass-thru entity will be inel-   sues:                                           861 method to allocate and apportion in-
igible to claim a section 199 deduction for        1. Questions have arisen as to the ap-      terest and other expenses such as research
the owners’ allocable or pro rata share of     plicability under section 199 of a Large        and experimentation expenses in comput-
items allocated or apportioned to the qual-    and Mid-Size Business (LMSB) directive          ing QPAI of the members of such affiliated
ified production activities of the pass-thru   dated March 14, 2002, “Field Directive          groups in which otherwise includible cor-
entity for their taxable years ending June     on the Use of Estimates from Probability        porations are owned indirectly through
30, 2005.                                      Samples,” that authorizes in appropriate        foreign corporations and partnerships.
    Until the date final regulations are       circumstances the use of statistical sam-          4. Comments are requested concerning
published in the Federal Register, the         pling by taxpayers. LMSB taxpayers are          whether gross receipts derived from the
proposed regulations provide that tax-         not precluded from applying the concepts        provision of certain types of online soft-
payers may rely on the rules set forth in      of the LMSB directive for purposes of sec-      ware should qualify under section 199 as
the interim guidance on section 199 as set     tion 199. The proposed regulations do not       being derived from a lease, rental, license,
forth in Notice 2005–14 (Notice) as well as    provide specific rules on the use of statis-    sale, exchange, or other disposition of the
the proposed regulations under §§1.199–1       tical sampling for 199 purposes, however        software and, if so, how to distinguish be-
through 1.199–8 (proposed regulations).        comments are requested on how taxpay-           tween such types of online software.
For this purpose, if the proposed regu-        ers can apply statistical sampling to section
lations and the Notice include different       199, what specific areas of section 199 sta-    Special Analyses
rules for the same particular issue, then      tistical sampling could be applied to, and
                                                                                                   It has been determined that this notice
the taxpayer may rely on either the rule       whether application of statistical sampling
                                                                                               of proposed rulemaking is not a significant
set forth in the proposed regulations or the   should be limited to specific areas of sec-
                                                                                               regulatory action as defined in Executive
rule set forth in the Notice. For example,     tion 199.
                                                                                               Order 12866. Therefore, a regulatory as-
the Notice and the proposed regulations            2. Taxpayers are eligible to make cer-
                                                                                               sessment is not required. It has also been
both include the small business simplified     tain elections under the section 861 regu-
                                                                                               determined that section 553(b) of the Ad-
overall method, however the eligibil-          lations. For example, §1.861–9T(g)(1)(ii)
                                                                                               ministrative Procedure Act (5 U.S.C. chap-
ity requirements for the method under the      permits a taxpayer to elect to determine
                                                                                               ter 5) does not apply. It is hereby certi-
Notice have been modified in the proposed      the value of its assets on the basis of ei-
                                                                                               fied that the collection of information in
regulations. Accordingly, a taxpayer may       ther their tax book value or fair market
                                                                                               this regulation will not have a significant
rely on the eligibility requirements for the   value. Some of the elections under the sec-
                                                                                               economic impact on a substantial num-
method set forth in either the Notice or       tion 861 regulations require the consent of
                                                                                               ber of small entities. This certification is
the proposed regulations. However, if the      the Commissioner to revoke or to change
                                                                                               based upon the fact that, as previously dis-
proposed regulations include a rule that       to another method. See §§1.861–8T(c)(2),
                                                                                               cussed, any burden on cooperatives is min-
was not included in the Notice, taxpayers      1.861–9T(i)(2), and 1.861–17(e). Because
                                                                                               imal. Accordingly, a Regulatory Flexibil-
are not permitted to rely on the absence       the section 861 method requires certain
                                                                                               ity Analysis under the Regulatory Flexibil-
of a rule to apply a rule contrary to the      taxpayers to use the rules of the section
                                                                                               ity Act (5 U.S.C. chapter 6) is not required.
proposed regulations. For example, No-         861 regulations in a new context, these
                                                                                               Pursuant to section 7805(f) of the Code,
tice 2005–14 does not include any rules        taxpayers may want to reconsider previ-
                                                                                               this notice of proposed rulemaking will be
regarding the treatment of hedging trans-      ously made elections under those regula-
                                                                                               submitted to the Chief Counsel for Advo-
actions whereas the proposed regulations       tions. The IRS and Treasury Department
                                                                                               cacy of the Small Business Administration
include such rules. Accordingly, taxpayers     intend to issue a revenue procedure grant-
                                                                                               for comment on their impact on small busi-
are not permitted to treat hedging transac-    ing taxpayers automatic consent to change
                                                                                               ness.
tions contrary to the treatment provided in    certain elections under the section 861 reg-
the proposed regulations.                      ulations. Comments are requested con-


2005–47 I.R.B.                                                    1008                                         November 21, 2005
Comments and Public Hearing                    Proposed Amendments to the                    §1.199–2 Wage limitation.
                                               Regulations
    Before these proposed regulations are                                                       (a) Rules of application.
adopted as final regulations, consideration       Accordingly, 26 CFR part 1 is proposed        (1) In general.
will be given to any written comments          to be amended as follows:                        (2) Wages paid by entity other than
(a signed original and eight (8) copies)                                                     common law employer.
or electronic comments that are submit-        PART 1—INCOME TAXES                              (b) No application in determining
ted timely to the IRS. Comments are re-                                                      whether amounts are wages for employ-
quested on all aspects of the proposed reg-       Paragraph 1. The authority citation for
                                                                                             ment tax purposes.
ulations. In addition, the IRS and Trea-       part 1 is amended by adding entries in nu-
                                                                                                (c) Application in case of taxpayer with
sury Department specifically request com-      merical order to read, in part, as follows:
                                                                                             short taxable year.
ments on the clarity of the proposed rules        Authority: 26 U.S.C. 7805 * * *
                                                                                                (d) Acquisition or disposition of a trade
and how they can be made easier to under-         Section 1.199–1 also issued under 26
                                                                                             or business (or major portion).
stand. All comments will be available for      U.S.C. 199(d).
                                                                                                (e) Non-duplication rule.
public inspection and copying.                    Section 1.199–2 also issued under 26
                                                                                                (f) Definition of W–2 wages.
    A public hearing has been scheduled for    U.S.C. 199(d).
                                                                                                (1) In general.
Wednesday, January 11, 2006, at 10 a.m.           Section 1.199–3 also issued under 26
                                                                                                (2) Methods for calculating W–2
in the IRS Auditorium, Internal Revenue        U.S.C. 199(d).
                                                                                             wages.
Building, 1111 Constitution Avenue, NW,           Section 1.199–4 also issued under 26
                                                                                                (i) Unmodified box method.
Washington, DC. Due to building security       U.S.C. 199(d).
                                                                                                (ii) Modified Box 1 method.
procedures, visitors must enter at the Con-       Section 1.199–5 also issued under 26
                                                                                                (iii) Tracking wages method.
stitution Avenue entrance. In addition, all    U.S.C. 199(d).
visitors must present photo identification        Section 1.199–6 also issued under 26       §1.199–3 Domestic production gross
to enter the building. Because of access       U.S.C. 199(d).                                receipts.
restrictions, visitors will not be admitted       Section 1.199–7 also issued under 26
beyond the immediate entrance area more        U.S.C. 199(d).                                   (a) In general.
than 30 minutes before the hearing starts.        Section 1.199–8 also issued under 26          (b) Related persons.
For information about having your name         U.S.C. 199(d). * * *                             (1) In general.
placed on the building access list to attend      Par. 2. Sections 1.199–0 through              (2) Exceptions.
the hearing, see the “FOR FURTHER IN-          1.199–8 are added to read as follows:            (c) Definition of gross receipts.
FORMATION CONTACT” section of this                                                              (d) Definition of manufactured, pro-
                                               §1.199–0 Table of contents.                   duced, grown, or extracted.
preamble.
    The rules of 26 CFR 601.601(a)(3) ap-         This section lists the headings that ap-      (1) In general.
ply to the hearing.                            pear in §§1.199–1 through 1.199–8.               (2) Packaging, repackaging, labeling,
    Persons who wish to present oral com-                                                    or minor assembly.
ments at the hearing must submit elec-         §1.199–1 Income attributable to domestic         (3) Installing.
tronic or written comments and an out-         production activities.                           (4) Consistency with section 263A.
line of the topics to be discussed and the                                                      (5) Examples.
time to be devoted to each topic (a signed        (a) In general.                               (e) Definition of by the taxpayer.
original and eight (8) copies) by Decem-          (b) Taxable income and adjusted gross         (1) In general.
ber 21, 2005. A period of 10 minutes will      income.                                          (2) Special rule for certain government
be allotted to each person for making com-        (1) In general.                            contracts.
ments. An agenda showing the scheduling           (2) Examples.                                 (3) Examples.
of the speakers will be prepared after the        (c) Qualified production activities in-       (f) Definition of in whole or in signifi-
deadline for receiving outlines has passed.    come.                                         cant part.
Copies of the agenda will be available free       (1) In general.                               (1) In general.
of charge at the hearing.                         (2) Definition of item.                       (2) Substantial in nature.
                                                  (i) In general.                               (3) Safe harbor.
Drafting Information                              (ii) Examples.                                (4) Examples.
                                                  (d) Allocation of gross receipts.             (g) Definition of United States.
   The principal authors of these reg-            (1) In general.                               (h) Definition of derived from the lease,
ulations are Paul Handleman and                   (2) De minimis rule.                       rental, license, sale, exchange, or other dis-
Lauren Ross Taylor, Office of Associate           (3) Examples.                              position.
Chief Counsel (Passthroughs and Special           (e) Timing rules for determining QPAI.        (1) In general.
Industries), IRS. However, other person-          (1) Gross receipts and costs recognized       (2) Examples.
nel from the IRS and Treasury Department       in different taxable years.                      (3) Hedging transactions.
participated in their development.                (2) Percentage of completion method.          (i) In general.
                  *****                           (3) Example.                                  (ii) Currency fluctuations.



November 21, 2005                                                1009                                                2005–47 I.R.B.
   (iii) Other rules.                             (k) Electricity, natural gas, or potable       (c) Other deductions allocable or ap-
   (4) Allocation of gross receipts — em-      water.                                         portioned to domestic production gross re-
bedded services and non-qualified prop-           (1) In general.                             ceipts or gross income attributable to do-
erty.                                             (2) Natural gas.                            mestic production gross receipts.
   (i) In general.                                (3) Potable water.                             (1) In general.
   (ii) Exceptions.                               (4) Exceptions.                                (2) Treatment of certain deductions.
   (iii) Examples.                                (i) Electricity.                               (i) In general.
   (5) Advertising income.                        (ii) Natural gas.                              (ii) Net operating losses.
   (i) Tangible personal property.                (iii) Potable water.                           (iii) Deductions not attributable to the
   (ii) Qualified films.                          (iv) De minimis exception.                  conduct of a trade or business.
   (iii) Examples.                                (5) Example.                                   (d) Section 861 method.
   (6) Computer software.                         (l) Definition of construction performed       (1) In general.
   (i) In general.                             in the United States.                             (2) Deductions for charitable contribu-
   (ii) Examples.                                 (1) Construction of real property.          tions.
   (7) Exception for certain oil and gas          (i) In general.                                (3) Research and experimental expen-
partnerships.                                     (ii) De minimis exception.                  ditures.
   (i) In general.                                (2) Activities constituting construction.      (4) Deductions related to gross receipts
   (ii) Example.                                  (3) Definition of infrastructure.           deemed to be domestic production gross
   (8) Partnerships owned by members of           (4) Definition of substantial renovation.   receipts.
a single expanded affiliated group.               (5) Derived from construction.                 (5) Examples.
   (i) In general.                                (i) In general.                                (e) Simplified deduction method.
   (ii) Special rules for distributions from      (ii) Land safe harbor.                         (1) In general.
EAG partnerships.                                 (iii) Examples.                                (2) Members of an expanded affiliated
   (iii) Examples.                                (m) Definition of engineering and ar-       group.
   (9) Non-operating mineral interests.        chitectural services.                             (i) In general.
   (i) Definition of qualifying production        (1) In general.                                (ii) Exception.
property.                                         (2) Engineering services.                      (iii) Examples.
   (1) In general.                                (3) Architectural services.                    (f) Small business simplified overall
   (2) Tangible personal property.                (4) De minimis exception for perfor-        method.
   (i) In general.                             mance of services in the United States.           (1) In general.
   (ii) Local law.                                (n) Exception for sales of certain food        (2) Qualifying small taxpayer.
   (iii) Machinery.                            and beverages.                                    (3) Members of an expanded affiliated
   (iv) Intangible property.                      (1) In general.                             group.
   (3) Computer software.                         (2) Examples.                                  (i) In general.
   (i) In general.                                                                               (ii) Exception.
   (ii) Incidental and ancillary rights.       §1.199–4 Costs allocable to domestic              (iii) Examples.
   (iii) Exceptions.                           production gross receipts.                        (4) Ineligible pass-thru entities.
   (4) Sound recordings.                                                                         (g) Average annual gross receipts.
   (i) In general.                                (a) In general.                                (1) In general.
   (ii) Exception.                                (b) Cost of goods sold allocable to do-        (2) Members of an EAG.
   (5) Tangible personal property with         mestic production gross receipts.                 (h) Total assets.
computer software or sound recordings.            (1) In general.                                (1) In general.
   (i) Computer software and sound                (2) Allocating cost of goods sold.             (2) Members of an EAG.
recordings.                                       (3) Special rules for imported items or        (i) Total costs for the current taxable
   (ii) Tangible personal property.            services.                                      year.
   (j) Definition of qualified film.              (4) Rules for inventories valued at mar-       (1) In general.
   (1) In general.                             ket or bona fide selling prices.                  (2) Members of an EAG.
   (2) Tangible personal property with a          (5) Rules applicable to inventories ac-
film.                                          counted for under the last-in, first-out       §1.199–5 Application of section 199 to
   (i) Film licensed by a taxpayer.            (LIFO) inventory method.                       pass-thru entities.
   (ii) Film produced by a taxpayer.              (i) In general.
   (A) Qualified films.                           (ii) LIFO/FIFO ratio method.                   (a) Partnerships.
   (B) Nonqualified films.                        (iii) Change in relative base-year cost        (1) Determination at partner level.
   (3) Derived from a qualified film.          method.                                           (2) Disallowed deductions.
   (4) Examples.                                  (6) Taxpayers using the simplified             (3) Partner’s share of W–2 wages.
   (5) Compensation for services.              production method or simplified resale            (4) Examples.
   (6) Determination of 50 percent.            method for additional section 263A costs.         (b) S corporations.
   (7) Exception.                                 (7) Examples.                                  (1) Determination at shareholder level.


2005–47 I.R.B.                                                   1010                                        November 21, 2005
   (2) Disallowed deductions.                    mance of engineering and architectural            (g) Effective date.
   (3) Shareholder’s share of W–2 wages.         services.
   (c) Grantor trusts.                               (3) Application of the simplified deduc-   §1.199–1 Income attributable to domestic
   (d) Non-grantor trusts and estates.           tion method and the small business simpli-     production activities.
   (1) Computation of section 199 deduc-         fied overall method.
                                                                                                    (a) In general. A taxpayer may deduct
tion.                                                (4) Determining the section 199 deduc-
                                                                                                an amount equal to 9 percent (3 percent
   (2) Example.                                  tion.
                                                                                                in the case of taxable years beginning in
   (e) Gain or loss from the disposition of          (i) Expanded affiliated group consists
                                                                                                2005 or 2006, and 6 percent in the case of
an interest in a pass-thru entity.               of consolidated group and non-consoli-
                                                                                                taxable years beginning in 2007, 2008, or
   (f) Section 199(d)(1)(B) wage limita-         dated group members.
                                                                                                2009) of the lesser of the taxpayer’s qual-
tion and tiered structures.                          (ii) Expanded affiliated group consists
                                                                                                ified production activities income (QPAI)
   (1) In general.                               only of members of a single consolidated
                                                                                                (as defined in paragraph (c) of this section)
   (2) Share of W–2 wages.                       group.
                                                                                                for the taxable year, or the taxpayer’s tax-
   (3) Example.                                      (5) Allocation of the section 199 de-
                                                                                                able income for the taxable year (or, in the
   (g) No attribution of qualified activities.   duction of a consolidated group among its
                                                                                                case of an individual, adjusted gross in-
                                                 members.
§1.199–6 Agricultural and horticultural                                                         come). The amount of the deduction al-
                                                     (e) Examples.
cooperatives.                                                                                   lowable under this paragraph (a) for any
                                                     (f) Allocation of income and loss by a
                                                                                                taxable year cannot exceed 50 percent of
                                                 corporation that is a member of the ex-
   (a) In general.                                                                              the W–2 wages of the employer for the tax-
                                                 panded affiliated group for only a portion
   (b) Written notice to patrons.                                                               able year (as determined under §1.199–2).
                                                 of the year.
   (c) Determining cooperative’s qualified                                                          (b) Taxable income and adjusted gross
                                                     (1) In general.
production activities income.                                                                   income—(1) In general. For purposes of
                                                     (i) Pro rata allocation method.
   (d) Additional rules relating to pass-                                                       paragraph (a) of this section, the defini-
                                                     (ii) Section 199 closing of the books
through of section 199 deduction.                                                               tion of taxable income under section 63
                                                 method.
   (e) W–2 wages.                                                                               applies and taxable income is determined
                                                     (iii) Making the section 199 closing of
   (f) Recapture of section 199 deduction.                                                      without regard to section 199. In the case
                                                 the books election.
   (g) Section is exclusive.                                                                    of individuals, adjusted gross income for
                                                     (2) Coordination with rules relat-
   (h) No double counting.                                                                      the taxable year is determined after ap-
                                                 ing to the allocation of income under
   (i) Examples.                                                                                plying sections 86, 135, 137, 219, 221,
                                                 §1.1502–76(b).
                                                                                                222, and 469, and without regard to sec-
§1.199–7 Expanded affiliated groups.                 (g) Total section 199 deduction for a
                                                                                                tion 199. For purposes of determining the
                                                 corporation that is a member of an ex-
                                                                                                tax imposed by section 511, paragraph (a)
   (a) In general.                               panded affiliated group for some or all of
                                                                                                of this section is applied using unrelated
   (1) Definition of expanded affiliated         its taxable year.
                                                                                                business taxable income. For purposes of
group.                                               (1) Member of the same expanded affil-
                                                                                                determining the amount of a net operating
   (2) Identification of members of an ex-       iated group for the entire taxable year.
                                                                                                loss (NOL) carryback or carryover under
panded affiliated group.                             (2) Member of the expanded affiliated
                                                                                                section 172(b)(2), taxable income is deter-
   (i) In general.                               group for a portion of the taxable year.
                                                                                                mined without regard to the deduction al-
   (ii) Becoming or ceasing to be a mem-             (3) Example.
                                                                                                lowed under section 199.
ber of an expanded affiliated group.                 (h) Computation of section 199 deduc-
                                                                                                    (2) Examples. The following examples
   (3) Attribution of activities.                tion for members of an expanded affiliated
                                                                                                illustrate the application of this paragraph
   (4) Examples.                                 group with different taxable years.
                                                                                                (b):
   (5) Anti-avoidance rule.                          (1) In general.                                Example 1. (i) Facts. X, a United States corpo-
   (b) Computation of expanded affiliated            (2) Example.                               ration that is not part of an expanded affiliated group
group’s section 199 deduction.                                                                  (EAG) (as defined in §1.199–7), engages in produc-
   (1) In general.                               §1.199–8 Other rules.                          tion activities that generate QPAI and taxable income
   (2) Net operating loss carryovers.                                                           (without taking into account the deduction under this
                                                                                                section) of $600 in 2010. During 2010, X incurs W–2
   (c) Allocation of an expanded affili-            (a) Individuals.                            wages of $300. X has an NOL carryover to 2010 of
ated group’s section 199 deduction among            (b) Trade or business requirement.          $500. X’s deduction under this section for 2010 is $9
members of the expanded affiliated group.           (c) Coordination with alternative mini-     (.09 x (lesser of QPAI of $600 and taxable income of
   (1) In general.                               mum tax.                                       $100) subject to the wage limitation of $150 (50% x
   (2) Use of section 199 deduction to cre-         (d) Nonrecognition transactions.            $300)).
                                                                                                    Example 2. (i) Facts. X, a United States corpo-
ate or increase a net operating loss.               (1) In general.                             ration that is not part of an EAG, engages in produc-
   (d) Special rules for members of the             (2) Section 1031 exchanges.                 tion activities that generate QPAI and taxable income
same consolidated group.                            (3) Section 381 transactions.               (without taking into account the deduction under this
   (1) Intercompany transactions.                   (e) Taxpayers with a 52–53 week tax-        section and an NOL deduction) of $100 in 2010. X
   (2) Attribution of activities in the con-     able year.                                     has an NOL carryover to 2010 of $500. X’s deduc-

struction of real property and the perfor-          (f) Section 481(a) adjustments.


November 21, 2005                                                  1011                                                      2005–47 I.R.B.
tion under this section for 2010 is $0 (.09 x (lesser of   barrels of oil). In the case of construc-                       (d) Allocation of gross receipts—(1) In
QPAI of $100 and taxable income of $0)).                   tion (as defined in §1.199–3(l)(1)) or en-                  general. A taxpayer must determine the
    (ii) Carryover to 2011. X’s taxable income for         gineering and architectural services (as de-                portion of its gross receipts that is DPGR
purposes of determining its NOL carryover to 2011
is $100. Accordingly, X’s NOL carryover to 2011 is
                                                           fined in §1.199–3(m)(1)), a taxpayer may                    and the portion of its gross receipts that
$400 ($500 NOL carryover to 2010 - $100 NOL used           use any reasonable method, taking into ac-                  is non-DPGR. Applicable Federal income
in 2010).                                                  count all of the facts and circumstances, to                tax principles apply to determine whether a
    (c) Qualified production activities in-                determine what construction activities and                  transaction is, in substance, a lease, rental,
come—(1) In general. QPAI for any tax-                     engineering or architectural services con-                  license, sale, exchange or other disposi-
able year is an amount equal to the excess                 stitute an item.                                            tion, or whether it is a service (or some
(if any) of the taxpayer’s domestic produc-                    (ii) Examples. The following exam-                      combination thereof). For example, if a
tion gross receipts (DPGR) over the sum of                 ples illustrate the application of paragraph                taxpayer leases, rents, licenses, sells, ex-
the cost of goods sold (CGS) that is alloca-               (c)(2)(i) of this section:                                  changes, or otherwise disposes of quali-
ble to such receipts, other deductions, ex-                    Example 1. X manufactures leather and rubber            fying production property (QPP) (as de-
penses, or losses (collectively, deductions)               shoe soles in the United States. X imports shoe up-         fined in §1.199–3(i)(1)), the gross receipts
                                                           pers, which are the parts of the shoe above the sole.
directly allocable to such receipts, and a                 X manufactures shoes for sale by sewing or other-
                                                                                                                       of which constitute DPGR, and engages in
ratable portion of deductions that are not                 wise attaching the soles to the imported uppers. If         transactions with respect to similar prop-
directly allocable to such receipts or an-                 the shoes do not meet the requirements under this sec-      erty, the gross receipts of which do not con-
other class of income. See §§1.199–3 and                   tion and §1.199–3, then under paragraph (c)(2)(i) of        stitute DPGR, the taxpayer must allocate
1.199–4. For purposes of this paragraph                    this section, X must treat the sole as the item if the      its gross receipts from all the transactions
                                                           sole meets the requirements under this section and
(c), QPAI is determined on an item-by-                     §1.199–3.
                                                                                                                       based on a reasonable method that is sat-
item basis (and not, for example, on a di-                     Example 2. The facts are the same as in Example         isfactory to the Secretary based on all of
vision-by-division, product line-by-prod-                  1 except that X also buys some finished shoes from          the facts and circumstances and that accu-
uct line, or transaction-by-transaction ba-                unrelated parties and resells them to retail shoe stores.   rately identifies the gross receipts that con-
sis) and is the sum of QPAI derived by                     X sells shoes in individual pairs. X ships the shoes in     stitute DPGR. Factors taken into consider-
                                                           boxes, each box containing 50 pairs of shoes, some
the taxpayer from each item (as defined                    of which X manufactured, and some of which X pur-
                                                                                                                       ation in determining whether the method
in paragraph (c)(2) of this section). For                  chased. X cannot treat a box of 50 pairs of shoes as        is reasonable include whether the taxpayer
purposes of this determination, QPAI from                  an item, because the box of shoes is not sold at retail.    uses the most accurate information avail-
each item may be positive or negative.                         Example 3. Y manufactures toy cars in the United        able; the relationship between the gross re-
DPGR and its related CGS and deductions                    States. Y also purchases cars that were manufac-            ceipts and the method chosen; the accu-
                                                           tured by unrelated parties. In addition to packaging
must be included in the QPAI computa-                      some cars individually, Y also packages some cars
                                                                                                                       racy of the method chosen as compared
tion regardless of whether, when viewed                    in sets of three. Some of the cars in the sets may          with other possible methods; whether the
in isolation, the DPGR exceeds the CGS                     have been manufactured by Y and some may have               method is used by the taxpayer for in-
and deductions allocated and apportioned                   been purchased. The three-car packages are sold by          ternal management or other business pur-
thereto. For example, if a taxpayer has $3                 toy stores at retail. Y must treat each three-car pack-     poses; whether the method is used for other
                                                           age as the item. However, if the three-car package
of QPAI from the sale of a shirt and derives               does not meet the requirements under this section and
                                                                                                                       Federal or state income tax purposes; the
($1) of QPAI from the sale of a hat, the tax-              §1.199–3, Y must treat a toy car in the three-car pack-     time, burden, and cost of using various
payer’s QPAI is $2.                                        age as the item, provided the toy car meets the re-         methods; and whether the taxpayer ap-
    (2) Definition of item—(i) In general.                 quirements under this section and §1.199–3.                 plies the method consistently from year to
Except as otherwise provided in this para-                     Example 4. The facts are the same as Example 3          year. Thus, if a taxpayer can, without un-
                                                           except that the toy store follows Y’s recommended
graph, the term item means, for purposes of                pricing arrangement for the individual toy cars for
                                                                                                                       due burden or expense, specifically iden-
§§1.199–1 through 1.199–8, the property                    sale to customers at three for $10. Frequently, this        tify where an item was manufactured, or
offered for sale to customers that meets                   results in retail customers purchasing three individual     if the taxpayer uses a specific identifica-
all of the requirements under this section                 cars in one transaction. Y must treat each toy car as an    tion method for other purposes, then the
and §1.199–3. If the property offered for                  item and cannot treat three individual toy cars as one      taxpayer must use that specific identifica-
                                                           item, because the individual toy cars are not packaged
sale does not meet these requirements, a                   together for retail sale.
                                                                                                                       tion method to determine DPGR. If a tax-
taxpayer must treat as the item any por-                       Example 5. Z produces in bulk form in the               payer does not use a specific identifica-
tion of the property offered for sale that                 United States the active ingredient for a pharmaceu-        tion method for other purposes and can-
meets these requirements. However, in no                   tical product. Z sells the active ingredient in bulk        not, without undue burden or expense, use
case shall the portion of the property of-                 form to FX, a foreign corporation. This sale qualifies      a specific identification method, then the
                                                           as DPGR assuming all the other requirements of this
fered for sale that is treated as the item ex-             section and §1.199–3 are met. FX uses the active
                                                                                                                       taxpayer is not required to use a specific
clude any other portion that meets these                   ingredient to produce the finished dosage form drug.        identification method to determine DPGR.
requirements. In no event may an item                      FX sells the drug in finished dosage to Z, which sells          (2) De minimis rule. All of a tax-
consist of two or more properties offered                  the drug to customers. Under paragraph (c)(2)(i)            payer’s gross receipts may be treated as
for sale that are not packaged and sold to-                of this section, if the finished dosage does not meet       DPGR if less than 5 percent of the tax-
                                                           the requirements under this section and §1.199–3, Z
gether as one item. In addition, in the case               must treat the active ingredient portion as the item
                                                                                                                       payer’s total gross receipts are non-DPGR
of property customarily sold by weight or                  if the ingredient meets the requirements under this         (after application of exceptions provided
by volume, the item is determined using                    section and §1.199–3.                                       in §1.199–3(h)(4), (k)(4)(iv), (l)(1)(ii),
the custom of the industry (for example,                                                                               (m)(4), and (n)(1) that result in gross


2005–47 I.R.B.                                                                     1012                                                November 21, 2005
receipts being treated as DPGR). If the                   tions related to such receipts as relating                §1.199–2 Wage limitation.
amount of the taxpayer’s gross receipts                   to DPGR, regardless of whether such
that do not qualify as DPGR equals or                     receipts ultimately qualify as DPGR. Sim-                     (a) Rules of application—(1) In gen-
exceeds 5 percent of the taxpayer’s total                 ilarly, if a taxpayer pays or incurs and                  eral. The amount of the deduction al-
gross receipts, the taxpayer is required                  reports on a Federal income tax return                    lowable under §1.199–1(a) (section 199
to allocate all gross receipts between                    CGS or deductions and identifies such                     deduction) to a taxpayer for any taxable
DPGR and non-DPGR in accordance with                      CGS or deductions as relating to DPGR,                    year shall not exceed 50 percent of the
paragraph (d)(1) of this section. If a cor-               then the taxpayer must treat the gross re-                W–2 wages of the taxpayer. For this pur-
poration is a member of an EAG or a                       ceipts related to such CGS or deductions                  pose, except as provided in paragraph (c)
consolidated group, the determination of                  as DPGR, regardless of whether such re-                   of this section, the Forms W–2, “Wage and
whether less than 5 percent of the tax-                   ceipts ultimately qualify as DPGR. Similar                Tax Statement,” used in determining the
payer’s total gross receipts are non-DPGR                 rules apply if the taxpayer recognizes and                amount of W–2 wages are those issued for
is made at the corporation level rather                   reports on a Federal income tax return                    the calendar year ending during the tax-
than at the EAG or consolidated group                     gross receipts that the taxpayer identifies               payer’s taxable year for wages paid to em-
level, as applicable. In the case of an                   as non-DPGR, or pays or incurs and re-                    ployees (or former employees) of the tax-
S corporation, partnership, estate or trust,              ports on a Federal income tax return CGS                  payer for employment by the taxpayer. For
or other pass-thru entity, the determina-                 or deductions that the taxpayer identifies                purposes of this section, employees of the
tion of whether less than 5 percent of                    as relating to non-DPGR. The determina-                   taxpayer are limited to employees of the
the pass-thru entity’s total gross receipts               tion of whether gross receipts qualify as                 taxpayer as defined in section 3121(d)(1)
are non-DPGR is made at the pass-thru                     DPGR or non-DPGR, and whether CGS or                      and (2) (that is, officers of a corporate tax-
entity level. In the case of an owner of                  deductions relate to DPGR or non-DPGR,                    payer and employees of the taxpayer un-
a pass-thru entity, the determination of                  must be made in accordance with the rules                 der the common law rules). For purposes
whether less than 5 percent of the owner’s                provided in §§1.199–1 through 1.199–8,                    of section 199(b)(2) and this section, the
total gross receipts are non-DPGR is made                 as applicable. If the gross receipts are                  term taxpayer means employer.
at the owner level, taking into account all               recognized in an intercompany transac-                        (2) Wages paid by entity other than
gross receipts earned by the owner from                   tion within the meaning of §1.1502–13,                    common law employer. In determining
its activities as well as the owner’s share               see also §1.199–7(d). See §1.199–4 for                    W–2 wages, a taxpayer may take into ac-
of any pass-thru entity’s gross receipts.                 allocation and apportionment of CGS and                   count any wages paid by another entity and
    (3) Examples. The following examples                  deductions.                                               reported by the other entity on Forms W–2
illustrate the application of this paragraph                  (2) Percentage of completion method.                  with the other entity as the employer listed
(d):                                                      A taxpayer using the percentage of com-                   in Box c of the Forms W–2, provided that
     Example 1. X derives its gross receipts from the     pletion method under section 460 must de-                 the wages were paid to employees of the
sale of gasoline refined by X within the United States    termine the ratio of DPGR and non-DPGR                    taxpayer for employment by the taxpayer.
and the sale of refined gasoline that X acquired (ei-                                                               If the taxpayer is treated as an employer
ther by purchase or in a taxable exchange for gasoline
                                                          using a reasonable method that accurately
                                                          identifies the gross receipts that constitute             described in section 3401(d)(1) because
refined by X in the United States) from an unrelated
party. X does not commingle the gasoline. X must          DPGR. See paragraph (d)(1) of this sec-                   of control of the payment of wages (that
allocate its gross receipts between the gross receipts    tion for the factors taken into considera-                is, the taxpayer is not the common law
attributable to the gasoline refined by X in the United   tion in determining whether the taxpayer’s                employer of the payee of the wages), the
States (that qualify as DPGR if all the other require-                                                              payment of wages may not be included in
ments of §1.199–3 are met) and X’s gross receipts
                                                          method is reasonable.
                                                              (3) Example. The following example                    determining W–2 wages of the taxpayer.
derived from the resale of the acquired gasoline (that
do not qualify as DPGR) if 5 percent or more of X’s       illustrates the application of paragraph                  If the taxpayer is paying wages as an agent
total gross receipts are not from the sale of gasoline    (e)(1) of this section:                                   of another entity to individuals who are
refined by X within the United States.                        Example. X, a calendar year accrual method tax-       not employees of the taxpayer, the wages
     Example 2. X manufactures the same type of QPP       payer, enters into a contract with Y, an unrelated per-   may not be included in determining the
at facilities within the United States and outside the    son, in 2005 for the sale of QPP. In 2005, X receives     W–2 wages of the taxpayer.
United States which are sold separately. X must al-       an advance payment from Y for the QPP. In 2006, X
locate its gross receipts between the receipts from                                                                     (b) No application in determining
                                                          manufactures the QPP within the United States and
the QPP manufactured within the United States and         delivers the QPP to Y. X’s method of accounting re-       whether amounts are wages for employ-
receipts from the QPP not manufactured within the         quires X to include the entire advance payment in         ment tax purposes. The discussion of
United States if 5 percent or more of X’s total gross     its gross income for Federal income tax purposes in       wages in this section is for purposes of
receipts are not from the sale of QPP manufactured        2005. Assuming X can determine, using any reason-         section 199 only and has no application in
by X within the United States.                            able method, that all the requirements of this section
                                                                                                                    determining whether amounts are wages
   (e) Timing rules for determining                       and §1.199–3 will be met, the advance payment qual-
                                                          ifies as DPGR in 2005. The CGS and deductions re-         under section 3121(a) for purposes of
QPAI—(1) Gross receipts and costs rec-
                                                          lating to the QPP under the contract are taken into       the Federal Insurance Contributions Act
ognized in different taxable years. If a
                                                          account under §1.199–4 in determining X’s QPAI in         (FICA), under section 3306(b) for pur-
taxpayer recognizes and reports on a Fed-                 2006, the taxable year the CGS and deductions are         poses of the Federal Unemployment Tax
eral income tax return gross receipts that                otherwise deductible for Federal income tax purposes
                                                                                                                    Act (FUTA), under section 3401(a) for
the taxpayer identifies as DPGR, then the                 and must be treated as relating to DPGR in that tax-
                                                          able year.                                                purposes of the Collection of Income Tax
taxpayer must treat the CGS and deduc-
                                                                                                                    at Source on Wages (Federal income tax


November 21, 2005                                                                1013                                                       2005–47 I.R.B.
withholding), or any other wage related         employed by the successor, regardless of         respect to employees of the taxpayer for
determination.                                  which permissible method for Form W–2            employment by the taxpayer; or
    (c) Application in case of taxpayer with    reporting is used.                                   (B) The total entries in Box 5 of all
short taxable year. In the case of a tax-           (e) Non-duplication rule. Amounts that       Forms W–2 filed with the SSA by the tax-
payer with a short taxable year, subject        are treated as W–2 wages for a taxable           payer with respect to employees of the tax-
to the rules of paragraph (a) of this sec-      year under any method may not be treated         payer for employment by the taxpayer.
tion, the W–2 wages of the taxpayer for         as W–2 wages of any other taxable year.              (ii) Modified Box 1 method. Under
the short taxable year shall include those      Also, an amount may not be treated as W–2        the Modified Box 1 method, the taxpayer
wages paid during the short taxable year        wages by more than one taxpayer.                 makes modifications to the total entries in
to employees of the taxpayer as deter-              (f) Definition of W–2 wages—(1) In           Box 1 of Forms W–2 filed with respect to
mined under the tracking wages method           general. Section 199(b)(2) defines W–2           employees of the taxpayer. W–2 wages
described in paragraph (f)(2)(iii) of this      wages for purposes of section 199(b)(1)          under this method are calculated as fol-
section. In applying the tracking wages         as the sum of the amounts required to            lows—
method in the case of a short taxable year,     be included on statements under section              (A) Total the amounts in Box 1 of all
the taxpayer must apply the method as           6051(a)(3) and (8) with respect to employ-       Forms W–2 filed with the SSA by the tax-
follows—                                        ment of employees of the taxpayer for the        payer with respect to employees of the tax-
    (1) In paragraph (f)(2)(iii)(A) of this     calendar year. Thus, the term W–2 wages          payer for employment by the taxpayer;
section, the total amount of wages subject      includes the total amount of wages as de-            (B) Subtract from the total in paragraph
to Federal income tax withholding and re-       fined in section 3401(a); the total amount       (f)(2)(ii)(A) of this section amounts in-
ported on Form W–2 must include only            of elective deferrals (within the meaning        cluded in Box 1 of Forms W–2 that are not
those wages subject to Federal income tax       of section 402(g)(3)); the compensation          wages for Federal income tax withholding
withholding that are actually paid to em-       deferred under section 457; and for taxable      purposes and amounts included in Box 1 of
ployees during the short taxable year and       years beginning after December 31, 2005,         Forms W–2 that are treated as wages under
reported on Form W–2 for the calendar           the amount of designated Roth contribu-          section 3402(o) (for example, supplemen-
year ending within that short taxable year;     tions (as defined in section 402A). Under        tal unemployment benefits); and
    (2) In paragraph (f)(2)(iii)(B) of this     the 2004 and 2005 Form W–2, the elec-                (C) Add to the amount obtained af-
section, only the supplemental unemploy-        tive deferrals under section 402(g)(3) and       ter paragraph (f)(2)(ii)(B) of this section
ment benefits paid during the short taxable     the amounts deferred under section 457           amounts that are reported in Box 12 of
year that were included in the total in para-   directly correlate to coded items reported       Forms W–2 with respect to employees of
graph (f)(2)(iii)(A) of this section as mod-    in Box 12 on Form W–2. Box 12, Code D,           the taxpayer for employment by the tax-
ified by paragraph (c)(1) of this section are   is for elective deferrals to a section 401(k)    payer and that are properly coded D, E, F,
required to be deducted; and                    cash or deferred arrangement; Box 12,            G, or S.
    (3) In paragraph (f)(2)(iii)(C) of this     Code E, is for elective deferrals under a            (iii) Tracking wages method. Under the
section, only the portion of the amounts re-    section 403(b) salary reduction agreement;       Tracking wages method, the taxpayer ac-
ported in Box 12, Codes D, E, F, G, and S,      Box 12, Code F, is for elective deferrals        tually tracks total wages subject to Federal
on Forms W–2, that are actually deferred        under a section 408(k)(6) salary reduction       income tax withholding and makes appro-
or contributed during the short taxable year    Simplified Employee Pension (SEP); Box           priate modifications. W–2 wages under
may be included in W–2 wages.                   12, Code G, is for elective deferrals under      this method are calculated as follows—
    (d) Acquisition or disposition of a trade   a section 457(b) plan; and Box 12, Code              (A) Total the amounts of wages subject
or business (or major portion). If a tax-       S, is for employee salary reduction con-         to Federal income tax withholding that are
payer (a successor) acquires a trade or         tributions under a section 408(p) SIMPLE         paid to employees of the taxpayer for em-
business, the major portion of a trade or       (simple retirement account).                     ployment by the taxpayer and that are re-
business, or the major portion of a separate        (2) Methods for calculating W–2 wages.       ported on Forms W–2 filed with the SSA
unit of a trade or business from another        For any taxable year, taxpayers may use          by the taxpayer for the calendar year;
taxpayer (a predecessor), then, for pur-        one of three methods in calculating W–2              (B) Subtract from the total in paragraph
poses of computing the respective section       wages. These three methods are subject to        (f)(2)(iii)(A) of this section the supple-
199 deduction of the successor and of the       the non-duplication rule provided in para-       mental unemployment compensation ben-
predecessor, the W–2 wages paid for that        graph (e) of this section, and the tracking      efits (as defined in section 3402(o)(2)(A))
calendar year shall be allocated between        wages method is subject to the rule pro-         that were included in the total in paragraph
the successor and the predecessor based         vided in paragraph (c) of this section, if ap-   (f)(2)(iii)(A) of this section; and
on whether the wages are for employment         plicable.                                            (C) Add to the amount obtained af-
by the successor or for employment by the           (i) Unmodified box method. Under the         ter paragraph (f)(2)(iii)(B) of this section
predecessor. Thus, in this situation, the       Unmodified box method, W–2 wages are             amounts that are reported in Box 12 of
W–2 wages are allocated based on whether        calculated by taking, without modifica-          Forms W–2 with respect to employees of
the wages are for employment for a period       tion, the lesser of—                             the taxpayer for employment by the tax-
during which the employee was employed              (A) The total entries in Box 1 of all        payer and that are properly coded D, E, F,
by the predecessor or for employment for        Forms W–2 filed with the Social Security         G, or S.
a period during which the employee was          Administration (SSA) by the taxpayer with


2005–47 I.R.B.                                                     1014                                         November 21, 2005
§1.199–3 Domestic production gross               of the unrelated person. Similarly, para-      MPGE includes manufacturing, produc-
receipts.                                        graph (b)(1) of this section does not apply    ing, growing, extracting, installing, de-
                                                 to the license of QPP or qualified films to    veloping, improving, and creating QPP;
    (a) In general. Domestic production          a related person for reproduction and sale,    making QPP out of scrap, salvage, or junk
gross receipts (DPGR) are the gross re-          exchange, lease, rental or sublicense to an    material as well as from new or raw mate-
ceipts (as defined in paragraph (c) of this      unrelated person for the ultimate use of the   rial by processing, manipulating, refining,
section) of the taxpayer that are derived        unrelated person.                              or changing the form of an article, or by
from (as defined in paragraph (h) of this            (c) Definition of gross receipts. The      combining or assembling two or more
section)—                                        term gross receipts means the taxpayer’s       articles; cultivating soil, raising livestock,
    (1) Any lease, rental, license, sale, ex-    receipts for the taxable year that are rec-    fishing, and mining minerals. The term
change, or other disposition of—                 ognized under the taxpayer’s methods of        MPGE also includes storage, handling,
    (i) Qualifying production property           accounting used for Federal income tax         or other processing activities (other than
(QPP) (as defined in paragraph (i)(1) of         purposes for the taxable year. If the gross    transportation activities) within the United
this section) that is manufactured, pro-         receipts are recognized in an intercom-        States related to the sale, exchange, or
duced, grown, or extracted (MPGE) (as            pany transaction within the meaning of         other disposition of agricultural products,
defined in paragraph (d) of this section)        §1.1502–13, see also §1.199–7(d). For          provided the products are consumed in
by the taxpayer (as defined in paragraph         this purpose, gross receipts include to-       connection with, or incorporated into, the
(e) of this section) in whole or in signif-      tal sales (net of returns and allowances)      MPGE of QPP whether or not by the tax-
icant part (as defined in paragraph (f) of       and all amounts received for services.         payer. The taxpayer must have the benefits
this section) within the United States (as       In addition, gross receipts include any        and burdens of ownership of the QPP un-
defined in paragraph (g) of this section);       income from investments and from inci-         der Federal income tax principles during
    (ii) Any qualified film (as defined in       dental or outside sources. For example,        the period the MPGE activity occurs, pur-
paragraph (j) of this section) produced          gross receipts include interest (including     suant to paragraph (e)(1) of this section, in
by the taxpayer (in accordance with para-        original issue discount and tax-exempt         order for gross receipts derived from the
graph (j) of this section); or                   interest within the meaning of section         MPGE of QPP to qualify as DPGR.
    (iii) Electricity, natural gas, or potable   103), dividends, rents, royalties, and an-         (2) Packaging, repackaging, labeling,
water (as defined in paragraph (k) of this       nuities, regardless of whether the amounts     or minor assembly. If a taxpayer pack-
section) (collectively, utilities) produced      are derived in the ordinary course of the      ages, repackages, labels, or performs mi-
by the taxpayer in the United States (in ac-     taxpayer’s trade of business. Gross re-        nor assembly of QPP and the taxpayer en-
cordance with paragraph (k) of this sec-         ceipts are not reduced by cost of goods        gages in no other MPGE activity with re-
tion);                                           sold (CGS) or by the cost of property sold     spect to that QPP, the taxpayer’s packag-
    (2) Construction (as defined in para-        if such property is described in section       ing, repackaging, labeling, or minor as-
graph (l) of this section) performed in the      1221(a)(1), (2), (3), (4), or (5). Gross       sembly do not qualify as MPGE.
United States (in accordance with para-          receipts do not include the amounts re-            (3) Installing. If a taxpayer installs
graph (l) of this section); or                   ceived in repayment of a loan or similar       an item of QPP and engages in no other
    (3) Engineering or architectural ser-        instrument (for example, a repayment of        MPGE with respect to the QPP, the tax-
vices (as defined in paragraph (m) of this       the principal amount of a loan held by         payer’s installing activity does not qualify
section) performed in the United States for      a commercial lender) and, except to the        as MPGE. However, if the taxpayer installs
construction projects in the United States       extent of gain recognized, do not include      an item of QPP MPGE by the taxpayer,
(in accordance with paragraph (m) of this        gross receipts derived from a non-recog-       and the taxpayer has the benefits and bur-
section).                                        nition transaction, such as a section 1031     dens of ownership of the item of QPP un-
    (b) Related persons—(1) In general.          exchange. Finally, gross receipts do not       der Federal income tax principles during
DPGR does not include any gross receipts         include amounts received by the taxpayer       the period the installing activity occurs, the
of the taxpayer derived from property            with respect to sales tax or other similar     portion of the installing activity that relates
leased, licensed, or rented by the taxpayer      state and local taxes if, under the appli-     to the item of QPP is MPGE.
for use by any related person. A person is       cable state or local law, the tax is legally       (4) Consistency with section 263A.
treated as related to another person if both     imposed on the purchaser of the good or        A taxpayer that has MPGE QPP for the
persons are treated as a single employer         service and the taxpayer merely collects       taxable year should treat itself as a pro-
under either section 52(a) or (b) (with-         and remits the tax to the taxing authority.    ducer under section 263A with respect
out regard to section 1563(b)), or section       If, in contrast, the tax is imposed on the     to the QPP for the taxable year unless
414(m) or (o).                                   taxpayer under the applicable law, then        the taxpayer is not subject to section
    (2) Exceptions. Paragraph (b)(1) of this     gross receipts include the amounts re-         263A. A taxpayer that currently is not
section does not apply to any QPP or qual-       ceived that are allocable to the payment of    properly accounting for its production ac-
ified films leased or rented by the taxpayer     such tax.                                      tivities under section 263A, and wishes
to a related person if the QPP or qualified          (d) Definition of manufactured, pro-       to change its method of accounting to
films are held for sublease or rent, or are      duced, grown, or extracted—(1) In gen-         comply with the producer requirements
subleased or rented, by the related person       eral. Except as provided in paragraphs         of section 263A, must follow the appli-
to an unrelated person for the ultimate use      (d)(2) and (3) of this section, the term       cable administrative procedures issued


November 21, 2005                                                  1015                                                 2005–47 I.R.B.
under §1.446–1(e)(3)(ii) for obtaining                     accessories. X’s activity is minor assembly under        QPP, or the production of the qualified
the Commissioner’s consent to a change                     paragraph (d)(2) of this section which is not an         films or utilities, is complete.
in accounting method (for further guid-                    MPGE activity.                                               (3) Examples. The following examples
                                                               Example 7. The facts are the same as in Ex-
ance, for example, see Rev. Proc. 97–27,                   ample 6 except that X manufactures some of the
                                                                                                                    illustrate the application of this paragraph
1997–1 C.B. 680, or Rev. Proc. 2002–9,                     accessories it adds to the automobiles. Pursuant to      (e):
2002–1 C.B. 327, whichever applies (see                    §1.199–1(c)(2), if an automobile with accessories             Example 1. X designs machines that it uses in its
§601.601(d)(2) of this chapter)).                          does not meet the requirements for being an item, X      trade or business. X contracts with Y, an unrelated
                                                           must treat each accessory that it manufactures as an     taxpayer, for the manufacture of the machines. The
    (5) Examples. The following examples                                                                            contract between X and Y is a fixed-price contract.
                                                           item for purposes of determining whether X MPGE
illustrate the application of this paragraph               the item in whole or in significant part within the      The contract specifies that the machines will be man-
(d):                                                       United States under paragraph (f)(1) of this section     ufactured in the United States using X’s design. X
     Example 1. A, B, and C are unrelated taxpayers        and whether the installation of the item is MPGE         owns the intellectual property attributable to the de-
and are not cooperatives to which Part I of subchapter     under paragraph (d)(3) of this section.                  sign and provides it to Y with a restriction that Y may
T of the Internal Revenue Code applies. A owns grain           Example 8. Y manufactures furniture in the           only use it during the manufacturing process and has
storage bins in the United States in which it stores       United States that it sells to unrelated persons. Y      no right to exploit the intellectual property. The con-
for a fee B’s agricultural products that were grown in     also engraves customers’ names on pens and pen-          tract specifies that Y controls the details of the man-
the United States. B sells its agricultural products to    cils purchased from unrelated persons and sells the      ufacturing process while the machines are being pro-
C. C processes B’s agricultural products into refined      pens and pencils to such customers. Although Y’s         duced; Y bears the risk of loss or damage during man-
agricultural products in the United States. The gross      sales of furniture qualify as DPGR if all the other      ufacturing of the machines; and Y has the economic
receipts from A’s, B’s, and C’s activities are DPGR        requirements of this section are met, Y’s sales of the   loss or gain upon the sale of the machines based on
from the MPGE of QPP.                                      engraved pens and pencils do not qualify as DPGR         the difference between Y’s costs and the fixed price.
     Example 2. The facts are the same as in Example       because Y does not MPGE the pens and pencils.            Y has legal title during the manufacturing process and
1 except that B grows the agricultural products out-                                                                legal title to the machines is not transferred to X until
                                                               (e) Definition of by the taxpayer—(1)
side the United States and C processes B’s agricul-                                                                 final manufacturing of the machines has been com-
tural products into refined agricultural products out-
                                                           In general. With the exception of the rules              pleted. Based on all of the facts and circumstances,
side the United States. Pursuant to paragraph (d)(1)       applicable to an expanded affiliated group               pursuant to paragraph (e)(1) of this section Y has the
of this section, the gross receipts derived by A are       (EAG) under §1.199–7, certain oil and                    benefits and burdens of ownership of the machines
DPGR from the MPGE of QPP within the United                gas partnerships under paragraph (h)(7)                  under Federal income tax principles during the period
States. B’s and C’s respective activities occur out-                                                                the manufacturing occurs and, as a result, Y is treated
                                                           of this section, EAG partnerships under
side the United States and, therefore, their respective                                                             as the manufacturer of the machines.
gross receipts are non-DPGR.
                                                           paragraph (h)(8) of this section, and gov-                    Example 2. X designs and engineers machines
     Example 3. Y is hired to reconstruct and refur-       ernment contracts in paragraph (e)(2) of                 that it sells to customers. X contracts with Y, an un-
bish unrelated customers’ tangible personal property.      this section, only one taxpayer may claim                related taxpayer, for the manufacture of the machines.
As part of the reconstruction and refurbishment, Y in-     the deduction under §1.199–1(a) with                     The contract between X and Y is a cost-reimbursable
stalls purchased replacement parts in the customers’                                                                type contract. X has the benefits and burdens of own-
                                                           respect to any qualifying activity under
property. Y’s installation of purchased replacement                                                                 ership of the machines under Federal income tax prin-
parts does not qualify as MPGE pursuant to paragraph
                                                           paragraph (d)(1) of this section performed               ciples during the period the manufacturing occurs ex-
(d)(3) of this section because Y did not MPGE the re-      in connection with the same QPP, or the                  cept that legal title to the machines is not transferred
placement parts.                                           production of qualified films or utilities. If           to X until final manufacturing of the machines is com-
     Example 4. The facts are the same as in Example       one taxpayer performs a qualifying activ-                pleted. Based on all of the facts and circumstances, X
3 except that Y manufactures the replacement parts it                                                               is treated as the manufacturer of the machines under
                                                           ity under paragraph (d)(1), (j)(1), or (k)(1)
uses for the reconstruction and refurbishment of cus-                                                               paragraph (e)(1) of this section.
tomers’ tangible personal property. Y has the ben-
                                                           of this section pursuant to a contract with
                                                                                                                        (f) Definition of in whole or in signif-
efits and burdens of ownership of the replacement          another party, then only the taxpayer that
                                                                                                                    icant part—(1) In general. QPP must be
parts during the reconstruction and refurbishment ac-      has the benefits and burdens of ownership
tivity and while installing the parts. Y’s gross re-
                                                                                                                    MPGE in whole or in significant part by
                                                           of the property under Federal income tax
ceipts from the MPGE of the replacement parts and                                                                   the taxpayer and in whole or in signifi-
                                                           principles during the period the qualifying
Y’s gross receipts from the installation of the replace-                                                            cant part within the United States to qual-
ment parts, which is an MPGE activity pursuant to
                                                           activity occurs is treated as engaging in
                                                                                                                    ify under section 199(c)(4)(A)(i)(I). If a
paragraph (d)(3) of this section, are DPGR.                the qualifying activity.
                                                                                                                    taxpayer enters into a contract pursuant to
     Example 5. Z MPGE QPP within the United                   (2) Special rule for certain government
States. The following activities are performed by
                                                                                                                    paragraph (e)(1) of this section with an
                                                           contracts. QPP, qualified films, or utili-
Z as part of the MPGE of the QPP while Z has the                                                                    unrelated party for the unrelated party to
                                                           ties will be treated as MPGE or otherwise
benefits and burdens of ownership under Federal                                                                     MPGE QPP for the taxpayer and the tax-
income tax principles: materials analysis and selec-
                                                           produced by the taxpayer notwithstanding
                                                                                                                    payer has the benefits and burdens of own-
tion, subcontractor inspections and qualifications,        the requirements of paragraph (e)(1) of this
                                                                                                                    ership of the QPP under applicable Federal
testing of component parts, assisting customers in         section if—
their review and approval of the QPP, routine produc-
                                                                                                                    income tax principles during the period the
                                                               (i) The QPP, qualified films, or utilities
tion inspections, product documentation, diagnosis                                                                  MPGE activity occurs, then the taxpayer
                                                           are MPGE or otherwise produced by the
and correction of system failure, and packaging for                                                                 is considered to MPGE the QPP under this
shipment to customers. Because Z MPGE the QPP,
                                                           taxpayer pursuant to a contract with the
                                                                                                                    section. The unrelated party must perform
these activities performed by Z are part of the MPGE       Federal government; and
                                                                                                                    the MPGE activity on behalf of the tax-
of the QPP.                                                    (ii) The Federal Acquisition Regulation
     Example 6. X purchases automobiles from
                                                                                                                    payer in whole or in significant part within
                                                           (Title 48 CFR) requires that title or risk
unrelated parties and customizes them by adding                                                                     the United States in order for the taxpayer
                                                           of loss with respect to the QPP, qualified
ground effects, spoilers, custom wheels, specialized                                                                to satisfy the requirements of this para-
paint and decals, sunroofs, roof racks, and similar
                                                           films, or utilities be transferred to the Fed-
                                                                                                                    graph (f)(1).
accessories. X does not manufacture any of the             eral government before the MPGE of the



2005–47 I.R.B.                                                                   1016                                                   November 21, 2005
    (2) Substantial in nature. QPP will                    QPP, conversion costs (direct labor and                  bers, as applicable, to MPGE the QPP are
be treated as MPGE in significant part by                  related factory burden) of such taxpayer to              taken into account. If a taxpayer enters
the taxpayer within the United States for                  MPGE the QPP within the United States                    into a contract with an unrelated party for
purposes of paragraph (f)(1) of this sec-                  account for 20 percent or more of the tax-               the unrelated party to MPGE QPP for the
tion if the MPGE of the QPP by the tax-                    payer’s CGS of the QPP. For purposes of                  taxpayer, and the taxpayer is considered
payer within the United States is substan-                 the safe harbor under this paragraph (f)(3),             pursuant to paragraph (e)(1) of this section
tial in nature taking into account all of the              research and experimental expenditures                   to MPGE the QPP, then for purposes of
facts and circumstances, including the rel-                under section 174 and the costs of creating              this safe harbor the taxpayer’s conversion
ative value added by, and relative cost of,                intangibles do not qualify as conversion                 costs shall include both the taxpayer’s
the taxpayer’s MPGE activity within the                    costs for any QPP other than computer                    conversion costs as well as the conversion
United States, the nature of the property,                 software and sound recordings. In the                    costs of the unrelated party to MPGE the
and the nature of the MPGE activity that                   case of tangible personal property (as de-               QPP under the contract.
the taxpayer performs within the United                    fined in paragraph (i)(2) of this section),                  (4) Examples. The following examples
States. Research and experimental activ-                   research and experimental expenditures                   illustrate the application of this paragraph
ities under section 174 and the creation of                under section 174 and any other costs in-                (f):
intangibles do not qualify as substantial in               curred in the creation of intangibles may                     Example 1. X purchases from Y unrefined oil
nature for any QPP other than computer                     be excluded from CGS for purposes of                     extracted outside the United States and X refines the
                                                                                                                    oil in the United States. The refining of the oil by X
software (as defined in paragraph (i)(3) of                determining whether the taxpayer meets                   is an MPGE activity that is substantial in nature.
this section) and sound recordings (as de-                 the safe harbor under this paragraph (f)(3).                  Example 2. X purchases gemstones and precious
fined in paragraph (i)(4) of this section).                For purposes of this safe harbor, research               metal from outside the United States and then uses
In the case of an EAG member, an EAG                       and experimental expenditures under sec-                 these materials to produce jewelry within the United
partnership (as defined in paragraph (h)(8)                tion 174 and any other costs of creating                 States by cutting and polishing the gemstones, melt-
                                                                                                                    ing and shaping the metal, and combining the fin-
of this section), or members of an EAG                     intangibles for computer software and                    ished materials. X’s activity is substantial in nature
in which the partners of the EAG partner-                  sound recordings must be allocated to the                under paragraph (f)(2) of this section. Therefore, X
ship are members, in determining whether                   computer software and sound recordings                   has MPGE the jewelry in significant part within the
the substantial in nature requirement is met               to which the expenditures and costs relate               United States.
with respect to an item of QPP, all of the                 under §1.199–4(b). In the case of an EAG                      Example 3. (i) X operates an automobile assem-
                                                                                                                    bly plant in the United States. In connection with
previous activities of the members of the                  member, an EAG partnership, or members                   such activity, X purchases assembled engines, trans-
EAG, the EAG partnership, and all mem-                     of an EAG in which the partners of the                   missions, and certain other components from Y, an
bers of the EAG in which the partners of                   EAG partnership are members, in deter-                   unrelated taxpayer, and X assembles all of the compo-
the EAG partnership are members, as ap-                    mining whether the requirements of the                   nent parts into an automobile. X also conducts stamp-
plicable, are taken into account.                          safe harbor under this paragraph (f)(3) are              ing, machining, and subassembly operations, and X
                                                                                                                    uses tools, jigs, welding equipment, and other ma-
    (3) Safe harbor. A taxpayer will be                    met with respect to an item of QPP, all of               chinery and equipment in the assembly of automo-
treated as having MPGE QPP in whole                        the previous conversion costs of the mem-                biles. On a per-unit basis, X ’s selling price and costs
or in significant part within the United                   bers of the EAG, the EAG partnership,                    of such automobiles are as follows:
States for purposes of paragraph (f)(1)                    and all members of the EAG in which the
of this section if, in connection with the                 partners of the EAG partnership are mem-


                            Selling price: $ 2,500
                            Cost of goods sold:
                                             Material — Acquired from Y: $ 1,475
                                             Conversion costs (direct labor and factory burden): $325
                                             Total cost of goods sold: $1,800
                            Gross profit: $700
                            Administrative and selling expenses: $300
                            Taxable income: $400


    (ii) Although X’s conversion costs are less than       of the film onto DVDs. Y purchases the DVDs from         section. Therefore, X’s gross receipts from the lease,
20 percent of total CGS ($325/$1,800, or 18 percent),      an unrelated person. Unless Y satisfies the safe har-    rental, license, sale, exchange, or other disposition of
the operations conducted by X in connection with the       bor under paragraph (f)(3) of this section, Y’s income   the QPP qualify as DPGR if all other applicable re-
property purchased and sold are substantial in nature      for duplicating X’s qualified film onto the DVDs is      quirements under this section are met.
under paragraph (f)(2) of this section because of the      non-DPGR because the duplication is not substantial          Example 6. X manufactures QPP in significant
nature of X’s activity and the relative value of X’s       in nature relative to the DVD with the film.             part within the United States and exports the QPP for
activity. Therefore, X’s automobiles will be treated           Example 5. X imports into the United States QPP      further manufacture outside the United States. As-
as MPGE in significant part by X within the United         that is partially manufactured. X completes the man-     suming X meets all the requirements under this sec-
States for purposes of paragraph (f)(1) of this section.   ufacture of the QPP within the United States and X’s     tion for the QPP after the further manufacturing, X’s
    Example 4. X produces a qualified film (as de-         completion of the manufacturing of the QPP within        gross receipts derived from the lease, rental, license,
fined in paragraph (j)(1) of this section) and licenses    the United States satisfies the in whole or in signif-   sale, exchange, or other disposition of the QPP will
the film to Y, an unrelated taxpayer, for duplication      icant part requirement under paragraph (f)(1) of this    be considered DPGR, regardless of whether the QPP



November 21, 2005                                                                1017                                                            2005–47 I.R.B.
is imported back into the United States prior to the      QPP or a qualified film. In addition,                     in the activity giving rise to DPGR, and
lease, rental, license, sale, exchange, or other dispo-   the proceeds from business interruption                   provided that the transaction is a hedging
sition of the QPP.                                        insurance, governmental subsidies, and                    transaction within the meaning of section
     Example 7. X is a retailer that sells cigars and
pipe tobacco that X purchases from an unrelated per-
                                                          governmental payments not to produce are                  1221(b)(2) and §1.1221–2(b), then—
son. While being displayed and offered for sale by        treated as gross receipts derived from the                    (A) In the case of a hedge of pur-
X, the cigars and pipe tobacco age on X’s shelves         lease, rental, license, sale, exchange, or                chases of property described in section
in a room with controlled temperature and humidity.       other disposition to the extent that they are             1221(a)(1), gain or loss on the hedging
Although X’s cigars and pipe tobacco may become           substitutes for gross receipts that would                 transaction must be taken into account in
more valuable as they age, the gross receipts derived
by X from the sale of the cigars and pipe tobacco are
                                                          qualify as DPGR. The value of property                    determining CGS;
non-DPGR because the aging of the cigars and pipe         received by a taxpayer in a taxable ex-                       (B) In the case of a hedge of sales of
tobacco while being displayed and offered for sale by     change of QPP MPGE in whole or in                         property described in section 1221(a)(1),
X does not qualify as an MPGE activity that occurs in     significant part within the United States,                gain or loss on the hedging transaction
whole or in significant part within the United States.    qualified films, or utilities for an unrelated            must be taken into account in determining
    (g) Definition of United States. For                  person’s property is DPGR for the tax-                    DPGR; and
purposes of this section, the term United                 payer (assuming all the other requirements                    (C) In the case of a hedge of pur-
States includes the 50 states, the District               of this section are met). However, un-                    chases of property described in section
of Columbia, the territorial waters of the                less the taxpayer further MPGE the QPP                    1221(a)(8), gain or loss on the hedging
United States, and the seabed and subsoil                 or further produces the qualified films                   transaction must be taken into account in
of those submarine areas that are adjacent                or utilities received in the exchange, any                determining DPGR.
to the territorial waters of the United States            gross receipts from the subsequent sale by                    (ii) Currency fluctuations. For pur-
and over which the United States has ex-                  the taxpayer of the property received in                  poses of this section, in the case of a trans-
clusive rights, in accordance with interna-               the exchange are non-DPGR because the                     action that manages the risk of currency
tional law, with respect to the exploration               taxpayer did not MPGE or otherwise pro-                   fluctuations, the determination of whether
and exploitation of natural resources. The                duce such property, even if the property                  the transaction is a hedging transaction
term United States does not include pos-                  was QPP, qualified films, or utilities in the             within the meaning of §1.1221–2(b) is
sessions and territories of the United States             hands of the other person.                                made without regard to whether the trans-
or the airspace or space over the United                     (2) Examples. The following exam-                      action is a section 988 transaction. See
States and these areas.                                   ples illustrate the application of paragraph              §1.1221–2(a)(4). The preceding sentence
    (h) Definition of derived from the lease,             (h)(1) of this section:                                   applies only to the extent that §1.988–5(b)
rental, license, sale, exchange, or other                     Example 1. X MPGE QPP within the United               does not apply.
disposition—(1) In general. The term                      States and sells the QPP to Y, an unrelated person.           (iii) Other rules. See §1.1221–2(e) for
derived from the lease, rental, license,                  Y leases the QPP for 3 years to Z, a taxpayer unre-
                                                          lated to both X and Y, and shortly thereafter, X repur-
                                                                                                                    rules applicable to hedging by members
sale, exchange, or other disposition is de-                                                                         of a consolidated group and §1.446–4 for
                                                          chases the QPP from Y subject to the lease. At the
fined as, and limited to, the gross receipts              end of the lease term, Z purchases the QPP from X.        rules regarding the timing of income, de-
directly derived from the lease, rental,                  X’s proceeds derived from the sale of the QPP to Y,       ductions, gain, or loss with respect to hedg-
license, sale, exchange, or other dispo-                  from the lease to Z, and from the sale of the QPP to Z    ing transactions.
sition, even if the taxpayer has already                  all qualify as DPGR (assuming all the other require-
                                                          ments of this section are met).
                                                                                                                        (4) Allocation of gross receipts — em-
recognized gross receipts from a previous                                                                           bedded services and non-qualified prop-
                                                              Example 2. X MPGE QPP within the United
lease, rental, license, sale, exchange, or                States and sells the QPP to Y, an unrelated taxpayer,     erty—(i) In general. Except as otherwise
other disposition of the same property.                   for $25,000. X finances Y’s purchase of the QPP and       provided in paragraph (h)(4)(ii), paragraph
Applicable Federal income tax principles                  receives total payments of $35,000, of which $10,000      (l) (relating to construction), and para-
apply to determine whether a transaction                  relates to interest and finance charges. The $25,000
                                                          qualifies as DPGR but the $10,000 in interest and fi-
                                                                                                                    graph (m) (relating to architectural and
is, in substance, a lease, rental, license,                                                                         engineering services) of this section, gross
                                                          nance charges do not qualify as DPGR because the
sale, exchange or other disposition, or                   $10,000 is not derived from the MPGE of QPP within        receipts derived from the performance
whether it is a service (or some combina-                 the United States but rather from X’s lending activity.   of services do not qualify as DPGR. In
tion thereof). For example, gross receipts                    Example 3. Cable company X charges sub-               the case of an embedded service, that is,
derived from the sale of QPP includes                     scribers $15 a month for its basic cable television. Y,
                                                          an unrelated taxpayer, produces in the United States
                                                                                                                    a service the price of which is not sepa-
gross receipts derived from the sale of                                                                             rately stated from the amount charged for
                                                          all of the programs on its cable channel which it
QPP MPGE in whole or in significant part                  licenses to X for $.10 per subscriber per month. The      the lease, rental, license, sale, exchange,
within the United States by a taxpayer                    programs are qualified films within the meaning of        or other disposition of QPP, qualified
for sale, as well as gross receipts derived               paragraph (j)(1) of this section. The gross receipts      films, or utilities, DPGR includes only
from the sale of QPP MPGE in whole or                     derived by Y are derived from a license of a qualified
                                                          film produced by Y and are DPGR (assuming all the
                                                                                                                    the receipts from the lease, rental, license,
in significant part within the United States                                                                        sale, exchange, or other disposition of
                                                          other requirements of this section are met).
by a taxpayer and used in the taxpayer’s                                                                            the item (if all the other requirements of
                                                             (3) Hedging transactions—(i) In gen-
trade or business before being sold. The                                                                            this section are met) and not any receipts
                                                          eral. For purposes of this section, provided
entire amount of lease income including                                                                             attributable to the embedded service by
                                                          that the risk being hedged relates to QPP
any interest that is not separately stated                                                                          the taxpayer. In addition, DPGR does not
                                                          described in section 1221(a)(1) or property
is considered derived from the lease of                                                                             include the gross receipts derived from
                                                          described in section 1221(a)(8) consumed


2005–47 I.R.B.                                                                   1018                                               November 21, 2005
the lease, rental, license, sale, exchange,          (1) In the normal course of the tax-         receipts derived from the lease, rental, li-
or other disposition of property that does       payer’s business, the price for the manual       cense, sale, exchange, or other disposi-
not meet all of the requirements under           is not separately stated from the amount         tion of the item of QPP, qualified films,
this section (non-qualified property). For       charged for the lease, rental, license, sale,    or utilities. For purposes of applying this
example, gross receipts derived from the         exchange, or other disposition of the prop-      de minimis exception, the gross receipts
lease, rental, license, sale, exchange, or       erty;                                            described in paragraphs (h)(4)(ii)(A), (B),
other disposition of a replacement part that         (2) The manual is neither separately of-     (C), (D) and (k)(4)(iv) of this section are
is non-qualified property does not qualify       fered by the taxpayer nor separately bar-        treated as DPGR. This de minimis excep-
as DPGR.                                         gained for with the customer (that is, a cus-    tion does not apply if the prices of the ser-
    (ii) Exceptions. There are five excep-       tomer cannot purchase the property with-         vices or non-qualified property are sepa-
tions to the rules under paragraph (h)(4)(i)     out the manual); and                             rately stated by the taxpayer, or if the ser-
of this section regarding embedded ser-              (3) The manual is not provided in con-       vices or non-qualified property are sepa-
vices and non-qualified property. A tax-         nection with a training course for the cus-      rately offered or separately bargained for
payer may include in DPGR, if all the other      tomer;                                           with the customer (that is, the customer can
requirements of this section are met with            (D) A qualified installation, that is, an    purchase the property without the services
respect to the underlying item of property       installation service (including minor as-        or non-qualified property).
to which the embedded services or non-           sembly) for QPP that is provided in con-             (iii) Examples. The following examples
qualified property relate, gross receipts de-    nection with the lease, rental, license, sale,   illustrate the application of this paragraph
rived from—                                      exchange, or other disposition of the QPP        (h)(4):
    (A) A qualified warranty, that is, a war-    if—                                                  Example 1. X MPGE QPP within the United
ranty that is provided in connection with            (1) In the normal course of the tax-         States. As part of the sale of the QPP to Z, X trains
                                                                                                  Z’s employees on how to use and operate the QPP.
the lease, rental, license, sale, exchange, or   payer’s business, the price for the instal-      No other services or property are provided to Z in
other disposition of QPP, qualified films or     lation service is not separately stated from     connection with the sale of the QPP to Z. The QPP
utilities if—                                    the amount charged for the lease, rental, li-    and training services are separately stated in the sales
    (1) In the normal course of the tax-         cense, sale, exchange, or other disposition      contract. Because the training services are separately
payer’s business, the price for the warranty     of the property; and                             stated, the training services are not treated as embed-
                                                                                                  ded services under the de minimis exception in para-
is not separately stated from the amount             (2) The installation is neither separately   graph (h)(4)(ii)(E) of this section.
charged for the lease, rental, license, sale,    offered by the taxpayer nor separately bar-          Example 2. The facts are the same as in Example
exchange, or other disposition of the prop-      gained for with the customer (that is, a cus-    1 except that the training services are not separately
erty; and                                        tomer cannot purchase the property with-         stated in the sales contract and the customer cannot
    (2) The warranty is neither separately       out the installation service); and               purchase the QPP without the training services. If the
                                                                                                  gross receipts for the embedded training services are
offered by the taxpayer nor separately bar-          (E) A de minimis amount of gross re-         less than 5 percent of the gross receipts derived from
gained for with the customer (that is, a cus-    ceipts from embedded services and non-           the sale of X’s QPP to Z, including the gross receipts
tomer cannot purchase the property with-         qualified property for each item of QPP,         for the training services, then the gross receipts may
out the warranty);                               qualified films, or utilities. For purposes      be included in DPGR under the de minimis exception
    (B) A qualified delivery, that is, a de-     of the preceding sentence, a de minimis          in paragraph (h)(4)(ii)(E) of this section.
                                                                                                      Example 3. X MPGE QPP within the United
livery or distribution service that is pro-      amount of gross receipts from embedded           States. As part of the sale of the QPP to retailers, X
vided in connection with the lease, rental,      services and non-qualified property is less      charges a fee for delivering the QPP. The price of the
license, sale, exchange, or other disposi-       than 5 percent of the total gross receipts de-   QPP and the delivery fee are separately stated in the
tion of QPP if—                                  rived from the lease, rental, license, sale,     sales contract. The retailer’s customers cannot pur-
    (1) In the normal course of the tax-         exchange, or other disposition of each item      chase the QPP without paying for the delivery fee.
                                                                                                  Because the delivery fee is separately stated, the de-
payer’s business, the price for the deliv-       of QPP, qualified films, or utilities (includ-   livery fee does not qualify as DPGR under the qual-
ery or distribution service is not separately    ing the gross receipts for the embedded ser-     ified delivery exception in paragraph (h)(4)(ii)(B) of
stated from the amount charged for the           vices and property described in paragraphs       this section or the de minimis exception under para-
lease, rental, license, sale, exchange, or       (h)(4)(ii)(A), (B), (C), (D) and (k)(4)(iv)      graph (h)(4)(ii)(E) of this section.
other disposition of the property; and           of this section). The allocation of the              Example 4. X enters into a single, lump-sum
                                                                                                  priced contract with Y, an unrelated taxpayer, and the
    (2) The delivery or distribution service     gross receipts attributable to the embedded      contract has the following terms: X will produce QPP
is neither separately offered by the tax-        services or non-qualified property will be       within the United States for Y; X will deliver the QPP
payer nor separately bargained for with the      deemed to be reasonable if the allocation        to Y; X will provide a one-year warranty on the QPP;
customer (that is, a customer cannot pur-        reflects the fair market value of the em-        X will provide operating and maintenance manuals
chase the property without delivery or dis-      bedded services or property. In the case         with the QPP; X will provide 100 hours of training
                                                                                                  and training manuals to Y’s employees on the use and
tribution service);                              of gross receipts derived from the lease,        maintenance of the QPP; X will provide purchased
    (C) A qualified operating manual, that       rental, license, sale, exchange, or other dis-   spare parts for the QPP; and X will provide a 3-year
is, a manual of instructions (including          position of QPP, qualified films, and utili-     service agreement for the QPP. None of the services
electronic instructions) that is provided in     ties that are received over a period of time     or property was separately offered or separately bar-
connection with the lease, rental, license,      (for example, a multi-year lease or install-     gained for. The receipts for the production of the QPP
                                                                                                  are DPGR under paragraphs (d)(1) and (f) of this sec-
sale, exchange, or other disposition of          ment sale), this de minimis exception is ap-     tion (assuming all the other requirements of this sec-
QPP, qualified films or utilities if—            plied by taking into account the total gross     tion are met). X may include in DPGR the gross re-



November 21, 2005                                                   1019                                                       2005–47 I.R.B.
ceipts for delivering the QPP, which is a qualified de-    newspapers to customers and payments from adver-            are non-DPGR under paragraph (h)(6)(i) of this sec-
livery under paragraph (h)(4)(ii)(B) of this section;      tisers to publish display advertising or classified ad-     tion.
the gross receipts for the one-year warranty, which is     vertisements in X’s newspapers. X’s gross receipts              Example 2. The facts are the same as in Exam-
a qualified warranty under paragraph (h)(4)(ii)(A) of      described above are DPGR derived from the sale of           ple 1 except that X’s gross receipts attributable to
this section; and the gross receipts for the operating     X’s newspapers.                                             the online version of its newspaper are derived from
and maintenance manuals, each of which is a quali-              Example 2. The facts are the same as in Example        fees from customers to view the newspaper online
fied operating manual under paragraph (h)(4)(ii)(C)        1 except that X also distributes with its newspapers        and payments from advertisers to display advertis-
of this section. If the gross receipts for the embed-      advertising flyers that are MPGE by the advertiser.         ing online. X’s gross receipts derived from allow-
ded services consisting of the employee training and       The fees X receives for distributing the advertising        ing customers online access to X’s newspaper are
3-year service agreement, and for the non-qualified        flyers are not derived from the sale of X’s newspapers      non-DPGR because, pursuant to paragraph (h)(6)(i)
property consisting of the purchased spare parts and       because X did not MPGE the advertising flyers that it       of this section, the gross receipts relating to online
the employee training manuals, which are not quali-        distributes. As a result, the distribution fee is for the   newspapers are not derived from the lease, rental, li-
fied operating manuals, are in total less than 5 percent   provision of a distribution service and is non-DPGR         cense, sale, exchange, or other disposition of QPP,
of the gross receipts derived from the sale of X’s QPP     under paragraph (h)(5)(i) of this section.                  but rather is the provision of an online access service.
to Y (including the gross receipts for the embedded             Example 3. X produces two television programs          As a result, because X’s gross receipts from the on-
services and non-qualified property), those gross re-      that are qualified films (as defined in paragraph (j)(1)    line access services are non-DPGR, the related on-
ceipts may be included in DPGR (assuming there are         of this section). X licenses the first television pro-      line advertising receipts are similarly non-DPGR un-
no other embedded services or non-qualified property       gram to Y’s television station and X licenses the sec-      der paragraph (h)(5)(i) of this section.
under the contract) under the de minimis exception         ond television program to Z’s television station. Both          (7) Exception for certain oil and gas
in paragraph (h)(4)(ii)(E) of this section. If, how-       television programs contain product placements for
                                                                                                                       partnerships—(i) In general. If a part-
ever, the gross receipts for the embedded services and     which X received compensation. Z, but not Y, is a
non-qualified property consisting of employee train-       related person to X within the meaning of paragraph
                                                                                                                       nership is engaged solely in the extrac-
ing, the 3-year service agreement, purchased spare         (b)(1) of this section. The gross receipts derived by       tion, refining, or processing of oil or nat-
parts, and employee training manuals equal or exceed       X from licensing the qualified film to Y are DPGR.          ural gas, and distributes the oil or natu-
5 percent of the gross receipts derived from the sale      As a result, pursuant to paragraph (h)(5)(ii) of this       ral gas or products derived from the oil
of X’s QPP to Y (including the gross receipts for the      section, all of X’s product placement income for the
                                                                                                                       or natural gas (products) to one or more
embedded services and non-qualified property), those       first television program is treated as gross receipts
gross receipts do not qualify as DPGR under the de         that are derived from the license of the qualified film.
                                                                                                                       partners, then each partner is treated as ex-
minimis exception in paragraph (h)(4)(ii)(E) of this       The gross receipts derived by X from licensing the          tracting, refining, or processing any oil or
section.                                                   qualified film to Z are non-DPGR under paragraph            natural gas or products extracted, refined,
    (5) Advertising income—(i) Tangible                    (b)(1) of this section. As a result, pursuant to para-      or processed by the partnership and dis-
                                                           graph (h)(5)(ii) of this section, none of X’s product
personal property. A taxpayer’s gross                                                                                  tributed to that partner. Thus, to the ex-
                                                           placement income for the second television program
receipts that are derived from the lease,                  is treated as gross receipts derived from the qualified
                                                                                                                       tent that the extracting, refining, or pro-
rental, license, sale, exchange, or other                  film under paragraph (h)(5)(ii) of this section.            cessing of the distributed oil or natural gas
disposition of newspapers, magazines,                          (6) Computer software—(i) In general.                   or products occurs in whole or in signif-
telephone directories, or periodicals that                 Gross receipts derived from the lease,                      icant part within the United States, gross
are MPGE in whole or in significant part                   rental, license, sale, exchange, or other                   receipts derived by each partner from the
within the United States include advertis-                 disposition of computer software (as de-                    sale, exchange, or other disposition of the
ing income from advertisements placed                      fined in paragraph (i)(3) of this section)                  distributed oil or natural gas or products
in those media, but only to the extent                     do not include gross receipts derived from                  are treated as DPGR (provided all require-
the gross receipts, if any, derived from                   Internet access services, online services,                  ments of this section are met). Solely for
the lease, rental, license, sale, exchange,                customer and technical support, telephone                   purposes of section 199(d)(1)(B)(ii), the
or other disposition of the newspapers,                    services, online electronic books and jour-                 partnership is treated as having gross re-
magazines, telephone directories, or peri-                 nals, games played through a website,                       ceipts in the taxable year of the distribu-
odicals are DPGR (without regard to this                   provider-controlled software online ac-                     tion equal to the fair market value of the
paragraph (h)(5)(i)).                                      cess services, and other similar services                   distributed oil or natural gas or products at
    (ii) Qualified films. A taxpayer’s gross               that do not constitute the lease, rental, li-               the time of distribution to the partner and
receipts that are derived from the lease,                  cense, sale, exchange, or other disposition                 the deemed gross receipts are allocated to
rental, license, sale, exchange, or other dis-             of computer software that was developed                     that partner, provided the partner derives
position of a qualified film include prod-                 by the taxpayer.                                            gross receipts from the distributed prop-
uct-placement income with respect to that                      (ii) Examples. The following examples                   erty during the taxable year of the partner
qualified film, that is, compensation for                  illustrate the application of this paragraph                with or within which the partnership’s tax-
placing or integrating a product into the                  (h)(6):                                                     able year (in which the distribution occurs)
qualified film, but only to the extent the                      Example 1. X produces and prints a newspaper           ends. Costs included in the adjusted basis
gross receipts derived from the qualified                  in the United States which it sells to customers. X         of the distributed oil or natural gas or prod-
                                                           also has an online version of the newspaper which
film (if any) are DPGR (without regard to                                                                              ucts and any other relevant deductions are
                                                           is available only to subscribers. The gross receipts
this paragraph (h)(5)(ii)).                                derived from the sale of the newspaper X produces
                                                                                                                       taken into account in computing the part-
    (iii) Examples. The following examples                 and prints qualify as DPGR. However, because X’s            ner’s QPAI. See §1.199–5 for the applica-
illustrate the application of this paragraph               gross receipts from the online newspaper subscription       tion of section 199 to pass-thru entities.
(h)(5):                                                    are not derived from the lease, rental, license, sale,          (ii) Example. The following example il-
    Example 1. X MPGE and sells newspapers within          exchange, or disposition of computer software under
                                                                                                                       lustrates the application of this paragraph
the United States. X’s gross receipts from the news-       paragraph (h)(6)(i) of this section, the gross receipts
                                                           attributable to the online newspaper subscription fees
                                                                                                                       (h)(7). Assume that PRS and X are calen-
papers include gross receipts derived from the sale of



2005–47 I.R.B.                                                                     1020                                                   November 21, 2005
dar year taxpayers. The example reads as                 ply for purposes of the construction of real               QPP within the United States and then sells the prop-
follows:                                                 property under §1.199–3(l)(1) and the per-                 erty to X for $6,000, its fair market value at the time
     Example. X is a partner in PRS, a partnership       formance of engineering and architectural                  of the sale. PRS’s gross receipts of $6,000 qualify
which engages solely in the extraction of oil within                                                                as DPGR. In 2010, X sells the QPP to customers for
                                                         services under §1.199–3(m)(2) and (3), re-                 $10,000, incurring selling expenses of $2,000. Under
the United States. In 2010, PRS distributes oil to X
that PRS derived from its oil extraction. PRS incurred
                                                         spectively. An EAG partnership may not                     this paragraph (h)(8), X is treated as having MPGE
$600 of CGS, including $500 of W–2 wages (as de-         use the small business simplified overall                  the QPP within the United States, and X’s $10,000 of
fined in §1.199–2(f)), extracting the oil distributed    method described in §1.199–4(f). Except                    gross receipts qualify as DPGR ($6,000 of CGS and
to X, and X’s adjusted basis in the distributed oil is   as provided in this paragraph (h)(8), an                   $2,000 of other selling expenses are subtracted from
$600. The fair market value of the oil at the time                                                                  DPGR in determining X’s QPAI). The results would
                                                         EAG partnership is treated the same as                     be the same if PRS sold the property to Z rather than
of the distribution to X is $1,000. X incurs $200 of
CGS, including $100 of W–2 wages, in refining the
                                                         other partnerships for purposes of section                 to X.
oil within the United States. In 2010, X sells the oil   199. Accordingly, an EAG partnership is                        Example 3. Distribution. X and Y, both mem-
for $1,500 to a customer. Under paragraph (h)(7)(i)      subject to the rules of §1.199–5 regarding                 bers of a single EAG, are the only partners in PRS,
of this section, X is treated as having extracted the    the application of section 199 to pass-thru                a partnership, for PRS’s entire 2010 taxable year. In
oil. The extraction and refining of the oil qualify as                                                              2010, PRS MPGE QPP within the United States, in-
                                                         entities, including application of the sec-                curring $600 of CGS, including $500 of W–2 wages
an MPGE activity under paragraph (d)(1) of this sec-
tion. Therefore, X’s $1,500 of gross receipts qualify
                                                         tion 199(d)(1)(B) wage limitation under                    (as defined in §1.199–2(f)), and then distributes the
as DPGR. X subtracts from the $1,500 of DPGR the         §1.199–5(a)(3). See paragraphs (f)(2) and                  QPP to X. X’s adjusted basis in the QPP is $600. At
$600 of CGS incurred by PRS and the $200 of refin-       (3) of this section for the aggregation of ac-             the time of the distribution, the fair market value of
ing costs incurred by X. Thus, X’s QPAI is $700 for      tivities and conversion costs among EAG                    the QPP is $1,000. X incurs $200 of directly alloca-
2010. In addition, PRS is treated as having $1,000 of                                                               ble costs, including $100 of W–2 wages, to further
                                                         partnerships and all members of the EAG                    MPGE the QPP within the United States. In 2010, X
DPGR solely for purposes of applying the wage lim-
itation of section 199(d)(1)(B)(ii). Accordingly, X’s
                                                         in which the partners of the EAG partner-                  sells the QPP for $1,500 to a customer. Under para-
share of PRS’s W–2 wages determined under section        ship are members.                                          graph (h)(8)(i) of this section, X is treated as having
199(d)(1)(B) is $72, the lesser of $500 (X’s alloca-         (ii) Special rules for distributions from              MPGE the QPP within the United States, and X’s
ble share of PRS’s W–2 wages included in CGS) and        EAG partnerships.          If an EAG part-                 $1,500 of gross receipts qualify as DPGR. X sub-
$72 (2 x ($400 ($1,000 deemed DPGR less $600 of                                                                     tracts from the $1,500 of DPGR the $600 of CGS in-
                                                         nership distributes property to a part-                    curred by PRS and the $200 of direct costs incurred
CGS) x .09)). X adds the $72 of PRS W–2 wages to
its $100 of W–2 wages incurred in refining the oil for
                                                         ner, then, solely for purposes of section                  by X. Thus, X’s QPAI is $700 for 2010. In addition,
purposes of section 199(b).                              199(d)(1)(B)(ii), the EAG partnership is                   PRS is treated as having DPGR of $1,000 solely for
                                                         treated as having gross receipts in the tax-               purposes of applying the wage limitation of section
    (8) Partnerships owned by members of
                                                         able year of the distribution equal to the                 199(d)(1)(B)(ii). Accordingly, X’s share of PRS’s
a single expanded affiliated group—(i) In                                                                           W–2 wages determined under section 199(d)(1)(B) is
general. For purposes of this section, if                fair market value of the property at the                   $72, the lesser of $500 (X’s allocable share of PRS’s
all of the interests in the capital and prof-            time of distribution to the partner and the                W–2 wages included in CGS) and $72 (2 x ($400
its of a partnership are owned by mem-                   deemed gross receipts are allocated to that                ($1,000 deemed DPGR less $600 of CGS) x .09)).
                                                         partner, provided the partner derives gross                X adds the $72 of PRS W–2 wages to its $100 of
bers of a single EAG at all times during
                                                         receipts from the distributed property dur-                W–2 wages incurred in MPGE the QPP for purposes
the taxable year of the partnership (EAG                                                                            of section 199(b).
partnership), then the EAG partnership and               ing the taxable year of the partner with                       Example 4. Multiple sales. X and Y, both
all members of that EAG are treated as                   or within which the partnership’s taxable                  non-consolidated members of a single EAG, are the
a single taxpayer for purposes of section                year (in which the distribution occurs)                    only partners in PRS, a partnership, for PRS’s entire
                                                         ends. Costs included in the adjusted basis                 2010 taxable year. PRS produces in bulk form in the
199(c)(4) during that taxable year. Thus,
                                                         of the distributed property and any other                  United States the active ingredient for a pharmaceuti-
if an EAG partnership MPGE or produces                                                                              cal product. Assume that PRS’s own MPGE activity
property and distributes, leases, rents, li-             relevant deductions are taken into account                 with respect to the active ingredient is not substantial
censes, sells, exchanges, or otherwise dis-              in computing the partner’s QPAI.                           in nature, taking into account all of the facts and
poses of that property to a member of an                     (iii) Examples. The following examples                 circumstances, and PRS’s conversion costs to MPGE
                                                         illustrate the rules of this paragraph (h)(8).             the active ingredient within the United States are $15
EAG in which the partners of the EAG
                                                         Assume that PRS, X, Y, and Z all are cal-                  and account for 15 percent of PRS’s $100 CGS of
partnership are members, then the MPGE                                                                              the active ingredient. PRS sells the active ingredient
or production activity conducted by the                  endar year taxpayers. The examples read                    in bulk form to X. X uses the active ingredient to
EAG partnership will be treated as hav-                  as follows:                                                produce the finished dosage form drug. Assume that
                                                             Example 1. Contribution. X and Y, both mem-            X’s own MPGE activity with respect to the drug is
ing been conducted by the members of the
                                                         bers of a single EAG, are the only partners in PRS,        not substantial in nature, taking into account all of the
EAG. Similarly, if one or more members                   a partnership, for PRS’s entire 2010 taxable year.         facts and circumstances, and X’s conversion costs to
of an EAG in which the partners of an                    In 2010, X MPGE QPP within the United States               MPGE the drug within the United States are $12 and
EAG partnership are members MPGE or                      and contributes the property to PRS. In 2010, PRS          account for 10 percent of X’s $120 CGS of the drug.
produces property and contributes, leases,               sells the QPP for $1,000. PRS’s $1,000 gross re-           X sells the drug in finished dosage to Y and Y sells
                                                         ceipts constitute DPGR. PRS, X, and Y must apply           the drug to customers. Y incurs $2 of conversion
rents, licenses, sells, exchanges, or other-
                                                         the rules of §1.199–5 regarding the application of         costs and Y’s CGS in selling the drug to customers
wise disposes of that property to the EAG                section 199 to pass-thru entities with respect to the      is $130. PRS’s gross receipts from the sale of the
partnership, then the MPGE or produc-                    activity of PRS, including application of the section      active ingredient to X are non-DPGR because PRS’s
tion activity conducted by the EAG mem-                  199(d)(1)(B) wage limitation under §1.199–5(a)(3).         MPGE activity is not substantial in nature and PRS
ber (or members) will be treated as hav-                     Example 2. Sale. X, Y, and Z are the only mem-         does not satisfy the safe harbor described in para-
                                                         bers of a single EAG. X and Y each own 50% of the          graph (f)(3) of this section because PRS’s conversion
ing been conducted by the EAG partner-
                                                         capital and profits interests in PRS, a partnership, for   costs account for less than 20 percent of PRS’s CGS
ship. Attribution of activities does not ap-             PRS’s entire 2010 taxable year. In 2010, PRS MPGE          of the active ingredient. X’s gross receipts from



November 21, 2005                                                               1021                                                              2005–47 I.R.B.
the sale of the drug to Y are DPGR because X is         components of a building) is tangible per-     use the computer software, and that are
considered to have MPGE the drug in significant         sonal property even if such property is lo-    used only in connection with that specific
part in the United States pursuant to the safe harbor   cated outside a building. Thus, for exam-      computer software. Such incidental and
described in paragraph (f)(3) of this section because
the $27 ($15 + $12) of conversion costs incurred
                                                        ple, a gasoline pump, hydraulic car lift, or   ancillary rights are not included in the
by PRS and X equals or exceeds 20 percent of X’s        automatic vending machine, although an-        definition of trademark or trade name un-
total CGS ($120) of the drug at the time the drug       nexed to the ground, is considered tangible    der §1.197–2(b)(10)(i). For example, a
is sold to Y. Similarly, Y’s gross receipts from the    personal property. A structure that is prop-   trademark or trade name that is ancillary
sale of the drug to customers are DPGR because Y        erty in the nature of machinery or is essen-   to the ownership or use of a specific com-
is considered to have MPGE the drug in significant
part in the United States pursuant to the safe harbor
                                                        tially an item of machinery or equipment       puter software program in the taxpayer’s
described in paragraph (f)(3) of this section because   is not an inherently permanent structure       trade or business and is not acquired for
the $29 ($15 + $12 + $2) of conversion costs incurred   and is tangible personal property. In the      the purpose of marketing the computer
by PRS, X, and Y equals or exceeds 20 percent of        case, however, of a building or inherently     software is included in the definition of
Y’s total CGS ($130) of the drug at the time the drug   permanent structure that includes property     computer software and is not included in
is sold to customers.
                                                        in the nature of machinery as a structural     the definition of trademark or trade name.
    (9) Non-operating mineral interests.
                                                        component, the property in the nature of           (iii) Exceptions. Computer software
DPGR does not include gross receipts
                                                        machinery is real property.                    does not include any data or information
derived from mineral interests other than
                                                            (iv) Intangible property. The term tan-    base unless the data or information base
operating mineral interests within the
                                                        gible personal property does not include       is in the public domain and is incidental
meaning of §1.614–2(b).
                                                        property in a form other than in a tangi-      to a computer program. For this purpose,
    (i) Definition of qualifying production
                                                        ble medium. For example, mass-produced         a copyrighted or proprietary data or infor-
property—(1) In general. QPP means—
                                                        books are tangible personal property, but      mation base is treated as in the public do-
    (i) Tangible personal property (as de-
                                                        neither the rights to the underlying manu-     main if its availability through the com-
fined in paragraph (i)(2) of this section);
                                                        script nor an online version of the book is    puter program does not contribute signif-
    (ii) Computer software (as defined in
                                                        tangible personal property.                    icantly to the cost of the program. For ex-
paragraph (i)(3) of this section); and
                                                            (3) Computer software—(i) In general.      ample, if a word-processing program in-
    (iii) Sound recordings (as defined in
                                                        The term computer software means any           cludes a dictionary feature that may be
paragraph (i)(4) of this section).
                                                        program or routine or any sequence of          used to spell-check a document or any por-
    (2) Tangible personal property—(i) In
                                                        machine-readable code that is designed         tion thereof, the entire program (including
general. The term tangible personal prop-
                                                        to cause a computer to perform a desired       the dictionary feature) is computer soft-
erty is any tangible property other than
                                                        function or set of functions, and the docu-    ware regardless of the form in which the
land, buildings (including items that are
                                                        mentation required to describe and main-       dictionary feature is maintained or stored.
structural components of such buildings),
                                                        tain that program or routine. For purposes         (4) Sound recordings—(i) In general.
and any property described in paragraph
                                                        of this paragraph (i)(3), computer software    The term sound recordings means any
(i)(3), (i)(4), (j)(1), or (k) of this section.
                                                        also includes the machine-readable code        works that result from the fixation of a
Property such as production machinery,
                                                        for video games and similar programs,          series of musical, spoken, or other sounds
printing presses, transportation and office
                                                        for equipment that is an integral part of      under section 168(f)(4). The definition of
equipment, refrigerators, grocery coun-
                                                        other property, and for typewriters, calcu-    sound recordings is limited to the master
ters, testing equipment, display racks and
                                                        lators, adding and accounting machines,        copy of the recordings (or other copy from
shelves, and neon and other signs that
                                                        copiers, duplicating equipment, and sim-       which the holder is licensed to make and
are contained in or attached to a building
                                                        ilar equipment, regardless of whether the      produce copies), and, except as provided
constitutes tangible personal property for
                                                        code is designed to operate on a computer      in paragraph (i)(5) of this section, if the
purposes of this paragraph (i)(2)(i). Ex-
                                                        (as defined in section 168(i)(2)(B)). Com-     medium (such as compact discs, tapes,
cept as provided in paragraphs (i)(5)(ii)
                                                        puter programs of all classes, for example,    or other phonorecordings) in which the
and (j)(2)(i) of this section, computer
                                                        operating systems, executive systems,          sounds may be embodied is tangible, the
software, sound recordings, and qualified
                                                        monitors, compilers and translators, as-       medium is considered tangible personal
films are not treated as tangible personal
                                                        sembly routines, and utility programs, as      property for purposes of paragraph (i)(2)
property regardless of whether they are
                                                        well as application programs, are included.    of this section.
fixed on a tangible medium. However, the
                                                        Except as provided in paragraph (i)(5) of          (ii) Exception. The term sound record-
tangible medium on which such property
                                                        this section, if the medium in which the       ings does not include the creation of copy-
may be fixed (for example, a videocas-
                                                        software is contained, whether written,        righted material in a form other than a
sette, a computer diskette, or other similar
                                                        magnetic, or otherwise, is tangible, then      sound recording, such as lyrics or music
tangible item) is tangible personal prop-
                                                        such medium is considered tangible per-        composition.
erty.
                                                        sonal property for purposes of this section.       (5) Tangible personal property with
    (ii) Local law. In determining whether
                                                            (ii) Incidental and ancillary rights.      computer software or sound record-
property is tangible personal property, lo-
                                                        Computer software also includes any            ings—(i) Computer software and sound
cal law is not controlling.
                                                        incidental and ancillary rights that are       recordings. If a taxpayer MPGE computer
    (iii) Machinery. Property that is in the
                                                        necessary to effect the acquisition of the     software or sound recordings that is fixed
nature of machinery (other than structural
                                                        title to, the ownership of, or the right to    on, or added to, tangible personal property


2005–47 I.R.B.                                                            1022                                        November 21, 2005
by the taxpayer (for example, a computer        raphers and composers providing services          other requirements of this section are met),
diskette, or an appliance), then for pur-       during the production of a film, casting          regardless of whether the taxpayer MPGE
poses of this section—                          agents, camera operators, set designers,          the tangible personal property in whole or
    (A) The computer software and the tan-      lighting technicians, make-up artists, and        in significant part within the United States;
gible personal property may be treated by       others whose activities are directly related      and
the taxpayer as computer software. If the       to the production of the film. The term pro-          (B) Nonqualified films. If the film is
taxpayer treats the tangible personal prop-     duction personnel does not include, how-          not a qualified film (nonqualified film),
erty as computer software under this para-      ever, individuals whose activities are an-        any gross receipts derived from the lease,
graph (i)(5)(i)(A), any costs under section     cillary to the production, such as advertis-      rental, license, sale, exchange, or other
174 attributable to the tangible personal       ers and promoters, distributors, studio ad-       disposition of the tangible personal prop-
property are not considered in determining      ministrators and managers, studio security        erty with the nonqualified film that are
whether the taxpayer’s activity is substan-     personnel, and personal assistants to ac-         allocable to the nonqualified film are
tial in nature under paragraph (f)(2) of this   tors. The term production personnel also          non-DPGR. The taxpayer, however, may
section and are not conversion costs under      does not include individuals whose activ-         treat the tangible personal property (with-
paragraph (f)(3) of this section; and           ities relate to fixing the film on tangible       out the nonqualified film) as an item of
    (B) The sound recordings and the tan-       personal property. The definition of quali-       QPP. Thus, the determination of whether
gible personal property with the sound          fied film is limited to the master copy of the    gross receipts of such a taxpayer de-
recordings may be treated by the tax-           film (or other copy from which the holder         rived from the lease, rental, license, sale,
payer as sound recordings. If the taxpayer      is licensed to make and produce copies),          exchange, or other disposition of the tan-
treats the tangible personal property as        and, except as provided in paragraph (j)(2)       gible personal property with the affixed
sound recordings under this paragraph           of this section, does not include tangible        nonqualified film, that are allocable to the
(i)(5)(i)(B), any costs under section 174       personal property embodying the qualified         tangible personal property, are DPGR is
attributable to the tangible personal prop-     film, such as DVDs or videocassettes.             made under the rules of paragraphs (d),
erty are not considered in determining              (2) Tangible personal property with a         (e), and (f) of this section.
whether the taxpayer’s activity is substan-     film—(i) Film licensed to a taxpayer. If              (3) Derived from a qualified film.
tial in nature under paragraph (f)(2) of this   a taxpayer MPGE tangible personal prop-           DPGR includes the gross receipts of the
section and are not conversion costs under      erty (such as a DVD) in whole or in signif-       taxpayer which are derived from any
paragraph (f)(3) of this section.               icant part in the United States and fixes to      lease, rental, license, sale, exchange, or
    (ii) Tangible personal property. If a       the tangible personal property a film that        other disposition of any qualified film
taxpayer MPGE tangible personal prop-           the taxpayer licenses from the producer of        produced by the taxpayer. Showing a
erty but not the computer software or           the film, then the taxpayer may treat the         qualified film on a television station is
sound recordings that the taxpayer fixes        tangible personal property with the affixed       not a lease, rental, license, sale, exchange,
on, or adds to, the tangible personal prop-     film as QPP, regardless of whether the film       or other disposition of the qualified film.
erty MPGE by the taxpayer (for example,         is a qualified film. The determination of         Ticket sales for viewing qualified films
a computer diskette or an appliance), then      whether gross receipts of such a taxpayer         do not constitute DPGR because the gross
for purposes of this section the tangible       from the lease, rental, license, sale, ex-        receipts are not derived from the lease,
personal property with the computer soft-       change, or other disposition of the tangi-        rental, license, sale, exchange, or other
ware or sound recordings may be treated         ble personal property with the affixed film       disposition of a qualified film. Because a
by the taxpayer as tangible personal prop-      are DPGR is made under the rules of para-         taxpayer that merely writes a screenplay or
erty under paragraph (i)(2) of this section.    graphs (d), (e), and (f) of this section. For     other similar material is not considered to
For purposes of paragraph (f)(3) of this        purposes of paragraph (f)(3) of this sec-         have produced a qualified film under para-
section, the taxpayer’s CGS for each item       tion, the taxpayer’s CGS for each item in-        graph (j)(1) of this section, the amounts
includes the taxpayer’s cost of licensing       cludes the taxpayer’s cost of licensing the       that the taxpayer receives from the sale of
the computer software or sound record-          film from the producer of the film.               the script or screenplay, even if the script
ings.                                               (ii) Film produced by a taxpayer. If          is developed into a qualified film, are not
    (j) Definition of qualified film—(1) In     a taxpayer produces a film and also fixes         gross receipts derived from a qualified
general. The term qualified film means          the film on tangible personal property (for       film. In addition, revenue from the sale of
any motion picture film or video tape un-       example, a DVD), then for purposes of this        film-themed merchandise is revenue from
der section 168(f)(3), or live or delayed       section—                                          the sale of tangible personal property and
television programming if not less than 50          (A) Qualified films. If the film is a qual-   not gross receipts derived from a qualified
percent of the total compensation paid to       ified film, the taxpayer may treat the tan-       film. Gross receipts derived from a license
all actors, production personnel, directors,    gible personal property on which the qual-        of the right to use the film characters are
and producers relating to the production        ified film is fixed as part of the qualified      not gross receipts derived from a qualified
of the motion picture film, video tape, or      film, in which case the gross receipts de-        film.
television programming is compensation          rived from the lease, rental, license, sale,          (4) Examples. The following exam-
for services performed in the United States     exchange, or other disposition of the tangi-      ples illustrate the application of paragraphs
by those individuals. The term produc-          ble personal property with the affixed qual-      (j)(2) and (3) of this section:
tion personnel includes writers, choreog-       ified film will be DPGR (assuming all the


November 21, 2005                                                  1023                                                  2005–47 I.R.B.
    Example 1. X produces a qualified film in the         expected to be paid for services performed      natural deposit and does not include, for
United States and duplicates the film onto purchased      by actors, production personnel, directors,     example, methane gas extracted from a
DVDs. X sells the DVDs with the qualified film to         and producers as participations and resid-      landfill. In the case of natural gas, pro-
customers. Under paragraph (j)(2)(ii)(A) of this sec-
tion, X may treat the DVD with the qualified film as
                                                          uals based on the total forecasted income       duction activities include all activities
a qualified film. Accordingly, X’s gross receipts de-     used in determining income forecast de-         involved in extracting natural gas from
rived from the sale of the qualified film to customers    preciation. Compensation for services in-       the ground and processing the gas into
are DPGR (assuming all the other requirements of          cludes all direct and indirect compensa-        pipeline quality gas.
this section are met).                                    tion costs required to be capitalized un-           (3) Potable water. The term potable
    Example 2. The facts are the same as in Ex-
ample 1 except that the film is a nonqualified film
                                                          der section 263A for film producers under       water means unbottled drinking water. In
because the film does not satisfy the 50 percent re-      §1.263A–1(e)(2) and (3). Compensation           the case of potable water, production ac-
quirement under (j)(1) of this section and X manu-        for services is not limited to W–2 wages        tivities include the acquisition, collection,
factures the DVDs in the United States. Under para-       and includes compensation paid to inde-         and storage of raw water (untreated water),
graph (j)(2)(ii)(B) of this section, X may treat the      pendent contractors.                            transportation of raw water to a water treat-
DVD without the nonqualified film as tangible per-
sonal property. X’s gross receipts (not including the
                                                             (6) Determination of 50 percent. A tax-      ment facility, and treatment of raw water
gross receipts attributable to the nonqualified film)     payer may use any reasonable method of          at such a facility. Gross receipts attribut-
derived from the sale of the tangible personal prop-      determining the compensation for services       able to any of these activities are included
erty are DPGR (assuming all the other requirements        performed in the United States by actors,       in DPGR if all other requirements of this
of this section are met).                                 production personnel, directors, and pro-       section are met.
    Example 3. X produces television programs that
are qualified films. X shows the programs on its
                                                          ducers, and the total compensation paid to          (4) Exceptions—(i) Electricity. Gross
own television station. X sells advertising time slots    those individuals for services relating to      receipts attributable to the transmission
to advertisers for the television programs. Because       the production of the property. Among           of electricity from the generating facil-
showing qualified films on a television station is not    the factors to be considered in determining     ity to a point of local distribution and
a lease, rental, license, sale, exchange, or other dis-   whether a taxpayer’s method of allocating       gross receipts attributable to the distribu-
position, pursuant to paragraph (j)(3) of this section,
the advertising income X receives from advertisers is
                                                          compensation is reasonable is whether the       tion of electricity to final customers are
not derived from the lease, rental, license, sale, ex-    taxpayer uses that method consistently.         non-DPGR.
change, or other disposition of qualified films.             (7) Exception. A qualified film does             (ii) Natural gas. Gross receipts attrib-
    Example 4. X produces a qualified film and con-       not include property with respect to which      utable to the transmission of pipeline qual-
tracts with Y, an unrelated taxpayer, to duplicate the    records are required to be maintained un-       ity gas from a natural gas field (or, if treat-
film onto DVDs. Y manufactures blank DVDs within
the United States, duplicates X’s film onto the DVDs
                                                          der 18 U.S.C. 2257. Section 2257 of Title       ment at a natural gas processing plant is
in the United States, and sells the DVDs with the         18 requires maintenance of certain records      necessary to produce pipeline quality gas,
qualified film to X who then sells them to customers.     with respect to any book, magazine, pe-         from a natural gas processing plant) to a
Y has all of the benefits and burdens of ownership un-    riodical, film, videotape, or other matter      local distribution company’s citygate (or
der Federal income tax principles of the DVDs dur-        that—                                           to another customer) are non-DPGR. Like-
ing the MPGE and duplication process. Assume Y’s
activities relating to manufacture of the blank DVDs
                                                             (i) Contains one or more visual depic-       wise, gross receipts of a local gas distri-
and duplicating the film onto the DVDs collectively       tions made after November 1, 1990, of ac-       bution company attributable to distribution
satisfy the safe harbor under paragraph (f)(3) of this    tual sexually explicit conduct; and             from the citygate to the local customers are
section. Y’s gross receipts from manufacturing the           (ii) Is produced in whole or in part with    non-DPGR.
DVDs and duplicating the film onto the DVDs are           materials that have been mailed or shipped          (iii) Potable water. Gross receipts at-
DPGR. X’s gross receipts from the sale of the DVDs
to customers are DPGR.
                                                          in interstate or foreign commerce, or is        tributable to the storage of potable wa-
   (5) Compensation for services. The                     shipped or transported or is intended for       ter after completion of treatment of the
term compensation for services means all                  shipment or transportation in interstate or     potable water, as well as gross receipts at-
payments for services performed by actors,                foreign commerce.                               tributable to the transmission and distribu-
production personnel, directors, and pro-                    (k) Electricity, natural gas, or potable     tion of potable water, are non-DPGR.
ducers, including participations and resid-               water—(1) In general. DPGR includes                 (iv) De minimis exception. Notwith-
uals. In the case of a taxpayer that uses the             gross receipts derived from any lease,          standing paragraphs (k)(4)(i), (ii), and (iii)
income forecast method of section 167(g)                  rental, license, sale, exchange, or other       of this section, if less than 5 percent of a
and capitalizes participations and residuals              disposition of utilities produced by the        taxpayer’s gross receipts derived from a
into the adjusted basis of the qualified film,            taxpayer in the United States if all other      sale, exchange, or other disposition of util-
the taxpayer must use the same estimate                   requirements of this section are met. In the    ities are attributable to the transmission or
of participations and residuals for services              case of an integrated producer that both        distribution of the utilities, then the gross
performed by actors, production person-                   produces and delivers utilities, see para-      receipts derived from that lease, rental, li-
nel, directors, and producers for purposes                graph (k)(4) of this section that describes     cense, sale, exchange, or other disposition
of this section. In the case of a taxpayer                certain gross receipts that do not qualify as   that are attributable to the transmission and
that excludes participations and residuals                DPGR, therefore requiring a taxpayer to         distribution of the utilities must be treated
from the adjusted basis of the qualified                  allocate its gross receipts between DPGR        for purposes of section 199 as being DPGR
film under section 167(g)(7)(D)(i), the tax-              and non-DPGR.                                   if all other requirements of this section are
payer must determine the compensation                        (2) Natural gas. The term natural gas        met.
                                                          includes only natural gas extracted from a


2005–47 I.R.B.                                                               1024                                         November 21, 2005
    (5) Example. The following example                      is real property, the fact that property is       license, or rental of equipment, for exam-
illustrates the application of this paragraph               real property under local law is not con-         ple, bulldozers, generators, or computers,
(k):                                                        trolling. Conversely, property may be real        to contractors for use by the contractors
    Example. X owns a wind turbine in the United            property for purposes of this paragraph           in the construction of real property is not
States that generates electricity and Y owns a high         (l)(1)(i) even though under local law the         a construction activity under this para-
voltage transmission line that passes near X’s wind
turbine and ends near the system of local distribu-
                                                            property is considered tangible personal          graph (l)(2). The term construction does
tion lines of Z. X sells the electricity produced at the    property.                                         not include any activity that is within the
wind turbine to Z and contracts with Y to transmit              (ii) De minimis exception. For purposes       definition of engineering and architectural
the electricity produced at the wind turbine to Z who       of paragraph (l)(1)(i) of this section, if less   services under paragraph (m) of this sec-
sells the electricity to customers using Z’s distribu-      than 5 percent of the total gross receipts        tion.
tion network. The gross receipts received by X for
the sale of electricity produced at the wind turbine
                                                            derived by a taxpayer from a construction            (3) Definition of infrastructure. The
are DPGR. The gross receipts of Y from transporting         project (as described in paragraph (l)(1)(i)      term infrastructure includes roads, power
X’s electricity to Z are non-DPGR under paragraph           of this section) are derived from activities      lines, water systems, railroad spurs, com-
(k)(4)(i) of this section. Likewise, the gross receipts     other than the construction of real property      munications facilities, sewers, sidewalks,
of Z from distributing the electricity are non-DPGR         in the United States (for example, from           cable, and wiring. The term also includes
under paragraph (k)(4)(i) of this section. If X made
direct sales of electricity to customers in Z’s service
                                                            non-construction activities or the sale of        inherently permanent oil and gas plat-
area and Z receives remuneration for the distribution       tangible personal property or land) then the      forms.
of electricity, the gross receipts of Z are non-DPGR        total gross receipts derived by the taxpayer         (4) Definition of substantial renovation.
under paragraph (k)(4)(i) of this section. If X, Y, and     from the project are DPGR from construc-          The term substantial renovation means the
Z are related persons (as defined in paragraph (b) of       tion.                                             renovation of a major component or sub-
this section), then X, Y, and Z must allocate gross re-
ceipts to production activities, transmission activities,
                                                                (2) Activities constituting construction.     stantial structural part of real property that
and distribution activities.                                Activities constituting construction in-          materially increases the value of the prop-
    (l) Definition of construction performed                clude activities performed in connection          erty, substantially prolongs the useful life
in the United States—(1) Construction of                    with a project to erect or substantially          of the property, or adapts the property to a
real property—(i) In general. The term                      renovate real property, but do not include        new or different use.
construction means the construction or                      tangential services such as hauling trash            (5) Derived from construction—(i) In
erection of real property (that is, residen-                and debris, and delivering materials, even        general. Assuming all the requirements
tial and commercial buildings (including                    if the tangential services are essential          of this section are met, DPGR derived
items that are structural components of                     for construction. However, if the tax-            from the construction of real property
such buildings), inherently permanent                       payer performing construction also, in            performed in the United States includes
structures other than tangible personal                     connection with the construction project,         the proceeds from the sale, exchange, or
property in the nature of machinery (see                    provides tangential services such as de-          other disposition of real property con-
paragraph (i)(2)(iii) of this section), inher-              livering materials to the construction site       structed by the taxpayer in the United
ently permanent land improvements, oil                      and removing its construction debris, the         States (whether or not the property is sold
and gas wells, and infrastructure) in the                   gross receipts derived from the tangential        immediately after construction is com-
United States by a taxpayer that, at the                    services are DPGR. Improvements to land           pleted and whether or not the construction
time the taxpayer constructs the real prop-                 that are not capitalizable to the land (for       project is complete). DPGR derived from
erty, is engaged in a trade or business (but                example, landscaping) and painting are            the construction of real property includes
not necessarily its primary, or only, trade                 activities constituting construction only if      compensation for the performance of con-
or business) that is considered construc-                   these activities are performed in connec-         struction services by the taxpayer in the
tion for purposes of the North American                     tion with other activities (whether or not        United States. However, DPGR derived
Industry Classification System (NAICS)                      by the same taxpayer) that constitute the         from the construction of real property
on a regular and ongoing basis. A trade                     erection or substantial renovation of real        does not include gross receipts from the
or business that is considered construction                 property and provided the taxpayer meets          lease or rental of real property constructed
under the NAICS means a construction                        the requirements under paragraph (l)(1)           by the taxpayer or, except as provided in
activity under the two-digit NAICS code                     of this section. The taxpayer engaged in          paragraph (l)(5)(ii) of this section, gross
of 23 and any other construction activity                   these activities must make a reasonable           receipts attributable to the sale or other
in any other NAICS code provided the                        inquiry to determine whether the activ-           disposition of land (including zoning,
construction activity relates to the con-                   ity relates to the erection or substantial        planning, entitlement costs, and other
struction of real property such as NAICS                    renovation of real property in the United         costs capitalized to the land such as the
code 213111 (drilling oil and gas wells)                    States. Construction activities also include      demolition of structures under section
and 213112 (support activities for oil and                  activities relating to drilling an oil well and   280B). In addition, DPGR derived from
gas operations). Tangible personal prop-                    mining and include any activities pursuant        the construction of real property includes
erty (for example, appliances, furniture,                   to which the taxpayer could deduct intan-         gross receipts from any qualified con-
and fixtures) that is sold as part of a con-                gible drilling and development costs under        struction warranty, that is, a warranty that
struction project is not considered real                    section 263(c) and §1.612–4 and develop-          is provided in connection with the con-
property for purposes of this paragraph                     ment expenditures for a mine or natural           structed real property if—
(l)(1)(i). In determining whether property                  deposit under section 616. The lease,


November 21, 2005                                                              1025                                                   2005–47 I.R.B.
    (A) In the normal course of the tax-                  ify as DPGR under paragraph (l)(5)(i) of this sec-          ments (including $30,000 in land costs) plus $30,000
payer’s business, the price for the con-                  tion provided Y and Z meet all of the requirements          in land costs for the lot), which are reduced by land
struction warranty is not separately stated               of paragraph (l)(1) of this section. The gross receipts     costs of $60,000). X calculates the DPGR for each
                                                          that X receives from the subsequent sale of the build-      house sold by May 31, 2010, by taking the gross re-
from the amount charged for the con-                      ing do not qualify as DPGR because X did not en-            ceipts of $300,000 and reducing that amount by land
structed real property; and                               gage in any activity constituting construction under        costs of $60,000 plus a percentage of $60,000. As
    (B) The construction warranty is nei-                 paragraph (l)(2) of this section even though X is in        X acquired the land on June 1, 2005, and sold the
ther separately offered by the taxpayer nor               the trade or business of construction. The results          houses on the land between January 31, 2010, and
separately bargained for with the customer                would be the same if X and Y were members of the            May 31, 2010, the percentage reduction for X is 5
                                                          same EAG under §1.199–7(a). However, if X and Y             percent because X has held the land for not more than
(that is, the customer cannot purchase the                were members of the same consolidated group, see            5 years from the anniversary of the date of acquisi-
constructed real property without the con-                §1.199–7(d)(2).                                             tion. Thus, the DPGR for each house is $237,000
struction warranty).                                           Example 2. X is engaged as an electrical con-          ($300,000 - $60,000 - $3,000) with costs for each
    (ii) Land safe harbor. For purposes of                tractor under NAICS code 238210 on a regular and            house of $195,000 for a calculation of QPAI for each
paragraph (l)(5)(i) of this section, a tax-               ongoing basis. X purchases the wires, conduits, and         house of $42,000.
                                                          other electrical materials that it installs in construc-        Example 6. The facts are the same as in Example
payer may allocate gross receipts between                 tion projects in the United States. In a particular con-    5 except some of the houses are sold between June
the proceeds from the sale, exchange, or                  struction project, all of the wires, conduits, and other    1, 2010, and December 31, 2010. X calculates the
other disposition of real property con-                   electrical materials installed by X for the operation       DPGR for each house sold between June 1, 2010, and
structed by the taxpayer and the gross                    of that building are considered structural components       December 31, 2010, by taking the gross receipts of
receipts attributable to the sale, exchange,              of the building. X’s gross receipts derived from in-        $300,000 and reducing that amount by land costs of
                                                          stalling that property are derived from the construc-       $60,000 plus a percentage of $60,000. As X acquired
or other disposition of land by reducing                  tion of real property under paragraph (l)(1) of this sec-   the land on June 1, 2005, and sold the houses on the
its costs related to DPGR under §1.199–4                  tion. However, X’s gross receipts derived from the          land between June 1, 2010, and December 31, 2010,
by costs of the land and any other costs                  purchased materials do not qualify as DPGR.                 the percentage reduction for X is 10 percent because
capitalized to the land (collectively, land                    Example 3. X is in a trade or business that is         X has held the land for more than 5 years but not
costs) (including zoning, planning, enti-                 considered construction under the two-digit NAICS           more than 10 years from the anniversary of the date
                                                          code of 23. X buys unimproved land. X gets the land         of acquisition. Thus, the DPGR for each house is
tlement costs, and other costs capitalized                zoned for residential housing through an entitlement        $234,000 ($300,000 - $60,000 - $6,000) with costs
to the land such as the demolition of struc-              process. X grades the land and sells the land to home       for each house of $195,000 for a calculation of QPAI
tures under section 280B and land costs                   builders. The gross receipts that X receives from the       for each house of $39,000.
in any common improvements as defined                     sale of the land do not qualify as DPGR under para-             (m) Definition of engineering and
in section 2.01 of Rev. Proc. 92–29,                      graph (l)(5)(i) of this section because the gross re-       architectural services—(1) In general.
                                                          ceipts are not derived from the construction of real
1992–1 C.B. 748, (see §601.601(d)(2) of                   property.
                                                                                                                      DPGR includes gross receipts derived
this chapter)) and by reducing its DPGR                        Example 4. The facts are the same as in Exam-          from engineering or architectural services
by those land costs plus a percentage. The                ple 3 except that X builds roads, sewers, sidewalks,        performed in the United States for a con-
percentage is based on the number of years                and installs power and water lines on the land. The         struction project described in paragraph
that elapse between the date the taxpayer                 gross receipts that X receives that are attributable to     (l) of this section. At the time the taxpayer
                                                          the sale of the roads, sewers, sidewalks, and power
acquires the land, including the date the                 and water lines, which qualify as infrastructure under
                                                                                                                      performs the engineering or architectural
taxpayer enters into the first option to ac-              paragraph (l)(3) of this section, are DPGR. X’s gross       services, the taxpayer must be engaged
quire all or a portion of the land, and ends              receipts from the land including capitalized costs of       in a trade or business (but not necessarily
on the date the taxpayer sells each item of               entitlements do not qualify as DPGR under paragraph         its primary, or only, trade or business)
real property on the land. The percentage                 (l)(5)(i) of this section because the gross receipts are    that is considered engineering or architec-
                                                          not derived from the construction of real property.
is 5 percent for years zero through 5; 10                      Example 5. (i) X is engaged in the business activ-
                                                                                                                      tural services for purposes of the NAICS,
percent for years 6 through 10; and 15                    ities of constructing housing within the meaning of         for example NAICS codes 541330 (engi-
percent for years 11 through 15. Land                     paragraph (l)(1) of this section. On June 1, 2005, X        neering services) or 541310 (architectural
held by a taxpayer for 16 or more years is                pays $50,000,000 for 1,000 acres of land that X will        services), on a regular and ongoing ba-
not eligible for the safe harbor under this               develop as a new housing development. In 2008, after        sis. DPGR includes gross receipts derived
                                                          the expenditure of $10,000,000 for entitlement costs,
paragraph (l)(5)(ii) and the taxpayer must                X receives permits to begin construction. After this
                                                                                                                      from engineering or architectural services,
allocate gross receipts between land and                  expenditure, X’s land costs total $60,000,000. The          including feasibility studies for a con-
qualifying real property.                                 development consists of 1,000 houses to be built on         struction project in the United States, even
    (iii) Examples. The following examples                half-acre lots over 5 years. On January 31, 2010, the       if the planned construction project is not
illustrate the application of this paragraph              first house is sold for $300,000. Construction costs        undertaken or is not completed.
                                                          for each house are $170,000. Common improve-
(l)(5):                                                   ments consisting of streets, sidewalks, sewer lines,
                                                                                                                          (2) Engineering services. Engineering
    Example 1. X, who is in the trade or business                                                                     services in connection with any con-
                                                          playgrounds, clubhouses, tennis courts, and swim-
of construction under NAICS code 23 on a regular                                                                      struction project include any professional
                                                          ming pools that X is contractually obligated or re-
and ongoing basis, purchases a building in the United
                                                          quired by law to provide cost $55,000 per lot. The          services requiring engineering educa-
States and retains Y, an unrelated taxpayer (a general
                                                          common improvements include $30,000 in land costs           tion, training, and experience and the
contractor), to oversee a substantial renovation of the
                                                          underlying the common improvements.
building (within the meaning of paragraph (l)(4) of
                                                               (ii) Pursuant to the land safe harbor under para-
                                                                                                                      application of special knowledge of the
this section). Y retains Z (a subcontractor) to install                                                               mathematical, physical, or engineering
                                                          graph (l)(5)(ii) of this section, X calculates the to-
a new electrical system in the building as part of that                                                               sciences to those professional services
                                                          tal costs under §1.199–4 for each house sold in 2010
substantial renovation. The amounts that Y receives
                                                          as $195,000 (total costs of $255,000 ($170,000 in           such as consultation, investigation, eval-
from X for construction services, and amounts that
                                                          construction costs plus $55,000 in common improve-          uation, planning, design, or responsible
Z receives from Y for construction services, qual-



2005–47 I.R.B.                                                                    1026                                                  November 21, 2005
supervision of construction for the pur-        are non-DPGR) and gross receipts derived                     portion of other deductions not directly
pose of assuring compliance with plans,         from the wholesale sale of the food and                      allocable to DPGR or to another class
specifications, and design.                     beverages prepared at the retail establish-                  of income. Paragraph (b) of this section
    (3) Architectural services. Architec-       ment (which are DPGR). Wholesale sales                       provides rules for determining CGS al-
tural services in connection with any           are sales of food and beverages to be resold                 locable to DPGR. Paragraph (c) of this
construction project include the offering       by the purchaser. The exception for sales                    section provides rules for determining
or furnishing of any professional services      of certain food and beverages also applies                   the deductions allocated and apportioned
such as consultation, planning, aesthetic       to food and beverages for non-human con-                     to DPGR and a ratable portion of de-
and structural design, drawings and spec-       sumption. A retail establishment does not                    ductions that are not directly allocable
ifications, or responsible supervision of       include the bonded premises of a distilled                   to DPGR or to another class of income.
construction (for the purpose of assuring       spirits plant or wine cellar, or the premises                Paragraph (d) of this section provides
compliance with plans, specifications, and      of a brewery (other than a tavern on the                     that a taxpayer generally must determine
design) or erection, in connection with any     brewery premises). See Chapter 51 of Ti-                     deductions allocated and apportioned to
construction project.                           tle 26 of the United States Code and the                     DPGR or to gross income attributable
    (4) De minimis exception for perfor-        implementing regulations thereunder.                         to DPGR using the rules of the regula-
mance of services in the United States.             (2) Examples. The following examples                     tions at §§1.861–8 through 1.861–17 and
If less than 5 percent of the total gross       illustrate the application of this paragraph                 §§1.861–8T through 1.861–14T (the sec-
receipts derived by a taxpayer from en-         (n):                                                         tion 861 regulations), subject to the rules
gineering or architectural services per-             Example 1. X buys coffee beans and roasts those         in paragraph (d) of this section (the section
formed in the United States for a construc-     beans at a facility in the United States, the only activ-    861 method). Paragraph (e) of this sec-
                                                ity of which is the roasting and packaging of roasted
tion project (described in paragraph (l) of     coffee beans. X sells the roasted coffee beans through
                                                                                                             tion provides that certain taxpayers may
this section) are derived from services not     a variety of unrelated third-party vendors and also          apportion deductions to DPGR using the
relating to a construction project described    sells roasted coffee beans at X’s retail establishments.     simplified deduction method. Paragraph
in paragraph (l) of this section (for exam-     At X’s retail establishments, X prepares brewed cof-         (f) of this section provides a small business
ple, the services are performed outside the     fee and other foods. To the extent that the gross re-        simplified overall method that a qualifying
                                                ceipts of X’s retail establishments represent receipts
United States or in connection with prop-       from the sale of coffee beans roasted at the facility, the
                                                                                                             small taxpayer may use to apportion CGS
erty other than real property) then the total   receipts are DPGR. To the extent the gross receipts of       and deductions to DPGR.
gross receipts derived by the taxpayer are      X’s retail establishments represent receipts from the            (b) Cost of goods sold allocable to
DPGR from engineering or architectural          retail sale of brewed coffee or food prepared at the re-     domestic production gross receipts—(1)
services performed in the United States         tail establishments, the receipts are non-DPGR. How-         In general. When determining its QPAI,
                                                ever, pursuant to §1.199–1(c)(2), X must allocate part
for a construction project.                     of the receipts from the retail sale of the brewed cof-
                                                                                                             a taxpayer must reduce DPGR by the
    (n) Exception for sales of certain food     fee as DPGR to the extent of the value of the coffee         CGS allocable to DPGR. A taxpayer de-
and beverages—(1) In general. DPGR              beans that were roasted at the facility and that were        termines its CGS allocable to DPGR in
does not include gross receipts of the tax-     used to brew coffee.                                         accordance with this paragraph (b) or, if
payer that are derived from the sale of food         Example 2. Y operates a bonded winery in                applicable, paragraph (f) of this section.
                                                California. Bottles of wine produced by Y at the
or beverages prepared by the taxpayer at        bonded winery are sold to consumers at the taxpaid
                                                                                                             In the case of a sale, exchange, or other
a retail establishment. A retail establish-     premises. Pursuant to paragraph (n)(1) of this sec-          disposition of inventory, CGS is equal to
ment is defined as tangible property (both      tion, the bonded premises is not considered a retail         beginning inventory plus purchases and
real and personal) leased, occupied, or oth-    establishment and is treated as separate and apart           production costs incurred during the tax-
erwise used by the taxpayer in its trade or     from the taxpaid premises, which is considered a re-         able year and included in inventory costs,
                                                tail establishment for purposes of paragraph (n)(1) of
business of selling food or beverages to        this section. Accordingly, the wine produced by Y in
                                                                                                             less ending inventory. CGS is determined
the public at which retail sales are made.      the bonded premises and sold by Y from the taxpaid           under the methods of accounting that the
In addition, a facility that prepares food      premises is not considered to have been produced at          taxpayer uses to compute taxable income.
and beverages solely for take out service       a retail establishment, and the sales of the wine are        See sections 263A, 471, and 472. Ad-
or delivery is a retail establishment (for      DPGR (assuming all the other requirements of this            ditional section 263A costs, as defined
                                                section are met).
example, a caterer). A facility at which                                                                     in §1.263A–1(d)(3), must be included in
food or beverages are prepared will not         §1.199–4 Costs allocable to domestic                         determining CGS. In the case of a sale,
be treated as a retail establishment if less    production gross receipts.                                   exchange, or other disposition (including,
than 5 percent of the gross receipts from                                                                    for example, theft, casualty, or abandon-
the sale of food or beverages at that fa-          (a) In general. To determine its quali-                   ment) of non-inventory property, CGS for
cility during the taxable year are attribut-    fied production activities income (QPAI)                     purposes of this section includes the ad-
able to retail sales. If a taxpayer’s facil-    (as defined in §1.199–1(c)) for a taxable                    justed basis of the property. CGS allocable
ity is a retail establishment in the United     year, a taxpayer must subtract from its do-                  to DPGR for a taxable year may include
States, then, for purposes of this section,     mestic production gross receipts (DPGR)                      the inventory cost and adjusted basis of
the taxpayer may allocate its gross receipts    (as defined in §1.199–3(a)) the cost of                      qualifying production property (QPP) (as
between gross receipts derived from the re-     goods sold (CGS) allocable to DPGR, the                      defined in §1.199–3(i)(1)), a qualified film
tail sale of the food and beverages prepared    amount of expenses or losses (deductions)                    (as defined in §1.199–3(j)(1)), or electric-
and sold at the retail establishment (which     directly allocable to DPGR, and a ratable                    ity, natural gas, and potable water (as


November 21, 2005                                                       1027                                                        2005–47 I.R.B.
defined in §1.199–3(k)) (collectively, util-     rate than the method used to allocate gross    consistently from year to year. If a tax-
ities) that will, or have, generated DPGR        receipts will not be considered reasonable.    payer does, or can, without undue burden
notwithstanding that the gross receipts at-      Depending on the facts and circumstances,      or expense, specifically identify from its
tributable to the sale of the QPP, qualified     reasonable methods may include methods         books and records the proper amount of
films, or utilities will, or have been, in-      based on gross receipts, number of units       inventory valuation adjustments allocable
cluded in the computation of gross income        sold, number of units produced, or total       to DPGR, then the taxpayer must allocate
for a different taxable year. For exam-          production costs.                              that amount to DPGR. A taxpayer that
ple, advance payments related to DPGR                (3) Special rules for imported items or    cannot, without undue burden or expense,
may be included in gross income under            services. The cost of any item or service      use a specific identification method to
§1.451–5(b)(1)(i) in a different taxable         brought into the United States (as defined     determine the proper amount of inventory
year than the related CGS allocable to that      in §1.199–3(g)) without an arm’s length        valuation adjustments allocable to DPGR
DPGR. CGS allocable to DPGR includes             transfer price may not be treated as less      is not required to use a specific identifi-
inventory valuation adjustments such as          than its value immediately after it entered    cation method to allocate adjustments to
writedowns under the lower of cost or            the United States for purposes of determin-    DPGR.
market method. If non-DPGR is treated            ing the CGS to be used in the computation          (5) Rules applicable to inventories ac-
as DPGR pursuant to §§1.199–1(d)(2) and          of QPAI. When an item or service is im-        counted for under the last-in, first-out
1.199–3(h)(4), (k)(4)(iv), (l)(1)(ii), (m)(4),   ported into the United States that had been    (LIFO) inventory method—(i) In gen-
or (n)(1), CGS related to such gross re-         exported by the taxpayer for further man-      eral. This paragraph applies to inventories
ceipts that are treated as DPGR must be          ufacture, the increase in cost may not ex-     accounted for using the specific goods
allocated or apportioned to DPGR.                ceed the difference between the value of       last-in, first-out (LIFO) method or the
    (2) Allocating cost of goods sold. A         the property when exported and the value       dollar-value LIFO method. Whenever a
taxpayer must use a reasonable method            of the property when imported back into        specific goods grouping or a dollar-value
that is satisfactory to the Secretary to allo-   the United States after further manufac-       pool contains QPP, qualified films, or util-
cate CGS between DPGR and non-DPGR.              ture. For this purpose, the value of prop-     ities that produces DPGR and goods that
Whether an allocation method is rea-             erty is its customs value as defined in sec-   do not, the taxpayer must allocate CGS at-
sonable is based on all of the facts and         tion 1059A(b)(1).                              tributable to that grouping or pool between
circumstances including whether the tax-             (4) Rules for inventories valued at mar-   DPGR and non-DPGR using a reasonable
payer uses the most accurate information         ket or bona fide selling prices. If part of    method. Whether a method of allocating
available; the relationship between CGS          CGS is attributable to inventory valuation     CGS between DPGR and non-DPGR is
and the method used; the accuracy of the         adjustments, CGS allocable to DPGR in-         reasonable must be determined in accor-
method chosen as compared with other             cludes inventory adjustments to QPP that       dance with paragraph (b)(2) of this section.
possible methods; whether the method is          is MPGE in whole or in significant part        In addition, this paragraph (b)(5) provides
used by the taxpayer for internal man-           within the United States, qualified films      methods that a taxpayer may use to allo-
agement and other business purposes;             produced in the United States, or utilities    cate CGS for inventories accounted for
whether the method is used for other Fed-        produced in the United States. Accord-         using the LIFO method. If a taxpayer uses
eral or state income tax purposes; the           ingly, taxpayers that value inventory under    the LIFO/FIFO ratio method provided in
availability of costing information; the         §1.471–4 (inventories at cost or market,       paragraph (b)(5)(ii) of this section or the
time, burden, and cost of using various          whichever is lower) or §1.471–2(c) (sub-       change in relative base-year cost method
methods; and whether the taxpayer ap-            normal goods at bona fide selling prices)      provided in paragraph (b)(5)(iii) of this
plies the method consistently from year          must allocate a proper share of such ad-       section, the taxpayer must use that method
to year. If a taxpayer does, or can, with-       justments (for example, writedowns) to         for all inventory accounted for under the
out undue burden or expense, specifically        DPGR based on a reasonable method that         LIFO method.
identify from its books and records CGS          is satisfactory to the Secretary based on          (ii) LIFO/FIFO ratio method. A tax-
allocable to DPGR, the CGS allocable             all of the facts and circumstances. Fac-       payer using the specific goods LIFO
to DPGR is that amount irrespective of           tors taken into account in determining         method or the dollar-value LIFO method
whether the taxpayer uses another allo-          whether the method is reasonable include       may use the LIFO/FIFO ratio method.
cation method to allocate gross receipts         whether the taxpayer uses the most accu-       The LIFO/FIFO ratio method is applied
between DPGR and non-DPGR. A tax-                rate information available; the relationship   with respect to all LIFO inventory of a
payer that cannot, without undue burden          between the adjustment and the allocation      taxpayer on a grouping-by-grouping or
or expense, use a specific identification        base chosen; the accuracy of the method        pool-by-pool basis. Under the LIFO/FIFO
method to determine CGS allocable to             chosen as compared with other possible         ratio method, a taxpayer computes the
DPGR is not required to use a specific           methods; whether the method is used            CGS of a grouping or pool allocable to
identification method to determine CGS           by the taxpayer for internal management        DPGR by multiplying the CGS of QPP,
allocable to DPGR. Ordinarily, if a tax-         or other business purposes; whether the        qualified films, or utilities in the grouping
payer uses a method to allocate gross            method is used for other Federal or state      or pool that produced DPGR computed
receipts between DPGR and non-DPGR,              income tax purposes; the time, burden,         using the first-in, first-out (FIFO) method
the use of a different method to allocate        and cost of using various methods; and         by the LIFO/FIFO ratio of the grouping or
CGS that is not demonstrably more accu-          whether the taxpayer applies the method        pool. The LIFO/FIFO ratio of a grouping


2005–47 I.R.B.                                                     1028                                         November 21, 2005
or pool is equal to the total CGS of the                 method for additional section 263A costs.                CGS and CGS allocable to DPGR in 2006. See
grouping or pool computed using the LIFO                 A taxpayer that uses the simplified produc-              §1.199–1(e)(1) for rules regarding gross receipts and
method over the total CGS of the grouping                tion method or simplified resale method                  costs recognized in different taxable years.
                                                                                                                       Example 2. Use of standard cost method. X, a
or pool computed using the FIFO method.                  to allocate additional section 263A costs,               calendar year taxpayer, manufactures item A in a fac-
    (iii) Change in relative base-year cost              as defined in §1.263A–1(d)(3), to end-                   tory located in the United States and item B in a fac-
method. A taxpayer using the dollar-value                ing inventory must follow the rules in                   tory located in Country Y. Item A is produced by X
LIFO method may use the change in rela-                  paragraph (b)(2) of this section to deter-               in significant part within the United States and the
tive base-year cost method. The change in                mine the amount of additional section                    sale of A generates DPGR. X uses the FIFO inventory
                                                                                                                  method to account for its inventory and determines
relative base-year cost method is applied                263A costs allocable to DPGR. Alloca-                    the cost of item A using a standard cost method. At
with respect to all LIFO inventory of a tax-             ble additional section 263A costs include                the beginning of its taxable year, X’s inventory con-
payer on a pool-by-pool basis. The change                additional section 263A costs included in                tains 2,000 units of item A at a standard cost of $5
in relative base-year cost method deter-                 beginning inventory as well as additional                per unit. X did not incur significant cost variances in
mines the CGS allocable to DPGR by in-                   section 263A costs incurred during the                   previous taxable years. During the 2005 taxable year,
                                                                                                                  X produces 8,000 units of item A at a standard cost
creasing or decreasing the total production              taxable year. Ordinarily, if a taxpayer uses             of $6 per unit. X determines that with regard to its
costs (section 471 costs and additional sec-             the simplified production method or the                  production of item A it has incurred a significant cost
tion 263A costs) of QPP, qualified films,                simplified resale method, then additional                variance. When X reallocates the cost variance to the
and utilities that generate DPGR by a por-               section 263A costs should be allocated in                units of item A that it has produced, the production
tion of any increment or liquidation of the              the same proportion as section 471 costs                 cost of item A is $7 per unit. X sells 7,000 units of
                                                                                                                  item A during the taxable year. X can identify from
dollar-value pool. The portion of an incre-              are allocated.                                           its books and records that CGS related to sale of item
ment or liquidation allocable to DPGR is                     (7) Examples. The following examples                 A is $45,000 ((2,000 x $5) + (5,000 x $7)). Accord-
determined by multiplying the LIFO value                 illustrate the application of this paragraph             ingly, X has CGS allocable to DPGR of $45,000.
of the increment or liquidation (expressed               (b):                                                          Example 3. Change in relative base-year cost
as a positive number) by the ratio of the                    Example 1. Advance payments. T, a calendar           method. (i) Y elects, beginning with the calendar
                                                         year taxpayer, is a manufacturer of furniture in the     year 2005, to compute its inventories using the dol-
change in total base-year cost (expressed                                                                         lar-value, LIFO method under section 472. Y estab-
                                                         United States. Under its method of accounting, T
as a positive number) of the QPP, quali-                 includes advance payments in gross income when           lishes a pool for items A and B. Y produces item A in
fying films, and utilities that will generate            the payments are received. In December 2005, T           significant part within the United States and the sales
DPGR in ending inventory to the change                   receives an advance payment of $5,000 from X with        of item A generate DPGR. Y does not produce item
in total base-year cost (expressed as a pos-             respect to an order of furniture to be manufactured      B in significant part within the United States and the
                                                         for a total price of $20,000. In 2006, T produces and    sale of item B does not generate DPGR. The compo-
itive number) of all goods in the ending in-                                                                      sition of the inventory for the pool at the base date,
                                                         ships the furniture to X. In 2006, T incurs $14,000
ventory. The portion of an increment or                  of section 471 and additional section 263A costs to      January 1, 2005, is as follows:
liquidation allocable to DPGR may be zero                produce the furniture ordered by X. T receives the
but cannot exceed the amount of the incre-               remaining $15,000 of the contract price from X in
ment or liquidation. Thus, a ratio in excess             2006. T must include the $5,000 advance payment in
of 1.0 must be treated as 1.0.                           income and DPGR in 2005. The remaining $15,000
                                                         of the contract price must be included in income and
    (6) Taxpayers using the simplified                   DPGR when received by T in 2006. T must include
production method or simplified resale                   the $14,000 it incurred to produce the furniture in



 Item                                                                      Unit                             Unit cost                           Total cost
 A                                                                         2,000                             $ 5.00                              $ 10,000
 B                                                                         1,250                               4.00                                 5,000
 Total                                                                                                                                           $ 15,000




    (ii) Y uses a standard cost method to allocate all   to produce 10,000 units of item A and $114,000 of        units of item B. The closing inventory of the pool
direct and indirect costs (section 471 and additional    section 471 costs and additional section 263A costs      at December 31, 2005, shown at base-year and cur-
section 263A costs) to the units of item A and item      to produce 20,000 units of item B.                       rent-year cost is as follows:
B that it produces. During 2005, Y incurs $52,500 of         (iii) The closing inventory of the pools at Decem-
section 471 costs and additional section 263A costs      ber 31, 2005, contains 3,000 units of item A and 2,500



                                                                Base-year                                               Current-year
 Item                                Quantity                     cost                        Amount                        cost                       Amount
 A                                      3,000                      $5.00                      $15,000                       $5.25                      $15,750
 B                                      2,500                       4.00                       10,000                        5.70                       14,250
 Totals                                                                                       $25,000                                                  $30,000




November 21, 2005                                                                 1029                                                         2005–47 I.R.B.
    (iv) The base-year cost of the closing LIFO in-        the current-year cost of the pool to total base-year cost   year cost) of the total inventory is $10,000 ($25,000
ventory at December 31, 2005, amounts to $25,000,          of the pool (that is, $30,000/$25,000, or 120 percent).     - $15,000). The ratio of the change in base-year cost
and exceeds the $15,000 base-year cost of the open-        The increment stated at current-year cost is $12,000        of item A to the change in base-year cost of the total
ing inventory for the taxable year by $10,000 (the in-     ($10,000 x 120%).                                           inventory is 50% ($5,000/$10,000).
crement stated at base-year cost). The increment val-          (v) The change in relative base-year cost of item           (vi) CGS allocable to DPGR is $46,500, com-
ued at current-year cost is computed by multiplying        A is $5,000 ($15,000 - $10,000). The change in rel-         puted as follows:
the increment stated at base-year cost by the ratio of     ative base-year cost (the increment stated at base-


 Current-year production costs related to DPGR                                                                                                 $52,500
 Less:    Increment stated at current-year cost                     $12,000
          Ratio                                                        50%
          Total                                                                                                                                 ( 6,000)
 Total                                                                                                                                         $46,500



    Example 4. Change in relative base-year cost           tion 263A costs to produce 12,000 units of item A and       units of item B. The closing inventory of the pool at
method. (i) The facts are the same as in Example 3         $150,000 of section 471 costs and additional section        December 31, 2006, shown at base-year and current-
except that, during the calendar year 2006, Y expe-        263A costs to produce 25,000 units of item B.               year cost is as follows:
riences an inventory decrement. During 2006, Y in-             (ii) The closing inventory of the pool at December
curs $66,000 of section 471 costs and additional sec-      31, 2006, contains 2,000 units of item A and 2,500


                                                                  Base-year                                                 Current-year
 Item                                 Quantity                      cost                          Amount                        cost                       Amount
 A                                       2,000                       $5.00                        $10,000                       $5.50                      $11,000
 B                                       2,500                         4.00                         10,000                        6.00                       15,000
 Totals                                                                                           $20,000                                                  $26,000



     (iii) The base-year cost of the closing LIFO inven-   ing inventory for that year by $5,000 (the decrement        by reducing the most recent layer of increment. The
tory at December 31, 2006, amounts to $20,000, and         stated at base-year cost). This liquidation is reflected    LIFO value of the inventory at December 31, 2006 is:
is less than the $25,000 base-year cost of the open-


                                                           Base cost                                       Index                                 LIFO value
 January 1, 2005, base cost                                  $15,000                                         1.00                                  $15,000
 December 31, 2005, increment                                  5,000                                         1.20                                    6,000
 Total                                                                                                                                             $21,000


    (iv) The change in relative base-year cost of item     ($25,000 - $20,000). The ratio of the change in base-           (v) CGS allocable to DPGR is $72,000, computed
A is $5,000 ($15,000 -$10,000). The change in rel-         year cost of item A to the change in base-year cost of      as follows:
ative base-year cost of the total inventory is $5,000      the total inventory is 100% ($5,000/$5,000).


 Current-year production costs related to DPGR                                                                                                 $66,000
 Plus:    LIFO value of decrement                                    $6,000
          Ratio                                                       100%
          Total                                                                                                                                   6,000
 Total                                                                                                                                         $72,000



    Example 5. LIFO/FIFO ratio method. (i) The                 (iv) Y’s total CGS computed on a FIFO basis is              Example 6. LIFO/FIFO ratio method. (i) The
facts are the same as in Example 3 except that Y uses      $151,500 (beginning inventory of $15,000 plus total         facts are the same as in Example 4 except that Y uses
the LIFO/FIFO ratio method to determine its CGS            production costs of $166,500 less ending inventory of       the LIFO/FIFO ratio method to compute CGS alloca-
allocable to DPGR.                                         $30,000).                                                   ble to DPGR.
    (ii) Y’s CGS related to item A on a FIFO basis is          (v) The ratio of Y’s CGS computed using the                 (ii) Y’s CGS related to item A on a FIFO basis
$46,750 ((2,000 units at $5) + (7,000 units at $5.25)).    LIFO method to its CGS computed using the FIFO              is $70,750 ((3,000 units at $5.25) + (10,000 units at
    (iii) Y’s total CGS computed on a LIFO basis is        method is 102% ($154,500/$151,500). Y’s CGS re-             $5.50)).
$154,500 (beginning inventory of $15,000 plus total        lated to DPGR computed using the LIFO/FIFO ratio                (iii) Y’s total CGS computed on a LIFO basis is
production costs of $166,500 less ending inventory of      method is $47,685 ($46,750 x 102%).                         $222,000 (beginning inventory of $27,000 plus total
$27,000).



2005–47 I.R.B.                                                                     1030                                                    November 21, 2005
production costs of $216,000 less ending inventory of   for purposes of allocating and apportion-       plies solely to deductions for charitable
$21,000).                                               ing deductions to DPGR or gross income          contributions that are attributable to the ac-
    (iv) Y’s total CGS computed on a FIFO basis is      attributable to DPGR for all of the meth-       tual conduct of a trade or business.
$220,000 (beginning inventory of $30,000 plus total
production costs of $216,000 less ending inventory of
                                                        ods provided by this section.                       (3) Research and experimental expendi-
$26,000).                                                   (ii) Net operating losses. A deduction      tures. Research and experimental expendi-
    (v) The ratio of Y’s CGS computed using the         under section 172 for a net operating loss      tures must be allocated and apportioned in
LIFO method to its CGS computed using the FIFO          is not allocated or apportioned to DPGR or      accordance with §1.861–17 without taking
method is 101% ($222,000/$220,000). Y’s CGS re-         gross income attributable to DPGR.              into account the exclusive apportionment
lated to DPGR computed using the LIFO/FIFO ratio
method is $71,457 ($70,750 x 101%).
                                                            (iii) Deductions not attributable to the    rule of §1.861–17(b).
   (c) Other deductions allocable or ap-                conduct of a trade or business. Deductions          (4) Deductions related to gross re-
portioned to domestic production gross re-              not attributable to the conduct of a trade or   ceipts deemed to be domestic production
ceipts or gross income attributable to do-              business are not allocated or apportioned       gross receipts. If non-DPGR is treated as
mestic production gross receipts—(1) In                 to DPGR or gross income attributable to         DPGR pursuant to §§1.199–1(d)(2) and
general. In determining its QPAI, a tax-                DPGR. For example, the standard deduc-          1.199–3(h)(4), (k)(4)(iv), (l)(1)(ii), (m)(4),
payer must subtract from its DPGR, in ad-               tion provided by section 63(c) and the de-      or (n)(1), deductions related to such gross
dition to its CGS allocable to DPGR, the                duction for personal exemptions provided        receipts that are treated as DPGR must be
deductions that are directly allocable to               by section 151 are not allocated or appor-      allocated or apportioned to gross income
DPGR, and a ratable portion of deductions               tioned to DPGR or gross income attribut-        attributable to DPGR.
that are not directly allocable to DPGR                 able to DPGR.                                       (5) Examples. The following examples
or to another class of income. A tax-                       (d) Section 861 method—(1) In gen-          illustrate the operation of the section 861
payer generally must allocate and appor-                eral. A taxpayer must allocate and appor-       method. Assume that with respect to the
tion these deductions using the rules of the            tion its deductions using the allocation and    allocation and apportionment of interest
section 861 method. In lieu of the section              apportionment rules provided by the sec-        expense, §1.861–10T does not apply in the
861 method, certain taxpayers may appor-                tion 861 method under which section 199         following examples. The examples read as
tion these deductions using the simplified              is treated as an operative section described    follows:
                                                        in §1.861–8(f). Accordingly, the taxpayer            Example 1. General section 861 method. (i) X,
deduction method provided in paragraph                                                                  a United States corporation that is not a member of
(e) of this section. Paragraph (f) of this              applies the rules of the section 861 regula-
                                                                                                        an expanded affiliated group (EAG) (as defined in
section provides a small business simpli-               tions to allocate and apportion deductions      §1.199–7), engages in activities that generate both
fied overall method that may be used by a               (including its distributive share of deduc-     DPGR and non-DPGR. All of X’s production activ-
qualified small taxpayer, as defined in that            tions from pass-thru entities) to gross in-     ities that generate DPGR are within Standard Indus-
                                                        come attributable to DPGR. If the taxpayer      trial Classification (SIC) Industry Group AAA (SIC
paragraph. A taxpayer using the simpli-                                                                 AAA)). All of X’s production activities that gener-
fied deduction method or the small busi-                applies the allocation and apportionment
                                                                                                        ate non-DPGR are within SIC Industry Group BBB
ness simplified overall method must use                 rules of the section 861 regulations for an     (SIC BBB). X is able to identify from its books and
that method for all deductions. A taxpayer              operative section other than section 199,       records CGS allocable to DPGR and to non-DPGR.
eligible to use the small business simpli-              the taxpayer must use the same method of        X incurs $900 of research and experimentation ex-
                                                        allocation and the same principles of ap-       penses (R&E) that are deductible under section 174,
fied overall method may choose at any                                                                   $300 of which are performed with respect to SIC
time to use the small business simplified               portionment for purposes of all operative
                                                                                                        AAA and $600 of which are performed with respect
overall method, the simplified deduction                sections (subject to the rules provided in      to SIC BBB. None of the R&E is legally mandated
method, or the section 861 method for a                 paragraphs (c)(2) and (d)(2) and (3) of this    R&E as described in §1.861–17(a)(4) and none of the
taxable year. A taxpayer eligible to use the            section). See §1.861–8(f)(2)(i).                R&E is included in CGS. X incurs section 162 sell-
                                                            (2) Deductions for charitable contribu-     ing expenses (that include W–2 wages as defined in
simplified deduction method may choose                                                                  §1.199–2(f)) that are not includible in CGS and not
at any time to use the simplified deduc-                tions. Deductions for charitable contri-
                                                                                                        directly allocable to any gross income. For 2010, the
tion method or the section 861 method for               butions (as allowed under sections 170,         adjusted basis of X’s assets that generate gross in-
a taxable year.                                         873(b)(2), and 882(c)(1)(B)) must be rat-       come attributable to DPGR and to non-DPGR is, re-
   (2) Treatment of certain deduc-                      ably apportioned between gross income at-       spectively, $4,000 and $1,000. For 2010, X’s taxable
                                                        tributable to DPGR and other gross income       income is $1,380 based on the following Federal in-
tions—(i) In general. The rules provided                                                                come tax items:
in this paragraph (c)(2) apply to net oper-             based on the relative amounts of gross in-
ating losses and certain other deductions               come. For individuals, this provision ap-




November 21, 2005                                                          1031                                                     2005–47 I.R.B.
                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                       $3,000
                  Non-DPGR (all from sales of products within SIC BBB). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                          $3,000
                  CGS allocable to DPGR (includes $100 of W–2 wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                          ($600)
                  CGS allocable to non-DPGR (includes $100 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                            ($1,800)
                  Section 162 selling expenses (includes $100 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                          ($840)
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          ($300)
                  Section 174 R&E–SIC BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          ($600)
                  Interest expense (not included in CGS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                           ($300)
                  Charitable contributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                  ($180)
                  X’s taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                 $1,380


     (ii) X’s QPAI. X chooses to allocate and apportion                     of this specific case, apportionment of those expenses                                 §1.861–9T(g). X has $2,400 of gross income attrib-
its deductions to gross income attributable to DPGR                         between DPGR and non-DPGR on the basis of X’s                                          utable to DPGR (DPGR of $3,000 - CGS of $600 (in-
under the section 861 method of this paragraph (d).                         gross receipts is appropriate. For purposes of appor-                                  cludes $100 of W–2 wages) allocated based on X’s
In this case, the section 162 selling expenses (includ-                     tioning R&E, X elects to use the sales method as de-                                   books and records). X’s QPAI for 2010 is $1,320, as
ing W–2 wages) are definitely related to all of X’s                         scribed in §1.861–17(c). X elects to apportion in-                                     shown below:
gross income. Based on the facts and circumstances                          terest expense under the tax book value method of


                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                       $3,000
                  CGS allocable to DPGR (includes $100 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                           ($600)
                  Section 162 selling expenses (includes $100 of W–2 wages)
                                   ($840 x ($3,000 DPGR/$6,000 total gross receipts)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          ($420)
                  Interest expense (not included in CGS) ($300 x ($4,000 (X’s DPGR assets)/
                                   $5,000 (X’s total assets))) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                   ($240)
                  Charitable contributions (not included in CGS) ($180 x ($2,400 gross income attributable to DPGR/
                             $3,600 total gross income)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           ($120)
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          ($300)
                  X’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           $1,320


    (iii) Section 199 deduction determination. X’s                          of Y. X and Y are not members of an affiliated group                                   SIC Industry Group AAA (SIC AAA). All of Y’s ac-
tentative deduction under §1.199–1(a) (section 199                          as defined in section 1504(a). Accordingly, the rules                                  tivities that generate non-DPGR are within SIC In-
deduction) is $119 (.09 x (lesser of QPAI of $1,320                         of §1.861–14T do not apply to X’s and Y’s selling                                      dustry Group BBB (SIC BBB). None of X’s and Y’s
and taxable income of $1,380)) subject to the wage                          expenses, R&E, and charitable contributions. X and                                     sales are to each other. Y is not able to identify from
limitation of $150 (50% x $300). Accordingly, X’s                           Y are, however, members of an affiliated group for                                     its books and records CGS allocable to DPGR and
section 199 deduction for 2010 is $119.                                     purposes of allocating and apportioning interest ex-                                   non-DPGR. In this case, because CGS is definitely
    Example 2. Section 861 method and EAG. (i)                              pense (see §1.861–11T(d)(6)) and are also members                                      related under the facts and circumstances to all of
Facts. The facts are the same as in Example 1 ex-                           of an EAG. For 2010, the adjusted basis of Y’s assets                                  Y’s gross receipts, apportionment of CGS between
cept that X owns stock in Y, a United States corpora-                       that generate gross income attributable to DPGR and                                    DPGR and non-DPGR based on gross receipts is ap-
tion, equal to 75 percent of the total voting power of                      to non-DPGR is, respectively, $21,000 and $24,000.                                     propriate. For 2010, Y’s taxable income is $1,910
stock of Y and 80 percent of the total value of stock                       All of Y’s activities that generate DPGR are within                                    based on the following tax items:


                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                       $3,000
                  Non-DPGR (all from sales of products within SIC BBB). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          $3,000
                  CGS allocated to DPGR (includes $300 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          ($1,200)
                  CGS allocated to non-DPGR (includes $300 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                            ($1,200)
                  Section 162 selling expenses (includes $300 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          ($840)
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          ($100)
                  Section 174 R&E–SIC BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          ($200)
                  Interest expense (not included in CGS and not subject to §1.861–10T) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                               ($500)
                  Charitable contributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       ($50)
                  Y’s taxable income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 $1,910


  (ii) QPAI. (A) X’s QPAI. Determination of X’s                             is apportioned to gross income attributable to DPGR                                    assets. See §1.861–11T(c). Accordingly, X’s QPAI
QPAI is the same as in Example 1 except that interest                       based on the combined adjusted bases of X’s and Y’s                                    for 2010 is $1,410, as shown below:




2005–47 I.R.B.                                                                                                1032                                                                               November 21, 2005
                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                $3,000
                  CGS allocated to DPGR (includes $300 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                    ($600)
                  Section 162 selling expenses (includes $100 of W–2 wages)
                                   $840 x ($3,000 DPGR/$6,000 total gross receipts)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              ($420)
                  Interest expense (not included in CGS and not subject to §1.861–10T) ($300 x ($25,000 (tax book value of X’s
                                    and Y’s DPGR assets)/$50,000 (tax book value of X’s and Y’s total assets))) . . . . . . . . . . . . . . . . . . .                                             ($150)
                  Charitable contributions (not included in CGS) ($180 x ($2,400 gross income attributable to DPGR/$3,600
                              total gross income)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                ($120)
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                   ($300)
                  X’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    $1,410


    (B) Y’s QPAI. Y makes the same elections under                          gross income attributable to DPGR (DPGR of $3,000                                      ceipts). Y’s QPAI for 2010 is $1,005, as shown be-
the section 861 method as does X. Y has $1,800 of                           - CGS of $1,200 allocated based on Y’s gross re-                                       low:


                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                $3,000
                  CGS allocated to DPGR (includes $300 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                   ($1,200)
                  Section 162 selling expenses (includes $300 of W–2 wages)
                                   ($840 x ($3,000 DPGR/$6,000 total gross receipts)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                               ($420)
                  Interest expense (not included in CGS and not subject to §1.861–10T) ($500 x ($25,000 (tax book value of X’s
                                   and Y’s DPGR assets)/$50,000 (tax book value of X’s and Y’s total assets))). . . . . . . . . . . . . . . . . . . .                                             ($250)
                  Charitable contributions (not included in CGS) ($50 x ($1,800 gross income attributable to DPGR/$3,600
                              total gross income)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 ($25)
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                   ($100)
                  Y’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    $1,005


    (iii) Section 199 deduction determination. The                          DPGR and non-DPGR based on relative                                                    duction method is determined by reference
section 199 deduction of the X and Y EAG is de-                             gross receipts. Accordingly, the amount of                                             to the average annual gross receipts and to-
termined by aggregating the separately determined                           deductions apportioned to DPGR is equal                                                tal assets of the EAG. If the average an-
QPAI, taxable income, and W–2 wages of X and Y.
See §1.199–7(b). Accordingly, the X and Y EAG’s
                                                                            to the same proportion of the total deduc-                                             nual gross receipts of the EAG are less than
tentative section 199 deduction is $217 (.09 x (lesser                      tions that the amount of DPGR bears to                                                 or equal to $25,000,000 or the total assets
of combined taxable incomes of X and Y of $3,290                            total gross receipts. Whether an owner                                                 of the EAG at the end of its taxable year
(X’s taxable income of $1,380 plus Y’s taxable in-                          of a pass-thru entity may use the simpli-                                              are less than or equal to $10,000,000, each
come of $1,910) and combined QPAI of $2,415 (X’s                            fied deduction method is determined at the                                             member of the EAG may individually de-
QPAI of $1,410 plus Y’s QPAI of $1,005)) subject to
the wage limitation of $600 (50% x ($300 (X’s W–2
                                                                            level of the owner of the pass-thru en-                                                termine whether to use the simplified de-
wages) + $900 (Y’s W–2 wages))). Accordingly, the                           tity. Whether a trust or an estate may                                                 duction method, regardless of the cost allo-
X and Y EAG’s section 199 deduction for 2010 is                             use the simplified deduction method is de-                                             cation method used by the other members.
$217. The $217 is allocated to X and Y in proportion                        termined at the trust or estate level. In                                                  (ii) Exception. Notwithstanding para-
to their QPAI. See §1.199–7(c).                                             the case of a trust or estate, the simpli-                                             graph (e)(2)(i) of this section, all members
   (e) Simplified deduction method—(1)                                      fied deduction method is applied at the                                                of the same consolidated group must use
In general. A taxpayer with average an-                                     trust or estate level, taking into account                                             the same cost allocation method.
nual gross receipts (as defined in para-                                    the trust’s or estate’s DPGR, non-DPGR,                                                    (iii) Examples. The following exam-
graph (g) of this section) of $25,000,000                                   and other items from all sources, includ-                                              ples illustrate the application of paragraph
or less, or total assets at the end of the                                  ing its distributive or allocable share of                                             (e)(2) of this section:
taxable year (as defined in paragraph (h)                                   those items of any lower-tier entity, prior                                                Example 1. Corporations X, Y, and Z are the
of this section) of $10,000,000 or less,                                    to any charitable or distribution deduc-                                               only three members of an EAG. Neither X, Y, nor
may use the simplified deduction method                                                                                                                            Z is a member of a consolidated group. X, Y, and
                                                                            tion. In the case of an owner of any other                                             Z have average annual gross receipts of $2,000,000,
to apportion deductions between DPGR                                        pass-thru entity, the simplified deduction                                             $7,000,000, and $13,000,000, respectively. X, Y,
and non-DPGR. This paragraph does not                                       method is applied at the level of the owner                                            and Z each have total assets at the end of the taxable
apply to CGS. Under the simplified de-                                      of the pass-thru entity taking into account                                            year of $5,000,000. Because the average annual
duction method, a taxpayer’s deductions                                     the owner’s DPGR, non-DPGR, and other                                                  gross receipts of the EAG are less than or equal to
(except the net operating loss deduction                                                                                                                           $25,000,000, each of X, Y, and Z may use either
                                                                            items from all sources including its dis-                                              the simplified deduction method or the section 861
as provided in paragraph (c)(2)(ii) of this                                 tributive or allocable share of those items                                            method.
section and deductions not attributable to                                  of the pass-thru entity.                                                                   Example 2. The facts are the same as in Example
the actual conduct of a trade or business                                       (2) Members of an expanded affiliated                                              1 except that X and Y are members of the same con-
as provided in paragraph (c)(2)(iii) of this                                group—(i) In general. Whether the mem-                                                 solidated group. X, Y, and Z may use either the sim-
section) are ratably apportioned between                                                                                                                           plified deduction method or the section 861 method.
                                                                            bers of an EAG may use the simplified de-


November 21, 2005                                                                                             1033                                                                               2005–47 I.R.B.
However, X and Y must use the same cost allocation      receipts and the total costs for the cur-                  during which the taxpayer was in exis-
method.                                                 rent taxable year of the EAG are less than                 tence) preceding the current taxable year,
    Example 3. The facts are the same as in Exam-       or equal to $5,000,000; the EAG, viewed                    even if one or more of such taxable years
ple 1 except that Z’s average annual gross receipts
are $17,000,000. Because the average annual gross
                                                        as a single corporation, is engaged in the                 began before the effective date of section
receipts of the EAG are greater than $25,000,000 and    trade or business of farming that is not re-               199. In the case of any taxable year of less
the total assets of the EAG at the end of the taxable   quired to use the accrual method of ac-                    than 12 months (a short taxable year), the
year are greater than $10,000,000, X, Y, and Z must     counting under section 447; or the EAG,                    gross receipts shall be annualized by mul-
each use the section 861 method.                        viewed as a single corporation, is eligible                tiplying the gross receipts for the short pe-
    (f) Small business simplified overall               to use the cash method as provided in Rev.                 riod by 12 and dividing the result by the
method—(1) In general. A qualifying                     Proc. 2002–28, then each member of the                     number of months in the short period.
small taxpayer may use the small business               EAG may individually determine whether                         (2) Members of an EAG. To compute
simplified overall method to apportion                  to use the small business simplified over-                 the average annual gross receipts of an
CGS and deductions between DPGR and                     all method, regardless of the cost alloca-                 EAG, the gross receipts, for the entire tax-
non-DPGR. Under the small business                      tion method used by the other members.                     able year, of each corporation that is a
simplified overall method, a taxpayer’s                     (ii) Exception. Notwithstanding para-                  member of the EAG at the end of its tax-
total costs for the current taxable year (as            graph (f)(3)(i) of this section, all members               able year that ends with or within the tax-
defined in paragraph (i) of this section)               of the same consolidated group must use                    able year of the computing member (as de-
are apportioned between DPGR and other                  the same cost allocation method.                           scribed in §1.199–7(h)) are aggregated.
receipts based on relative gross receipts.                  (iii) Examples. The following exam-                        (h) Total assets—(1) In general. For
Accordingly, the amount of total costs                  ples illustrate the application of paragraph               purposes of the simplified deduction
for the current taxable year apportioned                (f)(3) of this section:                                    method provided by paragraph (e) of this
to DPGR is equal to the same proportion                     Example 1. Corporations L, M, and N are the            section, total assets means the total assets
of total costs for the current taxable year             only three members of an EAG. Neither L, M, nor            the taxpayer has at the end of the taxable
that the amount of DPGR bears to total                  N is a member of a consolidated group. L, M, and N
                                                        have average annual gross receipts and total costs for
                                                                                                                   year that are attributable to the taxpayer’s
gross receipts. In the case of a pass-thru                                                                         trade or business. In the case of a C cor-
                                                        the current taxable year of $1,000,000, $1,500,000,
entity, whether the small business simpli-              and $2,000,000, respectively. Because both the aver-       poration, the corporation’s total assets at
fied overall method may be used by such                 age annual gross receipts and total costs for the cur-     the end of the taxable year is the amount
entity is determined at the pass-thru entity            rent taxable year of the EAG are less than or equal to     required to be reported on Schedule L of
level and, if such entity is eligible, the              $5,000,000, each of L, M, and N may use the small
                                                        business simplified overall method, the simplified de-
                                                                                                                   the Form 1120, “United States Corpora-
small business simplified overall method                                                                           tion Income Tax Return,” in accordance
                                                        duction method, or the section 861 method.
is applied at the pass-thru entity level.                   Example 2. The facts are the same as in Exam-          with the Form 1120 instructions.
    (2) Qualifying small taxpayer. For pur-             ple 1 except that M and N are members of the same              (2) Members of an EAG. To compute
poses of this paragraph (f), a qualifying               consolidated group. L, M, and N may use the small          the total assets at the end of the taxable
small taxpayer is—                                      business simplified overall method, the simplified de-
                                                        duction method, or the section 861 method. However,
                                                                                                                   year of an EAG, the total assets, at the end
    (i) A taxpayer that has both average                                                                           of its taxable year, of each corporation that
                                                        M and N must use the same cost allocation method.
annual gross receipts (as defined in para-                  Example 3. The facts are the same as in Example        is a member of the EAG at the end of its
graph (g) of this section) of $5,000,000 or             1 except that N has average annual gross receipts of       taxable year that ends with or within the
less and total costs for the current taxable            $4,000,000. Unless the EAG, viewed as a single cor-        taxable year of the computing member are
year of $5,000,000 or less;                             poration, is engaged in the trade or business of farm-
                                                        ing that is not required to use the accrual method of
                                                                                                                   aggregated.
    (ii) A taxpayer that is engaged in the                                                                             (i) Total costs for the current taxable
                                                        accounting under section 447, or the EAG, viewed as
trade or business of farming that is not re-            a single corporation, is eligible to use the cash method   year—(1) In general. For purposes of the
quired to use the accrual method of ac-                 as provided in Rev. Proc. 2002–28, because the aver-       small business simplified overall method,
counting under section 447; or                          age annual gross receipts of the EAG are greater than      total costs for the current taxable year
    (iii) A taxpayer that is eligible to use            $5,000,000, L, M, and N are all ineligible to use the
                                                        small business simplified overall method.
                                                                                                                   means the total CGS and deductions (ex-
the cash method as provided in Rev. Proc.                                                                          cluding the net operating loss deduction
2002–28, 2002–1 C.B. 815 (that is, cer-                    (4) Ineligible pass-thru entities. Qual-
                                                        ifying oil and gas partnerships under                      as provided in paragraph (c)(2)(ii) of this
tain taxpayers with average annual gross                                                                           section and deductions not attributable
receipts of $10,000,000 or less that are                §1.199–3(h)(7), EAG partnerships under
                                                        §1.199–3(h)(8), and trusts and estates un-                 to the conduct of a trade or business as
not prohibited from using the cash method                                                                          provided in paragraph (c)(2)(iii) of this
under section 448, including partnerships,              der §1.199–5(d) may not use the small
                                                        business simplified overall method.                        section) for the current taxable year.
S corporations, C corporations, or individ-                                                                            (2) Members of an EAG. To compute
uals). See §601.601(d)(2) of this chapter.                 (g) Average annual gross receipts—(1)
                                                        In general. For purposes of the simplified                 the total costs for the current taxable year
    (3) Members of an expanded affiliated                                                                          of an EAG, the total costs for the entire
group—(i) In general. Whether the mem-                  deduction method and the small business
                                                        simplified overall method, average annual                  taxable year of each corporation that is a
bers of an EAG may use the small busi-                                                                             member of the EAG at the end of the tax-
ness simplified overall method is deter-                gross receipts means the average annual
                                                        gross receipts of the taxpayer for the 3 tax-              able year that ends with or within the tax-
mined by reference to all the members of                                                                           able year of the computing member are ag-
the EAG. If both the average annual gross               able years (or, if fewer, the taxable years
                                                                                                                   gregated.


2005–47 I.R.B.                                                                 1034                                                November 21, 2005
§1.199–5 Application of section 199 to          taken into account in computing the part-        same as the share of QPAI allocated to the
pass-thru entities.                             ner’s section 199 deduction are taken into       partner. Each partner must compute its
                                                account only if and to the extent the part-      share of W–2 wages from the partnership
    (a) Partnerships—(1) Determination at       ner’s distributive share of those deduc-         in accordance with section 199(d)(1)(B)
partner level. The deduction allowable un-      tions from all of the partnership’s activi-      (with W–2 wages being allocated to the
der §1.199–1(a) (section 199 deduction) is      ties is not disallowed by section 465, 469,      partner in the same manner as is wage ex-
determined at the partner level. As a re-       704(d), or any other provision of the In-        pense), and then add that share to its W–2
sult, each partner must compute its deduc-      ternal Revenue Code. If only a portion           wages from other sources, if any. The ap-
tion separately. For purposes of this sec-      of the partner’s distributive share of the       plication of section 199(d)(1)(B) therefore
tion, each partner is allocated, in accor-      losses or deductions is allowed for a tax-       means that if QPAI, computed by taking
dance with sections 702 and 704, its share      able year, a proportionate share of those        into account only the items of the partner-
of partnership items (including items of in-    allowable losses or deductions that are al-      ship allocated to the partner for the taxable
come, gain, loss, and deduction), cost of       located to the partnership’s qualified pro-      year, is not greater than zero, the partner
goods sold (CGS) allocated to such items        duction activities, determined in a manner       may not take into account any W–2 wages
of income, and gross receipts that are in-      consistent with sections 465, 469, 704(d),       of the partnership in computing the part-
cluded in such items of income, even if the     and any other applicable provision of the        ner’s section 199 deduction. See §1.199–2
partner’s share of CGS and other deduc-         Internal Revenue Code, is taken into ac-         for the computation of W–2 wages, and
tions and losses exceeds domestic produc-       count in computing the section 199 deduc-        paragraph (f) of this section for rules re-
tion gross receipts (DPGR) (as defined in       tion for that taxable year. To the extent        garding pass-thru entities in a tiered struc-
§1.199–3(a)). A partnership may specially       that any of the disallowed losses or deduc-      ture.
allocate items of income, gain, loss, or de-    tions are allowed in a later taxable year, the       (4) Examples. The following examples
duction to its partners, subject to the rules   partner takes into account a proportionate       illustrate the application of this paragraph
of section 704(b) and the supporting reg-       share of those losses or deductions in com-      (a). Assume that each partner has suf-
ulations. To determine its section 199 de-      puting its QPAI for that later taxable year.     ficient adjusted gross income or taxable
duction for the taxable year, a partner gen-        (3) Partner’s share of W–2 wages. Un-        income so that the section 199 deduction
erally aggregates its distributive share of     der section 199(d)(1)(B), a partner’s share      is not limited under section 199(a)(1)(B);
such items, to the extent they are not oth-     of W–2 wages of a partnership for pur-           that the partnership and each of its partners
erwise disallowed by the Internal Revenue       poses of determining the partner’s section       (whether individual or corporate) are cal-
Code, with those items it incurs outside the    199(b) limitation is the lesser of the part-     endar year taxpayers; and that the amount
partnership (whether directly or indirectly)    ner’s allocable share of those wages (with-      of the partnership’s W–2 wages equals
for purposes of allocating and apportion-       out regard to section 199(d)(1)(B)), or 2        wage expense for each taxable year. The
ing deductions to DPGR and computing            times 9 percent (3 percent for taxable years     examples read as follows:
its qualified production activities income      beginning in 2005 or 2006, and 6 per-                Example 1. Section 861 method with interest ex-
(QPAI) (as defined in §1.199–1(c)). How-        cent for taxable years beginning in 2007,        pense. (i) Partnership Federal income tax items. X
                                                                                                 and Y, unrelated United States corporations, are each
ever, if a partnership uses the small busi-     2008, or 2009) of the QPAI computed by           50% partners in PRS, a partnership that engages in
ness simplified overall method described        taking into account only the items of the        production activities that generate both DPGR and
in §1.199–4(f), then each partner is allo-      partnership allocated to the partner for the     non-DPGR. X and Y share all items of income, gain,
cated its share of QPAI and W–2 wages (as       taxable year of the partnership. In gen-         loss, deduction, and credit 50% each. PRS is not
defined in §1.199–2(f)), which (subject to      eral, this QPAI calculation is performed         able to identify from its books and records CGS al-
                                                                                                 locable to DPGR and non-DPGR. In this case, be-
the limitation under section 199(d)(1)(B))      by the partner using the same cost alloca-       cause CGS is definitely related under the facts and cir-
are combined with the partner’s QPAI and        tion method that the partner uses in cal-        cumstances to all of PRS’s gross income, apportion-
W–2 wages from other sources. Under this        culating the partner’s section 199 deduc-        ment of CGS between DPGR and non-DPGR based
method, a partner’s distributive share of       tion. However, if a partnership uses the         on gross receipts is appropriate. For 2010, the ad-
QPAI from a partnership may be less than        small business simplified overall method         justed basis of PRS business assets is $5,000, $4,000
                                                                                                 of which generate gross income attributable to DPGR
zero.                                           described in §1.199–4(f), the QPAI used          and $1,000 of which generate gross income attribut-
    (2) Disallowed deductions. Deductions       by each partner to determine the wage lim-       able to non-DPGR. For 2010, PRS has the following
of a partnership that otherwise would be        itation under section 199(d)(1)(B) is the        Federal income tax items:




November 21, 2005                                                  1035                                                       2005–47 I.R.B.
                   DPGR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       $3,000
                   Non-DPGR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           $3,000
                   CGS (includes $200 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          $3,240
                   Section 162 selling expenses (includes $300 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                       $1,200
                   Interest expense (not included in CGS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          $300


    (ii) Allocation of PRS’s items of income, gain,
loss, deduction, or credit. X and Y each receive
the following distributive share of PRS’s items of in-
come, gain, loss, deduction or credit, as determined
under the principles of §1.704–1(b)(1)(vii):


                   Gross income attributable to DPGR ($1,500 (DPGR) - $810 (allocable CGS, includes $50
                              of W–2 wages)). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      $690
                   Gross income attributable to non-DPGR ($1,500 (non-DPGR) - $810 (allocable CGS, includes $50
                              of W–2 wages)). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      $690
                   Section 162 selling expenses (includes $150 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                         $600
                   Interest expense (not included in CGS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          $150


    (iii) Determination of QPAI. (A) X’s QPAI. Be-                           are investment assets, is $10,000. X’s only gross re-                                  of this specific case, apportionment of those expenses
cause the section 199 deduction is determined at the                         ceipts for 2010 are those attributable to the allocation                               between DPGR and non-DPGR on the basis of PRS’s
partner level, X determines its QPAI by aggregating,                         of gross income from PRS. X allocates and apportions                                   gross receipts is appropriate. X elects to apportion
to the extent necessary, its distributive share of PRS’s                     its deductible items to gross income attributable to                                   its distributive share of interest expense under the tax
Federal income tax items with all other such items                           DPGR under the section 861 method of §1.199–4(d).                                      book value method of §1.861–9T(g). X’s QPAI for
from all other, non-PRS-related activities. For 2010,                        In this case, the section 162 selling expenses (includ-                                2010 is $366, as shown below:
X does not have any other such items. For 2010, the                          ing W–2 wages) are definitely related to all of PRS’s
adjusted basis of X’s non-PRS assets, all of which                           gross receipts. Based on the facts and circumstances


                   DPGR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       $1,500
                   CGS allocable to DPGR (includes $50 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                        ($810)
                   Section 162 selling expenses (includes $75 of W–2 wages) ($600 x $1,500/$3,000). . . . . . . . . . . . . . . . . . . . . . . .                                                       ($300)
                   Interest expense (not included in CGS) ($150 x $2,000 (X’s share of PRS’s DPGR assets)/
                              $12,500 (X’s non-PRS assets and X’s share of PRS assets)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                ($24)
                   X’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          $366


     (B) Y’s QPAI. (1) For 2010, in addition to the ac-                      to DPGR and to non-DPGR. For 2010, the adjusted                                        is $2,000. Y has no other assets. Y has the following
tivities of PRS, Y engages in production activities                          basis of Y’s non-PRS assets attributable to its produc-                                Federal income tax items relating to its non-PRS ac-
that generate both DPGR and non-DPGR. Y is able                              tion activities that generate DPGR is $8,000 and to                                    tivities:
to identify from its books and records CGS allocable                         other production activities that generate non-DPGR


                   Gross income attributable to DPGR ($1,500 (DPGR) - $900 (allocable CGS, includes $70
                              of W–2 wages)). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      $600
                   Gross income attributable to non-DPGR ($3,000 (other gross receipts) - $1,620 (allocable CGS, includes
                                     $150 of W–2 wages)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 $1,380
                   Section 162 selling expenses (includes $30 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                        $540
                   Interest expense (not included in CGS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           $90


    (2) Y determines its QPAI in the same general                            tributive share of PRS’s section 162 selling expenses                                  to apportion its distributive share of interest expense
manner as X. However, because Y has activities out-                          (including W–2 wages), as well as those selling ex-                                    under the tax book value method of §1.861–9T(g).
side of PRS, Y must aggregate its distributive share                         penses from Y’s non-PRS activities, are definitely re-                                 Y has $1,290 of gross income attributable to DPGR
of PRS’s Federal income tax items with its own such                          lated to all of its gross income. Based on the facts and                               ($3,000 DPGR ($1,500 from PRS and $1,500 from
items. Y allocates and apportions its deductible items                       circumstances of this specific case, apportionment of                                  non-PRS activities) - $1,710 CGS ($810 from PRS
to gross income attributable to DPGR under the sec-                          those expenses between DPGR and non-DPGR on the                                        and $900 from non-PRS activities). Y’s QPAI for
tion 861 method of §1.199–4(d). In this case, Y’s dis-                       basis of Y’s gross receipts is appropriate. Y elects                                   2010 is $642, as shown below:




2005–47 I.R.B.                                                                                                  1036                                                                               November 21, 2005
                  DPGR ($1,500 from PRS and $1,500 from non-PRS activities). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                           $3,000
                  CGS allocable to DPGR ($810 from PRS and $900 from non-PRS activities) (includes $120 of W–2 wages) . . .                                                                         ($1,710)
                  Section 162 selling expenses (includes $180 of W–2 wages)
                                    ($1,140 ($600 from PRS and $540 from non-PRS activities) x
                                    ($1,500 PRS DPGR + $1,500 non-PRS DPGR)/($3,000 PRS
                                    total gross receipts + $4,500 non-PRS total gross receipts)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                   ($456)
                  Interest expense (not included in CGS) ($240 ($150 from PRS and $90 from non-PRS activities) x
                                    $10,000 (Y’s non-PRS DPGR assets and Y’s share of PRS DPGR
                             assets)/$12,500 (Y’s non-PRS assets and Y’s share of PRS assets)) . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                 ($192)
                  Y’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         $642


    (iv) PRS W–2 wages allocated to X and Y under                            use to determine their QPAI in paragraphs (iii)(A)                                          (A) QPAI of X and Y, solely for this purpose, is
section 199(d)(1)(B). Solely for purposes of calculat-                       and (B) of this Example 1, respectively. Accord-                                        determined by allocating and apportioning each part-
ing the PRS W–2 wages that are allocated to them                             ingly, X and Y must apportion deductible section 162                                    ner’s share of PRS expenses to each partner’s share
under section 199(d)(1)(B) for purposes of the wage                          selling expenses which includes W–2 wage expense                                        of PRS gross income of $690 attributable to DPGR
limitation of section 199(b), X and Y must separately                        on the basis of gross receipts, and apportion interest                                  ($1,500 DPGR - $810 CGS, apportioned based on
determine QPAI taking into account only the items of                         expense according to the tax book value method of                                       gross receipts). Thus, QPAI of X and Y solely for
PRS allocated to them. X and Y must use the same                             §1.861–9T(g).                                                                           this purpose is $270, as shown below:
methods of allocation and apportionment that they


                  DPGR. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      $1,500
                  CGS allocable to DPGR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  ($810)
                  Section 162 selling expenses (including W–2 wages) ($600 x ($1,500/$3,000)) . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                  ($300)
                  Interest expense (not included in CGS) ($150 x $2,000 (partner’s share of adjusted basis of
                                PRS’s DPGR assets)/$2,500 (partner’s share of adjusted basis of total PRS assets)) . . . . . . . . . . . . . .                                                       ($120)
                  QPAI. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      $270


    (B) X’s and Y’s shares of PRS’s W–2 wages de-                            Accordingly, Y’s section 199 deduction for 2010 is                                      is not able to identify from its books and records CGS
termined under section 199(d)(1)(B) for purposes of                          $58.                                                                                    allocable to DPGR and to non-DPGR and, therefore,
the wage limitation of section 199(b) are $49, the                               Example 2. Section 861 method with R&E ex-                                          apportions CGS to DPGR and non-DPGR based on
lesser of $250 (partner’s allocable share of PRS’s                           pense. (i) Partnership items of income, gain, loss, de-                                 its gross receipts. PRS incurs $900 of research and
W–2 wages ($100 included in CGS, and $150 in-                                duction or credit. X and Y, unrelated United States                                     experimentation expenses (R&E) that are deductible
cluded in selling expenses) and $49 (2 x ($270 x .09)).                      corporations, are partners in PRS, a partnership that                                   under section 174, $300 of which are performed with
    (v) Section 199 deduction determination. (A) X’s                         engages in production activities that generate both                                     respect to SIC AAA and $600 of which are performed
tentative section 199 deduction is $33 (.09 x $366                           DPGR and non-DPGR. Neither X nor Y is a mem-                                            with respect to SIC BBB. None of the R&E is legally
(that is, QPAI determined at partner level)) subject to                      ber of an affiliated group. X and Y share all items of                                  mandated R&E as described in §1.861–17(a)(4) and
the wage limitation of $25 (50% x $49). Accordingly,                         income, gain, loss, deduction, and credit 50% each.                                     none is included in CGS. PRS incurs section 162 sell-
X’s section 199 deduction for 2010 is $25.                                   All of PRS’s domestic production activities that gen-                                   ing expenses (that include W–2 wage expense) that
    (B) Y’s tentative section 199 deduction is $58 (.09                      erate DPGR are within Standard Industrial Classifi-                                     are not includible in CGS and not directly allocable
x $642 (that is, QPAI determined at the partner level)                       cation (SIC) Industry Group AAA (SIC AAA). All of                                       to any gross income. For 2010, PRS has the follow-
subject to the wage limitation of $150 (50% x ($49                           PRS’s production activities that generate non-DPGR                                      ing Federal income tax items:
(from PRS)) and $250 (from non-PRS activities)).                             are within SIC Industry Group BBB (SIC BBB). PRS


                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                   $3,000
                  Non-DPGR (all from sales of products within SIC BBB). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                      $3,000
                  CGS (includes $200 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         $2,400
                  Section 162 selling expenses (includes $100 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                        $840
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        $300
                  Section 174 R&E–SIC BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        $600


    (ii) Allocation of PRS’s items of income, gain,                          the following distributive share of PRS’s items of in-                                  come, gain, loss, deduction, or credit, as determined
loss, deduction, or credit. X and Y each receive                                                                                                                     under the principles of §1.704–1(b)(1)(vii):




November 21, 2005                                                                                               1037                                                                                2005–47 I.R.B.
                   Gross income attributable to DPGR ($1,500 (DPGR) - $600 (CGS, includes $50 of W–2 wages)) . . . . . . . . . . . .                                                                     $900
                   Gross income attributable to non-DPGR ($1,500 (other gross receipts) - $600
                                    (CGS, includes $50 of W–2 wages)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            $900
                   Section 162 selling expenses (includes $50 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                        $420
                   Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         $150
                   Section 174 R&E–SIC BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         $300


    (iii) Determination of QPAI. (A) X’s QPAI. Be-                           erate DPGR are within SIC AAA. X allocates and                                         sales method as described in §1.861–17(c). Because
cause the section 199 deduction is determined at the                         apportions its deductible items to gross income at-                                    X has no direct sales of products, and because all
partner level, X determines its QPAI by aggregat-                            tributable to DPGR under the section 861 method of                                     of PRS’s SIC AAA sales attributable to X’s share
ing, to the extent necessary, its distributive shares of                     §1.199–4(d). In this case, the section 162 selling ex-                                 of PRS’s gross income generate DPGR, all of X’s
PRS’s Federal income tax items with all other such                           penses (including W–2 wages) are definitely related                                    share of PRS’s section 174 R&E attributable to SIC
items from all other, non-PRS-related activities. For                        to all of PRS’s gross income. Based on the facts and                                   AAA is taken into account for purposes of determin-
2010, X does not have any other such tax items. X’s                          circumstances of this specific case, apportionment of                                  ing X’s QPAI. Thus, X’s total QPAI for 2010 is $540,
only gross receipts for 2010 are those attributable to                       those expenses between DPGR and non-DPGR on                                            as shown below:
the allocation of gross income from PRS. As stated,                          the basis of PRS’s gross receipts is appropriate. For
all of PRS’s domestic production activities that gen-                        purposes of apportioning R&E, X elects to use the


                   DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                    $1,500
                   CGS (includes $50 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         ($600)
                   Section 162 selling expenses (including W–2 wages) ($420 x ($1,500 DPGR/$3,000 total gross receipts)). . . . . .                                                                    ($210)
                   Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       ($150)
                   X’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          $540


     (B) Y’s QPAI. (1) For 2010, in addition to the ac-                      able to identify from its books and records CGS al-                                    portionment of CGS between DPGR and non-DPGR
tivities of PRS, Y engages in domestic production                            locable to DPGR and to non-DPGR. In this case, be-                                     based on Y’s non-PRS gross receipts is appropriate.
activities that generate both DPGR and non-DPGR.                             cause CGS is definitely related under the facts and cir-                               For 2010, Y has the following non-PRS Federal in-
With respect to those non-PRS activities, Y is not                           cumstances to all of Y’s non-PRS gross receipts, ap-                                   come tax items:


                   DPGR (from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                  $1,500
                   DPGR (from sales of products within SIC BBB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                  $1,500
                   Non-DPGR (from sales of products within SIC BBB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                      $3,000
                   CGS (allocated to DPGR within SIC AAA) (includes $56 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                      $750
                   CGS (allocated to DPGR within SIC BBB) (includes $56 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                      $750
                   CGS (allocated to non-DPGR within SIC BBB) (includes $113 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . .                                                         $1,500
                   Section 162 selling expenses (includes $30 of W–2 wages) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                        $540
                   Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         $300
                   Section 174 R&E–SIC BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         $450


    (2) Because Y has DPGR as a result of activi-                            apportionment of such expenses between DPGR                                            of the sales in SIC AAA generate DPGR, all of Y’s
ties outside PRS, Y must aggregate its distributive                          and non-DPGR on the basis of Y’s gross receipts                                        share of PRS’s section 174 R&E attributable to SIC
share of PRS’s Federal income tax items with such                            is appropriate. For purposes of apportioning R&E,                                      AAA and the section 174 R&E attributable to SIC
items from all its other, non-PRS-related activities.                        Y elects to use the sales method as described in                                       AAA that Y incurs in its non-PRS activities are taken
Y allocates and apportions its deductible items to                           §1.861–17(c).                                                                          into account for purposes of determining Y’s QPAI.
gross income attributable to DPGR under the section                              (3) With respect to sales that generate DPGR, Y                                    Because only a portion of the sales within SIC BBB
861 method of §1.199–4(d). In this case, the section                         has gross income of $2,400 ($4,500 DPGR ($1,500                                        generate DPGR, only a portion of the section 174
162 selling expenses (including W–2 wages) are                               from PRS and $3,000 from non-PRS activities) -                                         R&E attributable to SIC BBB is taken into account
definitely related to all of Y’s gross income. Based                         $2,100 CGS ($600 from sales of products by PRS                                         in determining Y’s QPAI. Thus, Y’s QPAI for 2010
on the facts and circumstances of the specific case,                         and $1,500 from non-PRS activities)). Because all                                      is $1,282, as shown below:


                   DPGR ($4,500 DPGR ($1,500 from PRS and $3,000 from non-PRS activities . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                       $4,500
                   CGS ($600 from sales of products by PRS and $1,500 from non-PRS activities . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                   ($2,100)
                   Section 162 selling expenses (including W–2 wages) ($420 from PRS + $540 from non-PRS activities) x
                                     ($4,500 DPGR/$9,000 total gross receipts)). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                             ($480)
                   Section 174 R&E–SIC AAA ($150 from PRS and $300 from non-PRS activities) . . . . . . . . . . . . . . . . . . . . . . . . .                                                          ($450)
                   Section 174 R&E–SIC BBB ($300 from PRS + $450 from non-PRS activities) x ($1,500 DPGR/$6,000
                              total gross receipts allocated to SIC BBB) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                 ($188)
                   Y’s QPAI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        $1,282



2005–47 I.R.B.                                                                                                 1038                                                                               November 21, 2005
     (iv) PRS W–2 wages allocated to X and Y un-                             cordingly, X and Y must apportion section 162 sell-                                     gross receipts). Because all of PRS’s SIC AAA sales
der section 199(d)(1)(B). Solely for purposes of cal-                        ing expense which includes W–2 wage expense on                                          generate DPGR, all of X’s and Y’s shares of PRS’s
culating the PRS W–2 wages that are allocated to X                           the basis of gross receipts, and apportion section 174                                  section 174 R&E attributable to SIC AAA is taken
and Y under section 199(d)(1)(B) for purposes of the                         R&E expense under the sales method as described in                                      into account for purposes of determining X’s and Y’s
wage limitation of section 199(b), X and Y must sep-                         §1.861–17(c).                                                                           QPAI. None of PRS’s section 174 R&E attributable
arately determine QPAI taking into account only the                              (A) QPAI of X and Y, solely for this purpose, is                                    to SIC BBB is taken into account because PRS has
items of PRS allocated to them. X and Y must use                             determined by allocating and apportioning each part-                                    no DPGR within SIC BBB. Thus, X and Y each has
the same methods of allocation and apportionment                             ner’s share of PRS expenses to each partner’s share                                     QPAI, solely for this purpose, of $540, as shown be-
that they use to determine their QPAI in paragraphs                          of PRS gross income of $900 attributable to DPGR                                        low:
(iii)(A) and (B) of this Example 2, respectively. Ac-                        ($1,500 DPGR - $600 CGS, allocated based on PRS’s


                  DPGR (all from sales of products within SIC AAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                  $1,500
                  CGS (includes $50 of W–2 wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      ($600)
                  Section 162 selling expenses (including W–2 wages) ($420 x $1,500/$3,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                 ($210)
                  Section 174 R&E–SIC AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                     ($150)
                  QPAI. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    $540


     (B) X’s and Y’s shares of PRS’s W–2 wages de-                           nership and $200 from non-partnership activities) x                                     determine its section 199 deduction using the section
termined under section 199(d)(1)(B) for purposes of                          ($3,000 DPGR/$5,000 total gross receipts)). Accord-                                     861 method.
the wage limitation of section 199(b) are $97, the                           ingly, X’s QPAI is $50 ($3,000 DPGR - $1,750 CGS                                            (b) S corporations—(1) Determination
lesser of $150 (partner’s allocable share of PRS’s                           - $1,200 of deductions). However, in determining the                                    at shareholder level. The section 199 de-
W–2 wages ($100 included in CGS, and $50 included                            section 199(d)(1)(B) wage limitation, QPAI is com-
in selling expenses)) and $97 (2 x ($540 x .09)).                            puted taking into account only the items of the part-
                                                                                                                                                                     duction is determined at the shareholder
     (v) Section 199 deduction determination. (A) X’s                        nership allocated to the partner for the taxable year of                                level. As a result, each shareholder must
tentative section 199 deduction is $49 (.09 x $540                           the partnership. Thus, X apportions $1,350 of deduc-                                    compute its deduction separately. For pur-
(QPAI determined at partner level)) subject to the                           tions to DPGR ($1,800 x ($3,000 DPGR/$4,000 total                                       poses of this section, each shareholder is
wage limitation of $49 (50% x $97). Accordingly,                             gross receipts from PRS)). Accordingly, X’s QPAI for                                    allocated, in accordance with section 1366,
X’s section 199 deduction for 2010 is $49.                                   purposes of the section 199(d)(1)(B) wage limitation
     (B) Y’s tentative section 199 deduction is $115                         is $0 ($3,000 DPGR - $1,750 CGS - $1,350 of de-
                                                                                                                                                                     its pro rata share of S corporation items
(.09 x $1,282 (QPAI determined at partner level) sub-                        ductions). X’s share of PRS’s W–2 wages is $0, the                                      (including items of income, gain, loss, and
ject to the wage limitation of $176 (50% x $352 ($97                         lesser of $1,600 (X’s 80% allocable share of $2,000                                     deduction), CGS allocated to such items
from PRS + $255 from non-PRS activities)). Accord-                           of wage expense for marketing) or $0 (2 x ($0 QPAI                                      of income, and gross receipts included in
ingly, Y’s section 199 deduction for 2010 is $115.                           x .09)). X’s tentative deduction is $5 ($50 QPAI x                                      such items of income, even if the share-
     Example 3. Simplified deduction method with                             .09), subject to the section 199(b)(1) wage limitation
special allocations. (i) In general. X and Y are                             of $100 (50% x $200 ($0 of PRS-related W–2 wages
                                                                                                                                                                     holder’s share of CGS and other deduc-
unrelated corporate partners in PRS. PRS engages in                          + $200 of non-PRS W–2 wages)). Accordingly, X’s                                         tions and losses exceeds DPGR. To de-
a domestic production activity and other activities.                         total section 199 deduction for the 2010 taxable year                                   termine its section 199 deduction for the
In general, X and Y share all partnership items of                           is $5.                                                                                  taxable year, the shareholder generally ag-
income, gain, loss, deduction, and credit equally,                               Example 4. Small business simplified overall                                        gregates its pro rata share of such items,
except that 80% of the wage expense of PRS and                               method. A, an individual, and X, a corporation,
20% of PRS’s other expenses are specially allocated                          are partners in PRS. PRS engages in manufacturing
                                                                                                                                                                     to the extent they are not otherwise disal-
to X (substantial economic effect under section                              activities that generate both DPGR and non-DPGR.                                        lowed by the Internal Revenue Code, with
704(b) is presumed). In the 2010 taxable year, PRS’s                         A and X share all items of income, gain, loss, de-                                      those items it incurs outside the S cor-
only wage expense is $2,000 for marketing, which                             duction, and credit equally. In the 2010 taxable year,                                  poration (whether directly or indirectly)
is not included in CGS. PRS has $8,000 of gross                              PRS has total gross receipts of $2,000 ($1,000 of                                       for purposes of allocating and apportion-
receipts ($6,000 of which is DPGR), $4,000 of CGS                            which is DPGR), CGS of $800 (including $400 of
($3,500 of which is allocable to DPGR), and $3,000                           W–2 wages), and deductions of $800. A and PRS use
                                                                                                                                                                     ing deductions to DPGR and computing
of deductions (comprised of $2,000 of wages for                              the small business simplified overall method under                                      its QPAI. However, if an S corporation
marketing and $1,000 of other expenses). X qualifies                         §1.199–4(f). X uses the section 861 method. Under                                       uses the small business simplified over-
for and uses the simplified deduction method under                           the small business simplified overall method, PRS’s                                     all method described in §1.199–4(f), then
§1.199–4(e). Y does not qualify to use that method                           CGS and deductions apportioned to DPGR equal
                                                                                                                                                                     each shareholder is allocated its share of
and therefore, must use the section 861 method under                         $800 (($800 CGS plus $800 of other deductions) x
§1.199–4(d). In the 2010 taxable year, X has gross                           ($1,000 DPGR/$2,000 total gross receipts)). Accord-
                                                                                                                                                                     QPAI and W–2 wages, which (subject to
receipts attributable to non-partnership activities of                       ingly, PRS’s QPAI is $200 ($1,000 DPGR - $800                                           the limitation under section 199(d)(1)(B))
$1,000 and wages of $200. None of X’s non-PRS                                CGS and other deductions). Under the partnership                                        are combined with the shareholder’s QPAI
gross receipts is DPGR.                                                      agreement, PRS’s QPAI is allocated $100 to A and                                        and W–2 wages from other sources. Un-
     (ii) Allocation and apportionment of costs. Under                       $100 to X. A’s share of partnership W–2 wages for
                                                                                                                                                                     der this method, a shareholder’s share of
the partnership agreement, X’s distributive share of                         purposes of the section 199(d)(1)(B) limitation is
the items of the partnership is $1,250 of gross income                       $18, the lesser of $200 (A’s 50% allocable share of
                                                                                                                                                                     QPAI from an S corporation may be less
attributable to DPGR ($3,000 DPGR - $1,750 alloca-                           PRS’s $400 of W–2 wages) or $18 (2 x ($100 QPAI                                         than zero.
ble CGS), $750 of gross income attributable to non-                          x .09)). A’s tentative deduction is $9 ($100 QPAI x                                         (2) Disallowed deductions. Deductions
DPGR ($1,000 non-DPGR - $250 allocable CGS),                                 .09), subject to the section 199(b)(1) wage limitation                                  of the S corporation that otherwise would
and $1,800 of deductions (comprised of X’s special                           of $9 (50% x $18). Assuming that A engages in no
                                                                                                                                                                     be taken into account in computing the
allocations of $1,600 of wage expense for market-                            other activities generating DPGR, A’s total section
ing and $200 of other expenses). Under the simpli-                           199 deduction for the 2010 taxable year is $9. X
                                                                                                                                                                     shareholder’s section 199 deduction are
fied deduction method, X apportions $1,200 of other                          must use $100 of QPAI and $18 of W–2 wages to                                           taken into account only if and to the ex-
deductions to DPGR ($2,000 ($1,800 from the part-                                                                                                                    tent the shareholder’s pro rata share of the


November 21, 2005                                                                                               1039                                                                                2005–47 I.R.B.
losses or deductions from all of the S cor-     that if QPAI, computed by taking into ac-        if the CGS and deductions allocated and
poration’s activities are not disallowed by     count only the items of the S corporation        apportioned to DPGR exceed the trust’s
section 465, 469, 1366(d), or any other         allocated to the shareholder for the taxable     or estate’s DPGR) and W–2 wages of the
provision of the Internal Revenue Code.         year, is not greater than zero, the share-       trust or estate are allocated to each ben-
If only a portion of the shareholder’s pro      holder may not take into account any W–2         eficiary and to the trust or estate based
rata share of the losses or deductions is al-   wages of the S corporation in computing          on the relative proportion of the trust’s or
lowed for a taxable year, a proportionate       the shareholder’s section 199 deduction.         estate’s distributable net income (DNI), as
share of the losses or deductions allocated     See §1.199–2 for the computation of W–2          defined by section 643(a), for the taxable
to the S corporation’s qualified production     wages, and paragraph (f) of this section for     year that is distributed or required to be
activities, determined in a manner consis-      rules regarding pass-thru entities in a tiered   distributed to the beneficiary or is retained
tent with sections 465, 469, 1366(d), and       structure.                                       by the trust or estate. To the extent that
any other applicable provision of the In-           (c) Grantor trusts. To the extent that       the trust or estate has no DNI for the tax-
ternal Revenue Code, is taken into account      the grantor or another person is treated as      able year, any QPAI and W–2 wages are
in computing the section 199 deduction for      owning all or part (the owned portion) of        allocated entirely to the trust or estate. A
that taxable year. To the extent that any       a trust under sections 671 through 679, the      trust or estate may claim the section 199
of the disallowed losses or deductions is       owner computes its QPAI with respect to          deduction in computing its taxable income
allowed in a later taxable year, the share-     the owned portion of the trust as if that        to the extent that QPAI and W–2 wages
holder takes into account a proportionate       QPAI had been generated by activities per-       are allocated to the trust or estate. A ben-
share of those losses or deductions in com-     formed directly by the owner. Similarly,         eficiary of a trust or estate is allowed the
puting its QPAI for that later taxable year.    for purposes of the section 199(b) wage          section 199 deduction in computing its
    (3) Shareholder’s share of W–2 wages.       limitation, the owner of the trust takes         taxable income based on its share of QPAI
Under section 199(d)(1)(B), an S corpora-       into account the owner’s share of the W–2        and W–2 wages from the trust or estate,
tion shareholder’s share of the W–2 wages       wages of the trust that are attributable to      which (subject to the wage limitation of
of the S corporation for purposes of de-        the owned portion of the trust. The section      section 199(d)(1)(B)) are aggregated with
termining the shareholder’s section 199(b)      199(d)(1)(B) wage limitation is not appli-       the beneficiary’s QPAI and W–2 wages
limitation is the lesser of the shareholder’s   cable to the owned portion of the trust.         from other sources. Each beneficiary
allocable share of those wages (without re-         (d) Non-grantor trusts and estates—(1)       must compute its share of W–2 wages
gard to section 199(d)(1)(B)), or 2 times       Computation of section 199 deduction.            from a trust or estate in accordance with
9 percent (3 percent for taxable years be-      Except as provided in paragraph (c) of           section 199(d)(1)(B). The application of
ginning in 2005 or 2006, and 6 percent          this section, solely for purposes of de-         section 199(d)(1)(B) therefore means that
for taxable years beginning in 2007, 2008,      termining the section 199 deduction for          if QPAI, computed by taking into account
or 2009) of the QPAI computed by taking         the taxable year, the QPAI of a trust or         only the items of the trust or estate allo-
into account only the items of the S corpo-     estate must be computed by allocating            cated to the beneficiary for the taxable
ration allocated to the shareholder for the     expenses described in section 199(d)(5)          year, is not greater than zero, the benefi-
taxable year. In general, this QPAI calcula-    under §1.652(b)–3 with respect to directly       ciary may not take into account any W–2
tion is performed by the shareholder using      attributable expenses, and under the sim-        wages of the trust or estate in computing
the same cost allocation method that the        plified deduction method of §1.199–4(e)          the beneficiary’s section 199 deduction.
shareholder uses in calculating the share-      with respect to other expenses described         See paragraph (f) of this section for rules
holder’s section 199 deduction. However,        in section 199(d)(5) (unless the trust or es-    applicable to pass-thru entities in a tiered
if an S corporation uses the small busi-        tate does not qualify to use the simplified      structure.
ness simplified overall method described        deduction method, in which case it must              (2) Example. The following example
in §1.199–4(f), the QPAI used by each           use the section 861 method of §1.199–4(d)        illustrates the application of this paragraph
shareholder to determine the wage limi-         with respect to such other expenses). For        (d). Assume that the partnership, trust,
tation under section 199(d)(1)(B) is the        this purpose, the trust’s or estate’s share of   and trust beneficiary all are calendar year
same as the share of QPAI allocated to          other expenses from a lower-tier pass-thru       taxpayers. The example is as follows:
the shareholder. Each shareholder must          entity is not directly attributable to any            Example. (i) Computation of DNI and inclusion
compute its share of W–2 wages from an          class of income (whether or not those            and deduction amounts. (A) Trust’s distributive
                                                                                                 share of partnership items. Trust, a complex trust, is
S corporation in accordance with section        other expenses are directly attributable to      a partner in PRS, a partnership that engages in activ-
199(d)(1)(B) (with W–2 wages being allo-        the aggregate pass-thru gross income as a        ities that generate DPGR and non-DPGR. In 2010,
cated to the shareholder in the same man-       class for purposes other than section 199).      PRS distributes $10,000 to Trust. Trust’s distributive
ner as is wage expense), and then add           A trust or estate may not use the small          share of PRS items, which are properly included in
that share to the shareholder’s W–2 wages       business simplified overall method for           Trust’s DNI, is as follows:

from other sources, if any. The application     computing its QPAI. See §1.199–4(f)(4).
of section 199(d)(1)(B) therefore means         The QPAI (which will be less than zero




2005–47 I.R.B.                                                     1040                                             November 21, 2005
                   Gross income attributable to DPGR ($15,000 DPGR - $5,000 CGS (including W–2 wages of $1,000)) . . . . . . . .                                                                   $10,000
                   Gross income attributable to other gross receipts ($5,000 other gross receipts - $0 CGS) . . . . . . . . . . . . . . . . . . . .                                                 $5,000
                   Selling expenses (includes W–2 wages of $2,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              $3,000
                   Other expenses (includes W–2 wages of $1,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              $2,000


    (B) Trust’s direct activities. In addition to receiv-                    rectly has the following items which are properly in-
ing in 2010 the distribution from PRS, Trust also di-                        cluded in Trust’s DNI:


                   Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   $10,000
                   Tax-exempt interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         $10,000
                   Rents from commercial real property that is subject to a section 6166 election . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                          $10,000
                   Real estate taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       $1,000
                   Trustee commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            $3,000
                   State income and personal property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       $5,000
                   W–2 wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        $2,000
                   Other business expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              $1,000


     (C) Allocation of deductions under §1.652(b)–3.                              (ii) Section 199 deduction. (A) Simplified deduc-                                 pose, the $1,500 of other expenses is determined by
(1) Directly attributable expenses. In computing                             tion method. For purposes of computing the section                                     multiplying $2,000 of other expenses from PRS by
Trust’s DNI for the taxable year, the distributive                           199 deduction for the taxable year, assume Trust                                       $15,000 of DPGR from PRS, divided by $20,000 of
share of expenses of PRS are directly attributable un-                       qualifies for the simplified deduction method under                                    total gross receipts from PRS. Trust adds this $990
der §1.652(b)–3(a) to the distributive share of income                       §1.199–4(e). Determining Trust’s QPAI under the                                        of W–2 wages to Trust’s own $2,000 of W–2 wages
of PRS. Accordingly, the $20,000 of gross receipts                           simplified deduction method requires a multi-step                                      (thus, $2,990). Because the $14,000 distribution to
from PRS is reduced by $5,000 of CGS, $3,000                                 approach to allocating costs. In step 1, the Trust’s                                   B equals one-half of Trust’s DNI, Trust and B each
of selling expenses, and $2,000 of other expenses,                           DPGR is first reduced by the Trust’s expenses di-                                      has W–2 wages of $1,495. After applying the sec-
resulting in net income from PRS of $10,000. With                            rectly attributable to DPGR under §1.652(b)–3(a). In                                   tion 199(d)(1)(B) wage limitation to B’s share of the
respect to the Trust’s direct expenses, $1,000 of the                        this step, the $15,000 of DPGR from PRS is reduced                                     W–2 wages allocated from Trust, B has W–2 wages
trustee commissions, the $1,000 of real estate taxes,                        by the directly attributable $5,000 of CGS and sell-                                   of $468 from Trust (lesser of $1,495 (allocable share
and the $2,000 of W–2 wages are directly attributable                        ing expenses of $3,000. In step 2, Trust allocates its                                 of W–2 wages) or 2 x .09 x $2,600 (Trust’s QPAI)).
under §1.652(b)–3(a) to the rental income.                                   other business expenses on the basis of its total gross                                B has W–2 wages of $100 from non-Trust activities
     (2) Non-directly attributable expenses. Under                           receipts. In this example, the portion of the trustee                                  for a total of $568 of W–2 wages.
§1.652(b)–3(b), the trustee must allocate a portion                          commissions not directly attributable to the rental op-                                    (C) Section 199 deduction computation. (1) B’s
of the sum of the balance of the trustee commissions                         eration, as well as the portion of the state income and                                computation. B is eligible to use the small business
($2,000), state income and personal property taxes                           personal property taxes not directly attributable to ei-                               simplified overall method. Assume that B has suf-
($5,000), and the other business expenses ($1,000) to                        ther the PRS interests or the rental operation, are not                                ficient adjusted gross income so that the section 199
the $10,000 of tax-exempt interest. The portion to be                        trade or business expenses and, thus, are ignored in                                   deduction is not limited under section 199(a)(1)(B). B
attributed to tax-exempt interest is $2,222 ($8,000 x                        computing QPAI. The portion of the state income and                                    has $1,000 of QPAI from non-Trust activities which
($10,000 tax exempt interest/$36,000 gross receipts                          personal property taxes that is treated as other trade                                 is added to the $2,600 QPAI from Trust for a total
net of direct expenses)), resulting in $7,778 ($10,000                       or business expenses is $3,000 ($5,000 x $30,000                                       of $3,600 of QPAI. B’s tentative deduction is $324
- $2,222) of net tax-exempt interest. Pursuant to                            total trade or business gross receipts/$50,000 total                                   (.09 x $3,600) which is limited under section 199(b)
its authority recognized under §1.652(b)–3(b), the                           gross receipts). Trust then combines its non-directly                                  to $284 (50% x $568 W–2 wages). Accordingly, B’s
trustee allocates the entire amount of the remaining                         attributable (other) expenses ($2,000 from PRS +                                       section 199 deduction for 2010 is $284.
$5,778 of trustee commissions, state income and                              $4,000 ($1,000 + $3,000) from its own activities)                                          (2) Trust’s computation. Trust has sufficient tax-
personal property taxes, and other business expenses                         and then apportions this total between DPGR and                                        able income so that the section 199 deduction is not
to the $6,000 of net rental income, resulting in $222                        other receipts on the basis of Trust’s total gross re-                                 limited under section 199(a)(1)(B). Trust’s tentative
($6,000 - $5,778) of net rental income.                                      ceipts ($6,000 x $15,000 DPGR/$50,000 total gross                                      deduction is $234 (.09 x $2,600 QPAI) which is lim-
     (D) Amounts included in taxable income. For                             receipts = $1,800). Thus, for purposes of computing                                    ited under section 199(b) to $748 (50% x $1,495 W–2
2010, Trust has DNI of $28,000 (net dividend in-                             Trust’s and B’s section 199 deduction, Trust’s QPAI                                    wages). Accordingly, Trust’s section 199 deduction
come of $10,000 + net PRS income of $10,000 + net                            is $5,200 ($7,000 - $1,800). Because the distribution                                  for 2010 is $234.
rental income of $222 + net tax-exempt income of                             of Trust’s DNI to B equals one-half of Trust’s DNI,                                        (e) Gain or loss from the disposition of
$7,778). Pursuant to Trust’s governing instrument,                           Trust and B each has QPAI from PRS for purposes                                        an interest in a pass-thru entity. DPGR
Trustee distributes 50%, or $14,000, of that DNI to                          of the section 199 deduction of $2,600.
B, an individual who is a discretionary beneficiary of                            (B) Section 199(d)(1)(B) wage limitation. The
                                                                                                                                                                    generally does not include gain or loss rec-
Trust. Assume that there are no separate shares un-                          wage limitation under section 199(d)(1)(B) must be                                     ognized on the sale, exchange, or other dis-
der Trust, and no distributions are made to any other                        applied both at the Trust level and at B’s level. Af-                                  position of an interest in a pass-thru entity.
beneficiary that year. Consequently, with respect to                         ter applying this limitation to the Trust’s share of                                   However, with respect to partnerships, if
the $14,000 distribution, B properly includes in B’s                         PRS’s W–2 wages, Trust is allocated $990 of W–2
                                                                                                                                                                    section 751(a) or (b) applies, gain or loss
gross income $5,000 of income from PRS, $111 of                              wages from PRS (the lesser of Trust’s allocable share
rents, and $5,000 of dividends, and properly excludes                        of PRS’s W–2 wages ($4,000) or 2 x 9% of PRS’s
                                                                                                                                                                    attributable to assets of the partnership giv-
from B’s gross income $3,889 of tax-exempt interest.                         QPAI ($5,500)). PRS’s QPAI for purposes of the sec-                                    ing rise to ordinary income under section
Trust includes $20,222 in its adjusted total income                          tion 199(d)(1)(B) limitation is determined by taking                                   751(a) or (b), the sale, exchange, or other
and deducts $10,111 under section 661(a) in comput-                          into account only the items of PRS allocated to Trust                                  disposition of which would give rise to
ing its taxable income.                                                      ($15,000 DPGR - ($5,000 of CGS + $3,000 selling
                                                                                                                                                                    DPGR, is taken into account in computing
                                                                             expenses + $1,500 of other expenses). For this pur-



November 21, 2005                                                                                               1041                                                                               2005–47 I.R.B.
the partner’s section 199 deduction. Ac-        though all wages paid during that taxable                  States, and contributes or leases, rents,
cordingly, to the extent that money or prop-    year are taken into account in computing                   licenses, sells, exchanges, or otherwise
erty received by a partner in a sale or ex-     QPAI, only the W–2 wages as described in                   disposes of the property to a partnership
change for all or part of its partnership in-   §1.199–2 are taken into account in com-                    which then leases, rents, licenses, sells,
terest is attributable to unrealized receiv-    puting the W–2 wage limitation.                            exchanges, or otherwise disposes of the
ables or inventory items within the mean-           (3) Example. The following example                     property, the partnership’s gross receipts
ing of section 751(c) or (d), respectively,     illustrates the application of this paragraph              from this latter disposition are not treated
and the sale or exchange of the unrealized      (f). Assume that each partnership and each                 as DPGR under §1.199–3.
receivable or inventory items would give        partner (whether or not an individual) is a
rise to DPGR if sold or exchanged or oth-       calendar year taxpayer. The example is as                  §1.199–6 Agricultural and horticultural
erwise disposed of by the partnership, the      follows:                                                   cooperatives.
money or property received is taken into             Example. (i) In 2010, A, an individual, owns a
account by the partner in determining its       50% interest in a partnership, UTP, which in turn              (a) In general. This section applies to
                                                owns a 50% interest in another partnership, LTP.
DPGR for the taxable year. Likewise, to         All partnership items are allocated in proportion to
                                                                                                           a cooperative to which Part I of subchap-
the extent that a distribution of property to   these ownership percentages. Both partnerships are         ter T of the Internal Revenue Code applies
a partner is treated under section 751(b) as    eligible for and use the small business simplified         and its patrons if the cooperative has man-
a sale or exchange of property between the      overall method under §1.199–4(f). LTP has QPAI             ufactured, produced, grown, or extracted
partnership and the distributee partner, and    of $400 ($900 DPGR - $450 CGS (which includes              (MPGE) (as defined in §1.199–3(d)) in
                                                W–2 wages of $100) - $50 other deductions). Before
any property deemed sold or exchanged           taking into account its distributive share from LTP,
                                                                                                           whole or significant part (as defined in
would give rise to DPGR if sold or ex-          UTP has QPAI of ($500) ($500 DPGR - $500 CGS               §1.199–3(f)) within the United States (as
changed by the partnership, the deemed          (which includes W–2 wages of $200) - $500 other            defined in §1.199–3(g)) any agricultural or
sale or exchange of the property must be        deductions). UTP’s distributive share of LTP’s QPAI        horticultural product, or has marketed agri-
taken into account in determining the part-     is $200.                                                   cultural or horticultural products. For this
                                                     (ii) UTP’s share of LTP’s W–2 wages for pur-
nership’s and distributee partner’s DPGR.       poses of the section 199(d)(1)(B) limitation is $36,
                                                                                                           purpose, agricultural or horticultural prod-
See §1.751–1(b).                                the lesser of $50 (UTP’s allocable share of LTP’s          ucts also include fertilizer, diesel fuel, and
    (f) Section 199(d)(1)(B) wage limita-       W–2 wages paid) or $36 (2 x ($200 QPAI x .09)). Af-        other supplies used in agricultural or hor-
tion and tiered structures—(1) In general.      ter taking into account its distributive share from LTP,   ticultural production. If any amount of a
If a pass-thru entity owns an interest, di-     UTP has QPAI of ($300) and W–2 wages of $236. A’s          patronage dividend or per-unit retain al-
                                                distributive share of UTP’s QPAI is ($150). A’s limi-
rectly or indirectly, in one or more pass-      tation under section 199(d)(1)(B) with respect to A’s
                                                                                                           location received by a patron is allocable
thru entities, the wage limitation of section   interest in UTP is $0, the lesser of $118 (A’s allocable   to the qualified production activities in-
199(d)(1)(B) must be applied at each tier       share of UTP’s W–2 wages paid) or $0 (because A’s          come (QPAI) (as defined in §1.199–1(c))
(that is, separately for each entity). Thus,    share of QPAI, ($150), is less than zero).                 of the cooperative, would be allowable as a
at each tier, the owner of a pass-thru en-          (g) No attribution of qualified activi-                deduction under §1.199–1(a) (section 199
tity calculates the amounts described in        ties. Except as provided in §1.199–3(h)(7)                 deduction) by the cooperative, and is des-
sections 199(d)(1)(B)(i) (allocable share)      regarding certain qualifying oil and gas                   ignated as such in a written notice to the
and 199(d)(1)(B)(ii) (twice the applicable      partnerships and §1.199–3(h)(8) regarding                  patron during the payment period defined
percentage of QPAI from that entity) sep-       EAG partnerships, for purposes of section                  under section 1382(d), then such amount
arately with regard to its interest in that     199, an owner of a pass-thru entity is not                 is deductible by the patron as a section
pass-thru entity.                               treated as conducting the qualified produc-                199 deduction. For this purpose, patron-
    (2) Share of W–2 wages. For purposes        tion activities of the pass-thru entity, and               age dividends and per-unit retain alloca-
of section 199(d)(1)(B)(i) and section          vice versa. This rule applies to all part-                 tions include any advances on patronage or
199(b), the W–2 wages of the owner of           nerships, including partnerships that have                 per-unit retains paid in money during the
an interest in a pass-thru entity (upper-tier   elected out of subchapter K under sec-                     taxable year.
entity) that owns an interest in one or more    tion 761(a). Accordingly, if a partnership                     (b) Written notice to patrons. In or-
pass-thru entities (lower-tier entities) are    MPGE QPP within the United States, or                      der for a patron to qualify for the section
equal to the sum of the owner’s allocable       otherwise produces a qualified film or util-               199 deduction, paragraph (a) of this sec-
share of W–2 wages of the upper-tier en-        ities in the United States, and distributes                tion requires that the cooperative designate
tity, as limited in accordance with section     or leases, rents, licenses, sells, exchanges,              in a written notice the amount of the pa-
199(d)(1)(B), and the owner’s own W–2           or otherwise disposes of the property to                   tron’s patronage dividend or per-unit re-
wages. The upper-tier entity’s W–2 wages        a partner who then leases, rents, licenses,                tain allocation that is allocable to QPAI
are equal to the sum of the upper-tier en-      sells, exchanges, or otherwise disposes                    and deductible by the cooperative. This
tity’s allocable share of W–2 wages of the      of the property, the partner’s gross re-                   written notice designating the patron’s por-
next lower-tier entity, as limited in accor-    ceipts from this latter lease, rental, license,            tion of the section 199 deduction must be
dance with section 199(d)(1)(B), and the        sale, exchange, or other disposition are                   mailed by the cooperative to its patrons
upper-tier entity’s own W–2 wages. The          not treated as DPGR under §1.199–3. In                     no later than the 15th day of the ninth
W–2 wages of each lower-tier entity in a        addition, if a partner MPGE QPP within                     month following the close of the taxable
tiered structure, in turn, is computed as       the United States, or otherwise produces                   year. The cooperative may use the same
described in the preceding sentence. Al-        a qualified film or utilities in the United                written notice, if any, that it uses to no-


2005–47 I.R.B.                                                         1042                                                November 21, 2005
tify patrons of their respective allocations       (g) Section is exclusive. This section                  As a consequence, Cooperative X is entitled to a pa-
of patronage dividends, or may use a sep-      is the exclusive method for cooperatives                    tronage dividend deduction for the taxable year end-
arate timely written notice(s) to comply       and their patrons to compute the amount of                  ing December 31, 2005, in the amount of $970,000
                                                                                                           ($1,000,000 - $30,000) and to a section 199 deduc-
with this section. The cooperative must        the section 199 deduction. Thus, a patron                   tion in the amount of $30,000 ($1,000,000 x .03). Its
report the amount of the patron’s section      may not deduct any amount with respect                      taxable income for 2005 is $0.
199 deduction on Form 1099-PATR, “Tax-         to a patronage dividend or a per-unit retain                     Example 3. (i) The facts are the same as in Ex-
able Distributions Received From Cooper-       allocation unless the requirements of this                  ample 1 except that Cooperative X paid out $500,000
atives,” issued to the patron.                 section are satisfied.                                      to its patrons as advances on expected patronage net
                                                                                                           earnings. In 2005, Cooperative X pays its patrons a
    (c) Determining cooperative’s qualified        (h) No double counting. A patronage                     $500,000 ($1,000,000 - $500,000 already paid) pa-
production activities income. In determin-     dividend or per-unit retain allocation re-                  tronage dividend in cash or a combination of cash
ing the portion of the cooperative’s QPAI      ceived by a patron of a cooperative is not                  and qualified written notices of allocation. Under
that would be allowable as a section 199       QPAI in the hands of the patron.                            sections 199(d)(3)(A) and 1382, Cooperative X is al-
deduction by the cooperative, the cooper-          (i) Examples. The following examples                    lowed a patronage dividend deduction of $470,000
                                                                                                           ($500,000 - $30,000 section 199 deduction), whether
ative’s taxable income is computed with-       illustrate the application this section:                    patronage net earnings are distributed on book or tax
out taking into account any deduction al-          Example 1. (i) Cooperative X markets corn
                                                                                                           net earnings.
lowable under section 1382(b) or (c) (re-      grown by its members within the United States for
                                                                                                                (ii) The patrons will have received a gross amount
                                               sale to retail grocers. For its calendar year ended
lating to patronage dividends, per-unit re-                                                                of $1,000,000 from Cooperative X ($500,000 paid
                                               December 31, 2005, Cooperative X has gross re-
tain allocations, and nonpatronage distri-                                                                 during the taxable year as advances and the additional
                                               ceipts of $1,500,000, all derived from the sale of
                                                                                                           $500,000 paid as qualified patronage dividends). If
butions) and, in the case of a cooperative     corn grown by its members. Cooperative X’s W–2
                                                                                                           Cooperative X passes through its entire section 199
engaged in the marketing of agricultural       wages for 2005 total $500,000. Cooperative X has
                                                                                                           deduction to its members by providing the notice re-
and/or horticultural products, the coopera-    no other costs. Patron A is a member of Cooperative
                                                                                                           quired by paragraph (b) of this section, the patrons
                                               X. Patron A is a cash basis taxpayer and files Federal
tive is treated as having MPGE in whole or                                                                 will be allowed a $30,000 section 199 deduction, re-
                                               income tax returns on a calendar year basis. All corn
in significant part within the United States                                                               sulting in a net $970,000 taxable distribution from
                                               grown by Patron A in 2005 is sold through Coopera-
                                                                                                           Cooperative X. Pursuant to paragraph (h) of this sec-
any agricultural or horticultural products     tive X and Patron A is eligible to share in patronage
                                                                                                           tion, the $1,000,000 received by the patrons from Co-
marketed by the cooperative that its pa-       dividends paid by Cooperative X for that year.
                                                                                                           operative X is not QPAI in the hands of the patrons.
trons have MPGE.                                   (ii) Cooperative X is an agricultural cooperative
                                               described in paragraph (a) of this section. Accord-
    (d) Additional rules relating to                                                                       §1.199–7 Expanded affiliated groups.
                                               ingly, this section applies to Cooperative X and its pa-
pass-through of section 199 deduction.         trons and all of Cooperative X’s gross receipts from
The cooperative may, at its discretion,        the sale of its patrons’ corn qualify as domestic pro-
                                                                                                              (a) In general. All members of an ex-
pass through all, some, or none of the         duction gross receipts (as defined §1.199–3(a)). Co-        panded affiliated group (EAG) are treated
section 199 deduction to its patrons. A        operative X’s QPAI under paragraph (c) of this sec-         as a single corporation for purposes of sec-
                                               tion is $1,000,000. Cooperative X’s section 199 de-         tion 199. Notwithstanding the preceding
cooperative member of a federated coop-        duction for its taxable year 2005 is $30,000 (.03 x
erative may pass through the section 199                                                                   sentence, except as otherwise provided in
                                               $1,000,000). Since this amount is less than 50% of
deduction it receives from the federated       Cooperative X’s W–2 wages, the entire amount is de-
                                                                                                           the Internal Revenue Code and regulations
cooperative to its member patrons. Pa-         ductible.                                                   (see, for example, sections 199(c)(7) and
trons may claim the section 199 deduction          Example 2. (i) The facts are the same as in Ex-         267, §1.199–3(b), paragraph (a)(3) of this
                                               ample 1 except that Cooperative X decides to pass its       section, and the consolidated return reg-
for the taxable year in which they receive     entire section 199 deduction through to its members.
the written notice from the cooperative                                                                    ulations), each member of an EAG is a
                                               Cooperative X declares a patronage dividend for its
informing them of the section 199 amount       2005 taxable year of $1,000,000, which it pays on
                                                                                                           separate taxpayer that computes its own
without regard to the taxable income limi-     March 15, 2006. Pursuant to paragraph (b) of this sec-      taxable income or loss, qualified produc-
tation under §1.199–1(a) and (b).              tion, Cooperative X notifies members in written no-         tion activites income (QPAI) (as defined in
                                               tices which accompany the patronage dividend notifi-        §1.199–1(c)), and W–2 wages (as defined
    (e) W–2 wages. The W–2 wage limita-        cation that it is allocating to them the section 199 de-
tion described in §1.199–2 shall be applied                                                                in §1.199–2(f)). If members of an EAG are
                                               duction it is entitled to claim in the taxable year 2005.
at the cooperative level whether or not the    On March 15, 2006, Patron A receives a $10,000 pa-
                                                                                                           also members of a consolidated group, see
cooperative chooses to pass through some       tronage dividend from Cooperative X. In the notice          paragraph (d) of this section.
or all of the section 199 deduction. Any       that accompanies the patronage dividend, Patron A              (1) Definition of expanded affiliated
                                               is designated a $300 section 199 deduction. Under           group. An EAG is an affiliated group as
section 199 deduction that has been passed     paragraph (d) of this section, Patron A may claim a
through by a cooperative to its patrons is                                                                 defined in section 1504(a), determined by
                                               $300 section 199 deduction for the taxable year end-
not subject to the W–2 wage limitation a       ing December 31, 2006, without regard to the taxable
                                                                                                           substituting “more than 50 percent” for “at
second time at the patron level.               income limitation under §1.199–1(a) and (b). Coop-          least 80 percent” each place it appears and
    (f) Recapture of section 199 deduction.    erative X must report the amount of Patron A’s sec-         without regard to section 1504(b)(2) and
                                               tion 199 deduction on Form 1099-PATR, “Taxable              (4).
If the amount of the section 199 deduction     Distributions Received From Cooperative,” issued to
that was passed through to patrons exceeds                                                                    (2) Identification of members of an ex-
                                               the Patron A for the calendar year 2006.
the amount allowable as a section 199 de-          (ii) Under section 199(d)(3)(A), Cooperative X is
                                                                                                           panded affiliated group—(i) In general. A
duction as determined on audit or reported     required to reduce its patronage dividend deduction         corporation must determine if it is a mem-
on the amended return, recapture of the ex-    of $1,000,000 by the $30,000 section 199 deduction          ber of an EAG on a daily basis.
                                               passed through to members (whether or not Cooper-              (ii) Becoming or ceasing to be a mem-
cess will occur at the cooperative level.      ative X pays patronage on book or tax net earnings).
                                                                                                           ber of an expanded affiliated group. If


November 21, 2005                                                      1043                                                             2005–47 I.R.B.
a corporation becomes or ceases to be a                   another member of the EAG MPGE the pens and pen-            among members of the expanded affiliated
member of an EAG, the corporation is                      cils.                                                       group—(1) In general. An EAG’s sec-
treated as becoming or ceasing to be a                         Example 2. For the entire 2006 taxable year, Cor-      tion 199 deduction is allocated among the
                                                          porations A and B are members of the same EAG.
member of the EAG at the end of the day                   A is engaged solely in the trade or business of man-
                                                                                                                      members of the EAG in proportion to each
on which its status as a member changes.                  ufacturing QPP in the United States. A and B each           member’s QPAI regardless of whether the
   (3) Attribution of activities. In general,             own 45 percent of partnership C and unrelated per-          EAG member has taxable income or loss
if a member of an EAG (the disposing                      sons own the remaining 10 percent. C is engaged             or W–2 wages for the taxable year. For
member) derives gross receipts (as de-                    solely in the trade or business of manufacturing the        this purpose, if a member has negative
                                                          same type of QPP in the United States as A. In 2006,
fined in §1.199–3(c)) from the lease,                     B purchases and then resells the QPP manufactured
                                                                                                                      QPAI, the QPAI of the member shall be
rental, license, sale, exchange, or other                 in 2006 by A and C. B also resells QPP it purchases         treated as zero.
disposition (as defined in §1.199–3(h))                   from unrelated persons. If only B’s activities were             (2) Use of section 199 deduction to cre-
of qualifying production property (QPP)                   considered, B would not qualify for the deduction un-       ate or increase a net operating loss. Not-
(as defined in §1.199–3(i)) that was man-                 der §1.199–1(a) (section 199 deduction). However,           withstanding §1.199–1(b), which gener-
                                                          because B is a member of the EAG that includes A, B
ufactured, produced, grown or extracted                   is treated as conducting A’s manufacturing activities
                                                                                                                      ally prevents the section 199 deduction
(MPGE) (as defined in §1.199–3(d)), in                    in determining whether B’s gross receipts are DPGR.         from creating or increasing an NOL, if a
whole or in significant part (as defined                  C is not a member of the EAG and thus C’s MPGE ac-          member of an EAG has some or all of the
in §1.199–3(f)), in the United States (as                 tivities are not attributed to B in determining whether     EAG’s section 199 deduction allocated to
defined in §1.199–3(g)), a qualifed film                  B’s gross receipts are DPGR. Accordingly, B’s gross         it under paragraph (c)(1) of this section and
                                                          receipts attributable to its sale of the QPP it purchases
(as defined in §1.199–3(j)) that was pro-                 from A are DPGR (assuming all the other require-
                                                                                                                      the amount allocated exceeds the mem-
duced in the United States, or electricity,               ments of §1.199–3 are met). B’s gross receipts attrib-      ber’s taxable income (determined prior to
natural gas, or potable water (as defined                 utable to its sale of the QPP it purchases from C and       allocation of the section 199 deduction),
in §1.199–3(k)) (collectively, utilities)                 from the unrelated persons are non-DPGR because no          the section 199 deduction will create an
that was produced in the United States by                 member of the EAG MPGE the QPP. If rather than re-          NOL for the member. Similarly, if a mem-
                                                          selling the QPP, B rented the QPP it acquired from A
another member or members of the same                     to unrelated persons, B’s gross receipts attributable to
                                                                                                                      ber of an EAG, prior to the allocation of
EAG, the disposing member is treated as                   the rental of the QPP would also be DPGR (assuming          some or all of the EAG’s section 199 de-
conducting the activities conducted by                    all the other requirements of §1.199–3 are met).            duction to the member, has an NOL for the
each other member of the EAG with re-                         (5) Anti-avoidance rule. If a transaction               taxable year, the portion of the EAG’s sec-
spect to the QPP, qualified film, or utilities            between members of an EAG is engaged                        tion 199 deduction allocated to the mem-
in determining whether its gross receipts                 in or structured with a principal purpose                   ber will increase the member’s NOL.
are domestic production gross receipts                    of qualifying for, or increasing the amount                     (d) Special rules for members of the
(DPGR) (as defined in §1.199–3(a)).                       of, the section 199 deduction of the EAG                    same consolidated group—(1) Intercom-
However, attribution of activities does not               or the portion of the section 199 deduction                 pany transactions. In the case of an in-
apply for purposes of the construction of                 allocated to one or more members of the                     tercompany transaction between consoli-
real property under §1.199–3(l) or the per-               EAG, adjustments must be made to elim-                      dated group members S and B (intercom-
formance of engineering and architectural                 inate the effect of the transaction on the                  pany transaction, S, and B as defined in
services under §1.199–3(m). A member                      computation of the section 199 deduction.                   §1.1502–13(b)(1)), S takes an intercom-
of an EAG must engage in a construction                       (b) Computation of expanded affili-                     pany transaction into account in comput-
activity under §1.199–3(l)(2), provide en-                ated group’s section 199 deduction—(1)                      ing the section 199 deduction at the same
gineering services under §1.199–3(m)(2),                  In general. The section 199 deduction                       time and in the same proportion as S takes
or provide architectural services under                   for an EAG is determined by aggregating                     into account the income, gain, deduction,
§1.199–3(m)(3) in order for the member’s                  each member’s taxable income or loss,                       or loss from the intercompany transaction
gross receipts to be derived from construc-               QPAI, and W–2 wages. For this purpose,                      under §1.1502–13.
tion, engineering, or architectural services.             a member’s QPAI is determined under                             (2) Attribution of activities in the con-
   (4) Examples. The following exam-                      §1.199–1. For purposes of this determi-                     struction of real property and the perfor-
ples illustrate the application of paragraph              nation, a member’s QPAI may be positive                     mance of engineering and architectural
(a)(3) of this section:                                   or negative. A member’s taxable income                      services.      Notwithstanding paragraph
    Example 1. Corporations M and N are members           or loss and QPAI shall be determined by                     (a)(3) of this section, a disposing member
of the same EAG. M is engaged solely in the trade         reference to the member’s methods of                        (as described in such paragraph) is treated
or business of manufacturing furniture in the United
States that it sells to unrelated persons. N is engaged
                                                          accounting.                                                 as conducting the activities conducted by
solely in the trade or business of engraving compa-           (2) Net operating loss carryovers. In                   each other member of the consolidated
nies’ names on pens and pencils purchased from un-        determing the taxable income of an EAG,                     group with respect to the construction of
related persons and then selling the pens and pencils     if a member of an EAG has a net operating                   real property under §1.199–3(l) and the
to such companies. If N was not a member of an            loss (NOL) carryback or carryover to the                    performance of engineering and architec-
EAG, its activities would not qualify as MPGE. Ac-
cordingly, although M’s sales of the furniture qual-
                                                          taxable year, then the amount of the NOL                    tural services under §1.199–3(m).
ify as DPGR (assuming all the other requirements of       used to offset taxable income cannot ex-                        (3) Application of the simplified de-
§1.199–3 are met), N’s sales of the engraved pens and     ceed the taxable income of that member.                     duction method and the small business
pencils do not qualify as DPGR because neither N nor          (c) Allocation of an expanded af-                       simplified overall method. For purposes of
                                                          filiated group’s section 199 deduction                      applying the simplified deduction method


2005–47 I.R.B.                                                                    1044                                                November 21, 2005
under §1.199–4(e) and the small busi-         or W–2 wages for the taxable year. For                   because they are allocable to the consolidated group
ness simplified overall method under          purposes of allocating the section 199 de-               deriving DPGR). Accordingly, for this purpose, X
§1.199–4(f), a consolidated group deter-      duction of a consolidated group among its                is deemed to have ($1,000) of QPAI (X’s $0 DPGR
                                                                                                       - X’s $1,000 depreciation deduction). Because X
mines its QPAI by reference to its mem-       members, any redetermination of a cor-                   is deemed to have negative QPAI, also pursuant to
bers’ DPGR, non-DPGR, cost of goods           poration’s receipts from an intercompany                 paragraph (d)(5) of this section, X’s QPAI is treated
sold (CGS), and all other deductions, ex-     transaction as DPGR or non-DPGR or as                    as zero. Y has $4,600 of QPAI (Y’s $7,500 DPGR
penses, or losses (deductions), determined    non-receipts, and any redetermination of                 - Y’s $1,400 CGS allocable to such receipts - Y’s
on a consolidated basis.                      a corporation’s CGS or other deductions                  $1,500 of rental expense). Accordingly, X is allo-
                                                                                                       cated $0/($0 + $4,600) of the consolidated group’s
    (4) Determining the section 199 deduc-    from an intercompany transaction as ei-                  section 199 deduction and Y is allocated $4,600/($0
tion—(i) Expanded affiliated group con-       ther allocable to or not allocable to DPGR               + $4,600) of the consolidated group’s section 199
sists of consolidated group and non-con-      under §1.1502–13(c)(1)(i) or (c)(4) is not               deduction.
solidated group members. If an EAG in-        taken into account. Also, for purposes                        Example 3. (i) Facts. Corporations A and B
cludes corporations that are members of       of this allocation, if a consolidated group              are the only two members of an EAG but are not
                                                                                                       members of a consolidated group. A and B each file
the same consolidated group and corpora-      member has negative QPAI, the QPAI of                    Federal income tax returns on a calendar year basis.
tions that are not members of the same con-   the member shall be treated as zero.                     The average annual gross receipts of the EAG are less
solidated group, in computing the taxable         (e) Examples. The following examples                 than or equal to $25,000,000 and A and B each use
income of the EAG, the consolidated tax-      illustrate the application of paragraphs (b),            the simplified deduction method under §1.199–4(e).
able income or loss, QPAI, and W–2 wages      (c), and (d) of this section:                            In 2006, A MPGE televisions within the United
                                                                                                       States. A has $10,000,000 of DPGR from sales of
of the consolidated group, not the separate       Example 1. Corporations X and Y are members of
                                                                                                       televisions to unrelated persons and $2,000,000 of
taxable income or loss, QPAI, and W–2         the same EAG but are not members of a consolidated
                                              group. X and Y each use the section 861 method de-       DPGR from sales of televisions to B. In addition,
wages of the members of the consolidated      scribed in §1.199–4(d) for allocating and apportion-
                                                                                                       A has gross receipts from computer consulting ser-
group, are aggregated with the taxable in-                                                             vices with unrelated persons of $3,000,000. A has
                                              ing their deductions. X incurs $5,000 in costs in man-
come or loss, QPAI, and W–2 wages of the      ufacturing a machine, all of which are capitalized. X    CGS of $6,000,000. A is able to determine from its
                                                                                                       books and records that $4,500,000 of its CGS are
non-consolidated group members. For ex-       is entitled to a $1,000 depreciation deduction for the
                                                                                                       attributable to televisions sold to unrelated persons
ample, if A, B, C, S1, and S2 are members     machine in the current taxable year. X rents the ma-
                                              chine to Y for $1,500. Y uses the machine in man-        and $1,500,000 are attributable to televisions sold to
of the same EAG, and A, S1, and S2 are        ufacturing QPP within the United States. Y incurs
                                                                                                       B (see §1.199–4(b)(2)). A has other deductions of
members of the same consolidated group                                                                 $4,000,000. A has no other items of income, gain,
                                              $1,400 of CGS in manufacturing the QPP. Y sells the
(the A consolidated group), the A consoli-    QPP to unrelated persons for $7,500. Pursuant to sec-    or deductions. In 2006, B sells the televisions it pur-
                                                                                                       chased from A to unrelated persons for $4,100,000
dated group is treated as one member of the   tion 199(c)(7) and §1.199–3(b), X’s rental income is
                                                                                                       and pays $100,000 for administrative services per-
EAG. Accordingly, the EAG is considered       non-DPGR (and its related costs are not attributable
                                              to DPGR). Accordingly, Y has $4,600 of QPAI (Y’s         formed in 2006. B has no other items of income,
to have three members, the A consolidated     $7,500 DPGR received from unrelated persons - Y’s
                                                                                                       gain, or deductions.
group, B, and C. The consolidated taxable                                                                   (ii) QPAI. (A) A’s QPAI. In order to determine
                                              $1,400 CGS allocable to such receipts - Y’s $1,500
income or loss, QPAI, and W–2 wages of        of rental expense), X has $0 of QPAI, and the EAG        A’s QPAI, A subtracts its $6,000,000 CGS from its
                                                                                                       $12,000,000 DPGR. Under the simplified deduction
the A consolidated group are aggregated       has $4,600 of QPAI.
                                                                                                       method, A then apportions its remaining $4,000,000
with the taxable income or loss, QPAI, and        Example 2. The facts are the same as in Example
                                              1 except that X and Y are members of the same con-       of deductions to DPGR in proportion to the ratio
W–2 wages of B and C in determining the       solidated group. Pursuant to section 199(c)(7) and
                                                                                                       of its DPGR to total gross receipts. Thus, of A’s
EAG’s section 199 deduction.                                                                           $4,000,000 of deductions, $3,200,000 is apportioned
                                              §1.199–3(b), X’s rental income ordinarily would not
    (ii) Expanded affiliated group consists   be DPGR (and its related costs would not be allocable    to DPGR ($4,000,000 x $12,000,000/$15,000,000).
                                                                                                       Accordingly, A’s QPAI is $2,800,000 ($12,000,000
only of members of a single consolidated      to DPGR). However, because X and Y are members
                                                                                                       DPGR - $6,000,000 CGS - $3,200,000 deductions
group. If all the members of an EAG are       of the same consolidated group, §1.1502–13(c)(1)(i)
                                              provides that the separate entity attributes of X’s      apportioned to its DPGR).
members of the same consolidated group,       income or Y’s expenses, or both X’s income and Y’s
                                                                                                            (B) B’s QPAI. Although B did not MPGE the
the consolidated group’s section 199 de-                                                               televisions it sold, pursuant to paragraph (a)(3) of
                                              expenses, may be redetermined in order to produce
duction is determined by reference to the     the same effect as if X and Y were divisions of a        this section, B is treated as conducting A’s MPGE of
                                                                                                       the televisions in determining whether B’s gross re-
consolidated group’s consolidated taxable     single corporation. If X and Y were divisions of
                                                                                                       ceipts are DPGR. Thus, B has $4,100,000 of DPGR.
income or loss, QPAI, and W–2 wages, not      a single corporation, X and Y would have QPAI
                                              of $5,100 ($7,500 DPGR received from unrelated           In order to determine B’s QPAI, B subtracts its
the separate taxable income or loss, QPAI,    persons - $1,400 CGS allocable to such receipts
                                                                                                       $2,000,000 CGS from its $4,100,000 DPGR. Under
and W–2 wages of its members.                                                                          the simplified deduction method, B then apportions
                                              - $1,000 depreciation deduction). To obtain this
    (5) Allocation of the section 199 de-     same result for the consolidated group, X’s rental       its remaining $100,000 of deductions to DPGR in
                                                                                                       proportion to the ratio of its DPGR to total gross
duction of a consolidated group among its     income is recharacterized as DPGR, which results
                                                                                                       receipts. Thus, because B has no other gross receipts,
members. The section 199 deduction of a       in the consolidated group having $9,000 of DPGR
                                              (the sum of Y’s DPGR of $7,500 + X’s DPGR of             all of B’s $100,000 of deductions is apportioned
consolidated group (or the section 199 de-    $1,500) and $3,900 of costs allocable to DPGR
                                                                                                       to DPGR ($100,000 x $4,100,000/$4,100,000).
duction allocated to a consolidated group                                                              Accordingly, B’s QPAI is $2,000,000 ($4,100,000
                                              (the sum of Y’s $1,400 CGS + Y’s $1,500 rental
that is a member of an EAG) must be           expense + X’s $1,000 depreciation expense). For          DPGR - $2,000,000 CGS - $100,000 deductions
                                                                                                       apportioned to its DPGR).
allocated to the members of the consoli-      purposes of determining how much of the consoli-
                                                                                                            Example 4. (i) Facts. The facts are the same
dated group in proportion to each consol-     dated group’s section 199 deduction is allocated to
                                              X and Y, pursuant to paragraph (d)(5) of this section,   as in Example 3 except that A and B are members
idated group member’s QPAI, regardless        the redetermination of X’s rental income as DPGR
                                                                                                       of the same consolidated group, B does not sell the
of whether the consolidated group mem-                                                                 televisions purchased from A until 2007, and B’s
                                              under §1.1502–13(c)(1)(i) is not taken into account
ber has separate taxable income or loss       (X’s costs are considered to be allocable to DPGR        $100,000 paid for administrative services are paid



November 21, 2005                                                   1045                                                            2005–47 I.R.B.
in 2007 for services performed in 2007. In addition,     section 199 deduction to its members, pursuant to           solidated group. X, Y, and Z each files Federal in-
in 2007, A has $3,000,000 in gross receipts from         paragraph (d)(5) of this section, the redetermination       come tax returns on a calendar year basis. Assume
computer consulting services with unrelated persons      of A’s $2,000,000 in receipts as non-DPGR and               that the EAG has W–2 wages in excess of the sec-
and $1,000,000 in related deductions.                    non-receipts is disregarded. Accordingly, for this          tion 199(b) wage limitation. Prior to 2006, X had
    (ii) Consolidated group’s 2006 QPAI. The con-        purpose, A’s DPGR is $2,000,000 (receipts from the          no taxable income or loss. In 2006, X has $0 of
solidated group’s DPGR and total gross receipts          sale of televisions to B taken into account in 2007)        taxable income and $2,000 of QPAI, Y has $4,000
in 2006 are $10,000,000 and $13,000,000, respec-         and its total receipts are $5,000,000 ($2,000,000           of taxable income and $3,000 of QPAI, and Z has
tively, because, pursuant to paragraph (d)(1) of this    DPGR + $3,000,000 non-DPGR from its computer                $4,000 of taxable income and $5,000 of QPAI. Ac-
section and §1.1502–13, the sale of the televisions      consulting services). In determining A’s QPAI, A            cordingly, the EAG has taxable income of $8,000,
from A to B is not taken into account in 2006. In        subtracts its $1,500,000 CGS from the televisions           the sum of X’s taxable income of $0, Y’s taxable in-
order to determine the consolidated group’s QPAI,        sold to B from its $2,000,000 DPGR. Under the sim-          come of $4,000, and Z’s taxable income of $4,000.
the consolidated group subtracts its $4,500,000          plified deduction method, A apportions its remaining        The EAG has QPAI of $10,000, the sum of X’s QPAI
CGS from the televisions sold to unrelated persons       $1,000,000 of deductions in proportion to the ra-           of $2,000, Y’s QPAI of $3,000, and Z’s QPAI of
from its $10,000,000 DPGR. Under the simplified          tio of its DPGR to total receipts. Thus, $400,000           $5,000. Because X’s, Y’s, and Z’s taxable years all
deduction method, the consolidated group appor-          ($1,000,000 x $2,000,000/$5,000,000) is allocated           began in 2006, the transition percentage under section
tions its remaining $4,000,000 of deductions to          to DPGR. Thus, A’s QPAI is $100,000 ($2,000,000             199(a)(2) is 3 percent. Thus, the EAG’s section 199
DPGR in proportion to the ratio of its DPGR to           DPGR - $1,500,000 CGS - $400,000 deductions                 deduction for 2006 is $240 (3% of the lesser of the
total gross receipts. Thus, $3,076,923 ($4,000,000 x     allocated to its DPGR).                                     EAG’s taxable income of $8,000 or the EAG’s QPAI
$10,000,000/$13,000,000) is allocated to DPGR. Ac-            (B) B’s QPAI. B’s DPGR and its total gross             of $10,000). Pursuant to paragraph (c)(1) of this sec-
cordingly, the consolidated group’s QPAI for 2006 is     receipts are each $4,100,000. For purposes of               tion, the $240 section 199 deduction is allocated to X,
$2,423,077 ($10,000,000 DPGR - $4,500,000 CGS -          allocating the consolidated group’s section 199 de-         Y, and Z in proportion to their respective amounts of
$3,076,923 deductions apportioned to its DPGR).          duction to its members, pursuant to paragraph (d)(5)        QPAI, that is $48 to X ($240 x $2,000/$10,000), $72
    (iii) Allocation of consolidated group’s 2006 sec-   of this section, the redetermination of B’s $2,000,000      to Y ($240 x $3,000/$10,000), and $120 to Z ($240
tion 199 deduction to its members. Because B’s only      CGS as not allocable to DPGR is disregarded. In             x $5,000/$10,000). Although X’s taxable income for
activity during 2006 is the purchase of televisions      determining B’s QPAI, B subtracts its $2,000,000            2006 determined prior to allocation of a portion of the
from A, B has no DPGR or deductions and thus, no         CGS from the televisions purchased from A from              EAG’s section 199 deduction to it was $0, pursuant to
QPAI, in 2006. Accordingly, the entire section 199       its $4,100,000 DPGR. Under the simplified deduc-            paragraph (c)(2) of this section X will have an NOL
deduction in 2006 for the consolidated group will be     tion method, B apportions its remaining $100,000            for 2006 equal to $48. Because X’s NOL for 2006
allocated to A.                                          deductions in proportion to the ratio of its DPGR           cannot be carried back to a previous taxable year, X’s
    (iv) Consolidated group’s 2007 QPAI. Pursuant to     to total receipts. Thus, all $100,000 ($100,000             NOL carryover to 2007 will be $48.
paragraph (d)(1) of this section and §1.1502–13(c),      x $4,100,000/$4,100,000) is allocated to DPGR.                  (f) Allocation of income and loss by a
A’s sale of televisions to B in 2006 is taken into       Thus, B’s QPAI is $2,000,000 ($4,100,000 DPGR -
                                                                                                                     corporation that is a member of the ex-
account in 2007 when B sells the televisions to unre-    $2,000,000 CGS - $100,000 deductions allocated to
lated persons. However, because A and B are mem-         its DPGR).
                                                                                                                     panded affiliated group for only a portion
bers of a consolidated group, §1.1502–13(c)(1)(i)             (C) Allocation to A and B. Pursuant to para-           of the year—(1) In general. A corporation
provides that the separate entity attributes of A’s      graph (d)(5) of this section, the consolidated              that becomes or ceases to be a member of
income or B’s expenses, or both A’s income and B’s       group’s section 199 deduction for 2007 is allo-             an EAG during its taxable year must allo-
expenses, may be redetermined in order to produce        cated $100,000/($100,000 + $2,000,000) to A and
                                                                                                                     cate its taxable income or loss, QPAI, and
the same effect as if A and B were divisions of a        $2,000,000/($100,000 + $2,000,000) to B.
single corporation. Accordingly, A’s $2,000,000 of            Example 5. Corporations S and B are members
                                                                                                                     W–2 wages between the portion of the tax-
gross receipts are redetermined to be non-DPGR and       of the same consolidated group. In 2006, S manu-            able year that it is a member of the EAG
non-receipts and B’s $2,000,000 CGS are redeter-         factures office furniture for B to use in B’s corporate     and the portion of the taxable year that it
mined to be not allocable to DPGR. Notwithstanding       headquarters and S sells the office furniture to B. S       is not a member of the EAG. In general,
that A’s receipts are redetermined to be non-DPGR        and B have no other activities in the taxable year. If S
                                                                                                                     this allocation of items must be made by
and non-receipts, A’s CGS are still considered to        and B were not members of a consolidated group, S’s
be allocable to DPGR because they are allocable          gross receipts from the sale of the office furniture to B
                                                                                                                     using the pro rata allocation method de-
to the consolidated group deriving DPGR. Accord-         would be DPGR (assuming all the other requirements          scribed in paragraph (f)(1)(i) of this sec-
ingly, the consolidated group’s DPGR in 2007 is          of §1.199–3 are met) and S’s CGS or other deduc-            tion. However, a corporation may elect to
$4,100,000 from B’s sales of televisions, and its        tions, expenses, or losses from the sale to B would be      use the section 199 closing of the books
total receipts are $7,100,000 ($4,100,000 DPGR           allocable to S’s DPGR. However, because S and B are
                                                                                                                     method described in paragraph (f)(1)(ii) of
plus $3,000,000 non-DPGR from A’s computer               members of a consolidated group, the separate entity
consulting services). To determine the consolidated      attributes of S’s income or B’s expenses, or both S’s
                                                                                                                     this section. Neither the pro rata allocation
group’s QPAI, the consolidated group subtracts A’s       income and B’s expenses, may be redetermined un-            method nor the section 199 closing of the
$1,500,000 CGS from the televisions sold to B from       der §1.1502–13(c)(1)(i) or (c)(4) in order to produce       books method is a method of accounting.
its $4,100,000 DPGR. Under the simplified deduc-         the same effect as if S and B were divisions of a sin-          (i) Pro rata allocation method. Under
tion method, the consolidated group apportions its       gle corporation. If S and B were divisions of a single
                                                                                                                     the pro rata allocation method, an equal
remaining $1,100,000 of deductions ($1,000,000           corporation, there would be no DPGR with respect to
from A and $100,000 from B) to DPGR in propor-           the office furniture because there would be no lease,
                                                                                                                     portion of a corporation’s taxable income
tion to the consolidated group’s ratio of its DPGR to    rental, license, sale, exchange, or other disposition of    or loss, QPAI, and W–2 wages for the tax-
total gross receipts. Thus, $635,211 ($1,100,000 x       the furniture by the single corporation (and no CGS or      able year is assigned to each day of the cor-
$4,100,000/$7,100,000) is allocated to DPGR. Ac-         other deductions allocable to DPGR). Thus, in order         poration’s taxable year. Those items as-
cordingly, the consolidated group’s QPAI for 2007        to produce the same effect as if S and B were divisions
                                                                                                                     signed to those days that the corporation
is $1,964,789 ($4,100,000 DPGR - $1,500,000 CGS          of a single corporation, S’s gross receipts are redeter-
- $635,211 deductions apportioned to its DPGR),          mined as non-DPGR. Accordingly, the consolidated
                                                                                                                     was a member of the EAG are then aggre-
the same QPAI that would result if A and B were          group has no DPGR (and no CGS or other deductions           gated.
divisions of a single corporation.                       allocated or apportioned to DPGR) and receives no               (ii) Section 199 closing of the books
    (v) Allocation of consolidated group’s 2007 sec-     section 199 deduction in 2006.                              method. Under the section 199 closing
tion 199 deduction to its members. (A) A’s QPAI.              Example 6. Corporations X, Y, and Z are mem-
                                                                                                                     of the books method, a corporation’s tax-
For purposes of allocating the consolidated group’s      bers of the same EAG but are not members of a con-



2005–47 I.R.B.                                                                   1046                                                   November 21, 2005
able income or loss, QPAI, and W–2 wages          is the sum of its section 199 deductions for              itation under section 199(b). For its taxable year end-
for the period during which the corpora-          each portion of the taxable year.                         ing June 30, 2005, Z’s QPAI is $4,000. For the tax-
tion was a member of an EAG are com-                  (3) Example. The following example                    able year ending December 31, 2005, X’s QPAI is
                                                                                                            $8,000 and Y’s QPAI is ($6,000). For its taxable year
puted by treating the corporation’s taxable       illustrates the application of paragraphs (f)             ending June 30, 2006, Z’s QPAI is $2,000.
year as two separate taxable years, the first     and (g) of this section:                                       (ii) Because Z’s taxable year ending June 30,
of which ends at the close of the day on               Example. Corporations X and Y, calendar year         2005, began on July 1, 2004, prior to the effective
which the corporation’s status as a mem-          corporations, are members of the same EAG for the         date of section 199, Z is not allowed a section 199
                                                  entire 2005 taxable year. Corporation Z, also a cal-      deduction for its taxable year ending June 30, 2005.
ber of the EAG changes and the second of          endar year corporation, is a member of the EAG of              (iii) In computing X’s and Y’s respective section
which begins at the beginning of the day          which X and Y are members for the first half of 2005      199 deductions for their taxable years ending Decem-
after the corporation’s status as a member        and not a member of any EAG for the second half           ber 31, 2005, Z’s items from its taxable year ending
of the EAG changes.                               of 2005. During the 2005 taxable year, Z does not         June 30, 2005, are not taken into account because
    (iii) Making the section 199 closing of       join in the filing of a consolidated return. Z makes      Z’s taxable year began before the effective date of
                                                  a section 199 closing of the books election. As a re-     section 199. Instead, only X’s and Y’s taxable in-
the books election. A corporation makes           sult, Z has $80 of taxable income and $100 of QPAI        come, QPAI, and W–2 wages from their respective
the section 199 closing of the books elec-        that is allocated to the first half of the taxable year   taxable years ending December 31, 2005, are aggre-
tion by making the following statement:           and a $150 taxable loss and ($200) of QPAI that is        gated. The EAG’s QPAI for this purpose is $2,000
“The section 199 closing of the books             allocated to the second half of the taxable year. Tak-    (X’s QPAI of $8,000 + Y’s QPAI of ($6,000)). Be-
election is hereby made with respect to           ing into account Z’s taxable income, QPAI, and W–2        cause the taxable years of the computing members, X
                                                  wages allocated to the first half of the taxable year     and Y, began in 2005, the transition percentage un-
[insert name of corporation and its em-           pursuant to the section 199 closing of the books elec-    der section 199(a)(2) is 3 percent. Accordingly, the
ployer identification number] with respect        tion, the EAG has positive taxable income and QPAI        EAG’s section 199 deduction is $60 ($2,000 x .03).
to the following periods [insert dates of         for the taxable year and W–2 wages in excess of the       The $60 deduction is allocated to each of X and Y in
the two periods between which items are           section 199(b) wage limitation. Because the EAG has       proportion to their respective QPAI as a percentage of
allocated pursuant to the closing of the          both positive taxable income and QPAI and sufficient      the QPAI of each member of the EAG that was taken
                                                  W–2 wages, and because Z has positive QPAI for the        into account in computing the EAG’s section 199 de-
books method].” The statement must be             first half of the year, a portion of the EAG’s section    duction. Pursuant to paragraph (c)(1) of this section,
filed with the corporation’s timely filed         199 deduction is allocated to Z. Because Z has nega-      in allocating the section 199 deduction between X and
(including extensions) Federal income tax         tive QPAI for the second half of the year, Z is allowed   Y, because Y’s QPAI is negative, Y’s QPAI is treated
return for the taxable year that includes         no section 199 deduction for the second half of the       as being $0. Accordingly, X’s section 199 deduction
the periods that are subject to the election.     taxable year. Thus, despite the fact that Z has a $70     for its taxable year ending December 31, 2005, is $60
                                                  taxable loss and ($100) of QPAI for the entire 2005       ($60 x $8,000/($8,000 + $0)). Y’s section 199 deduc-
Once made, a section 199 closing of the           taxable year, Z is entitled to a section 199 deduction    tion for its taxable year ending December 31, 2005,
books election is irrevocable.                    for the taxable year equal to the section 199 deduc-      is $0 ($60 x $0/($8,000 + $0)).
    (2) Coordination with rules relat-            tion allocated to Z as a member of the EAG.                    (iv) In computing Z’s section 199 deduction for
ing to the allocation of income under                 (h) Computation of section 199 deduc-                 its taxable year ending June 30, 2006, X’s and Y’s
§1.1502–76(b). If §1.1502–76(b) (relating         tion for members of an expanded affiliated                items from their respective taxable years ending De-
to items included in a consolidated return)       group with different taxable years—(1) In                 cember 31, 2005, are taken into account. Therefore,
                                                                                                            X’s and Y’s taxable income or loss, QPAI, and W–2
applies to a corporation that is a member of      general. If members of an EAG have dif-                   wages from their taxable years ending December 31,
an EAG, any allocation of items required          ferent taxable years, in determining the                  2005, are aggregated with Z’s taxable income or loss,
under this paragraph (f) is made only after       section 199 deduction of a member (the                    QPAI, and W–2 wages from its taxable year ending
the allocation of the corporation’s items         computing member), the computing mem-                     June 30, 2006. The EAG’s QPAI is $4,000 (X’s QPAI
pursuant to §1.1502–76(b).                        ber is required to take into account the tax-             of $8,000 + Y’s QPAI of ($6,000) + Z’s QPAI of
                                                                                                            $2,000). Because the taxable year of the computing
    (g) Total section 199 deduction for a         able income or loss, QPAI, and W–2 wages                  member, Z, began in 2005, the transition percentage
corporation that is a member of an ex-            of each group member that are both—                       under section 199(a)(2) is 3 percent. Accordingly, the
panded affiliated group for some or all of            (i) Attributable to the period that the               EAG’s section 199 deduction is $120 ($4,000 x .03).
its taxable year—(1) Member of the same           member of the EAG and the computing                       A portion of the $120 deduction is allocated to Z in
expanded affiliated group for the entire          member are both members of the EAG;                       proportion to its QPAI as a percentage of the QPAI of
                                                                                                            each member of the EAG that was taken into account
taxable year. If a corporation is a mem-          and                                                       in computing the EAG’s section 199 deduction. Pur-
ber of the same EAG for its entire taxable            (ii) Taken into account in a taxable year             suant to paragraph (c)(1) of this section, in allocat-
year, the corporation’s section 199 deduc-        that begins after the effective date of sec-              ing a portion of the $120 deduction to Z, because Y’s
tion for the taxable year is the amount of        tion 199 and ends with or within the tax-                 QPAI is negative, Y’s QPAI is treated as being $0.
the section 199 deduction allocated to the        able year of the computing member with                    Z’s section 199 deduction for its taxable year ending
                                                                                                            June 30, 2006, is $24 ($120 x $2,000/($8,000 + $0 +
corporation by the EAG under paragraph            respect to which the section 199 deduction                $2,000)).
(c)(1) of this section.                           is computed.
    (2) Member of the expanded affiliated             (2) Example. The following example                    §1.199–8 Other rules.
group for a portion of the taxable year. If       illustrates the application of this paragraph
a corporation is a member of an EAG only          (h):                                                         (a) Individuals. In the case of an in-
for a portion of its taxable year and is either       Example. (i) Corporations X, Y, and Z are mem-        dividual, the deduction under §1.199–1(a)
not a member of any EAG or is a member            bers of the same EAG. Neither X, Y, nor Z is a mem-       (section 199 deduction) is equal to the ap-
                                                  ber of a consolidated group. X and Y are calendar
of another EAG, or both, for another por-         year taxpayers and Z is a June 30 fiscal year taxpayer.
                                                                                                            plicable percentage of the lesser of the tax-
tion of the taxable year, the corporation’s       Each corporation has taxable income that exceeds its      payer’s qualified production activities in-
section 199 deduction for the taxable year        QPAI and has sufficient W–2 wages to avoid the lim-       come (QPAI) (as defined in §1.199–1(c))


November 21, 2005                                                        1047                                                            2005–47 I.R.B.
for the taxable year, or adjusted gross in-     the activities performed by the entity with-    the transition percentage for that taxable
come (AGI) for the taxable year deter-          out regard to the activities performed by       year is 3 percent.
mined after applying sections 86, 135, 137,     the taxpayer prior to the contribution of the       (f) Section 481(a) adjustments. For
219, 221, 222, and 469, and without regard      property to the entity. Except as provided      purposes of determining QPAI, a section
to section 199.                                 in §1.199–3(h)(7) and (8) (exceptions for       481(a) adjustment, whether positive or
    (b) Trade or business requirement. Sec-     certain oil and gas partnerships and EAG        negative, taken into account during the
tion 1.199–3 is applied by taking into ac-      partnerships), if property is transferred by    taxable year that is solely attributable
count only items that are attributable to the   a partnership to a partner in a transaction     to either gross receipts, cost of goods
actual conduct of a trade or business.          to which section 731 applies, then whether      sold (CGS), or deductions, expenses, or
    (c) Coordination with alternative min-      gross receipts derived by the partner are       losses (deductions) must be allocated or
imum tax. For purposes of determin-             DPGR shall be determined based on the           apportioned in the same manner as the
ing alternative minimum taxable income          activities performed by the partner without     gross receipts, CGS, or deductions to
(AMTI) under section 55, a taxpayer that        regard to the activities performed by the       which it is attributable. See §§1.199–1(d),
is not a corporation may deduct an amount       partnership before the distribution of the      1.199–4(b), and 1.199–4(c) for rules re-
equal to 9 percent (3 percent in the case       property to the partner.                        lated to the allocation and apportionment
of taxable years beginning in 2005 or               (2) Section 1031 exchanges. If a tax-       of gross receipts, CGS, and deductions.
2006, and 6 percent in the case of taxable      payer exchanges property for replacement        For example, if a taxpayer changes its
years beginning in 2007, 2008, or 2009)         property in a transaction to which section      method of accounting for inventories from
of the lesser of the taxpayer’s QPAI for        1031 applies, then whether the gross re-        the last-in, first-out (LIFO) method to the
the taxable year, or the taxpayer’s taxable     ceipts derived from the lease, rental, li-      first-in, first-out (FIFO) method, the tax-
income for the taxable year, determined         cense, sale, exchange, or other disposi-        payer is required to allocate the resulting
without regard to the section 199 deduc-        tion of the replacement property are DPGR       section 481(a) adjustment, whether posi-
tion (or in the case of an individual, AGI).    shall be determined based solely on the ac-     tive or negative, in the same manner as the
For purposes of determining AMTI in             tivities performed by the taxpayer with re-     CGS computed for the taxable year with
the case of a corporation (including a          spect to the replacement property.              respect to those inventories. If a section
corporation subject to tax under section            (3) Section 381 transactions. If a corpo-   481(a) adjustment is not solely attributable
511(a)), a taxpayer may deduct an amount        ration (the acquiring corporation) acquires     to either gross receipts, CGS, or deduc-
equal to 9 percent (3 percent in the case       the assets of another corporation (the target   tions (for example, the taxpayer changes
of taxable years beginning in 2005 or           corporation) in a transaction to which sec-     its overall method of accounting from an
2006, and 6 percent in the case of taxable      tion 381(a) applies, the acquiring corpora-     accrual method to the cash method and
years beginning in 2007, 2008, or 2009)         tion shall be treated as performing those       the section 481(a) adjustment cannot be
of the lesser of the taxpayer’s QPAI for        activities of the target corporation with re-   specifically identified with either gross
the taxable year, or the taxpayer’s AMTI        spect to the acquired assets of the target      receipts, CGS, or deductions), the section
for the taxable year, determined without        corporation. Therefore, to the extent that      481(a) adjustment, whether positive or
regard to the section 199 deduction. For        the acquired assets of the target corpora-      negative, must be attributed to, or among,
purposes of computing AMTI, QPAI is             tion would have given rise to DPGR if           gross receipts, CGS, or deductions using
determined without regard to any adjust-        leased, rented, licensed, sold, exchanged,      any reasonable method that is satisfactory
ments under sections 56 through 59. In          or otherwise disposed of by the target cor-     to the Secretary and allocated or appor-
the case of an individual or a trust, AGI       poration, then the assets will give rise to     tioned in the same manner as the gross
and taxable income are also determined          DPGR if leased, rented, licensed, sold, ex-     receipts, CGS, or deductions to which it is
without regard to any adjustments under         changed, or otherwise disposed of by the        attributable. Factors taken into considera-
sections 56 through 59. The amount of the       acquiring corporation.                          tion in determining whether the method is
deduction allowable under this paragraph            (e) Taxpayers with a 52–53 week tax-        reasonable include whether the taxpayer
(c) for any taxable year cannot exceed 50       able year. For purposes of applying             uses the most accurate information avail-
percent of the W–2 wages of the employer        §1.441–2(c)(1) in the case of a taxpayer        able; the relationship between the section
for the taxable year (as determined under       using a 52–53 week taxable year, any ref-       481(a) adjustment and the apportionment
§1.199–2).                                      erence in section 199(a)(2) (the phase-in       base chosen; the accuracy of the method
    (d) Nonrecognition transactions—(1)         rule), §§1.199–1 through 1.199–7, and this      chosen as compared with other possible
In general. Except as provided for an ex-       section to a taxable year beginning after a     methods; and the time, burden, and cost of
panded affiliated group (EAG) (as defined       particular calendar year means a taxable        using various methods. If a section 481(a)
in §1.199–7) and EAG partnerships (as           year beginning after December 31st of that      adjustment is spread over more than one
defined in §1.199–3(h)(8)), if property is      year. Similarly, any reference to a taxable     taxable year, a taxpayer must attribute the
transferred by the taxpayer to an entity in     year beginning in a particular calendar         section 481(a) adjustment among gross re-
a transaction to which section 351 or 721       year means a taxable year beginning after       ceipts, CGS, or deductions, as applicable,
applies, then whether the gross receipts        December 31st of the preceding calendar         in the same manner for each taxable year
derived by the entity are domestic produc-      year. For example, a 52–53 week taxable         within the spread period. For example,
tion gross receipts (DPGR) (as defined in       year that begins on December 26, 2004, is       if a taxpayer, using a reasonable method,
§1.199–3) shall be determined based on          deemed to begin on January 1, 2005, and         determines that a section 481(a) adjust-


2005–47 I.R.B.                                                     1048                                        November 21, 2005
ment that is required to be spread over four    date final regulations are published in the    However, if the proposed regulations in-
taxable years should be attributed entirely     Federal Register, taxpayers may rely on        clude a rule that was not included in No-
to gross receipts, then the taxpayer must       the interim guidance on section 199 as set     tice 2005–14, taxpayers are not permitted
attribute the section 481(a) adjustment en-     forth in Notice 2005–14, 2005–7 I.R.B.         to rely on the absence of a rule to apply a
tirely to gross receipts in each of the four    498 (see §601.601(d)(2) of this chapter),      rule contrary to the proposed regulations.
taxable years of the spread period.             as well as the proposed regulations under
    (g) Effective date. The final regulations   §§1.199–1 through 1.199–7, and this sec-                                Kevin M. Brown,
will be applicable to taxable years begin-      tion. For this purpose, if the proposed reg-              Acting Deputy Commissioner for
ning after December 31, 2004. In the case       ulations and Notice 2005–14 include dif-                        Services and Enforcement.
of pass-thru entities described in §1.199–5,    ferent rules for the same particular issue,    (Filed by the Office of the Federal Register on November 3,
the final regulations will be applicable to     then the taxpayer may rely on either the       2005, 8:45 a.m., and published in the issue of the Federal
                                                                                               Register for November 4, 2005, 70 F.R. 67219)
taxable years of pass-thru entities begin-      rule set forth in the proposed regulations
ning after December 31, 2004. Until the         or the rule set forth in Notice 2005–14.




November 21, 2005                                                 1049                                                        2005–47 I.R.B.
Definition of Terms
Revenue rulings and revenue procedures           and B, the prior ruling is modified because      of a prior ruling, a combination of terms
(hereinafter referred to as “rulings”) that      it corrects a published position. (Compare       is used. For example, modified and su-
have an effect on previous rulings use the       with amplified and clarified, above).            perseded describes a situation where the
following defined terms to describe the ef-          Obsoleted describes a previously pub-        substance of a previously published ruling
fect:                                            lished ruling that is not considered deter-      is being changed in part and is continued
    Amplified describes a situation where        minative with respect to future transac-         without change in part and it is desired to
no change is being made in a prior pub-          tions. This term is most commonly used in        restate the valid portion of the previously
lished position, but the prior position is be-   a ruling that lists previously published rul-    published ruling in a new ruling that is self
ing extended to apply to a variation of the      ings that are obsoleted because of changes       contained. In this case, the previously pub-
fact situation set forth therein. Thus, if       in laws or regulations. A ruling may also        lished ruling is first modified and then, as
an earlier ruling held that a principle ap-      be obsoleted because the substance has           modified, is superseded.
plied to A, and the new ruling holds that the    been included in regulations subsequently            Supplemented is used in situations in
same principle also applies to B, the earlier    adopted.                                         which a list, such as a list of the names of
ruling is amplified. (Compare with modi-             Revoked describes situations where the       countries, is published in a ruling and that
fied, below).                                    position in the previously published ruling      list is expanded by adding further names in
    Clarified is used in those instances         is not correct and the correct position is       subsequent rulings. After the original rul-
where the language in a prior ruling is be-      being stated in a new ruling.                    ing has been supplemented several times, a
ing made clear because the language has              Superseded describes a situation where       new ruling may be published that includes
caused, or may cause, some confusion.            the new ruling does nothing more than re-        the list in the original ruling and the ad-
It is not used where a position in a prior       state the substance and situation of a previ-    ditions, and supersedes all prior rulings in
ruling is being changed.                         ously published ruling (or rulings). Thus,       the series.
    Distinguished describes a situation          the term is used to republish under the              Suspended is used in rare situations
where a ruling mentions a previously pub-        1986 Code and regulations the same po-           to show that the previous published rul-
lished ruling and points out an essential        sition published under the 1939 Code and         ings will not be applied pending some
difference between them.                         regulations. The term is also used when          future action such as the issuance of new
    Modified is used where the substance         it is desired to republish in a single rul-      or amended regulations, the outcome of
of a previously published position is being      ing a series of situations, names, etc., that    cases in litigation, or the outcome of a
changed. Thus, if a prior ruling held that a     were previously published over a period of       Service study.
principle applied to A but not to B, and the     time in separate rulings. If the new rul-
new ruling holds that it applies to both A       ing does more than restate the substance


Abbreviations
The following abbreviations in current use       ER—Employer.                                     PRS—Partnership.
and formerly used will appear in material        ERISA—Employee Retirement Income Security Act.   PTE—Prohibited Transaction Exemption.
                                                 EX—Executor.                                     Pub. L.—Public Law.
published in the Bulletin.
                                                 F—Fiduciary.                                     REIT—Real Estate Investment Trust.
                                                 FC—Foreign Country.                              Rev. Proc.—Revenue Procedure.
A—Individual.
                                                 FICA—Federal Insurance Contributions Act.        Rev. Rul.—Revenue Ruling.
Acq.—Acquiescence.
B—Individual.                                    FISC—Foreign International Sales Company.        S—Subsidiary.
                                                 FPH—Foreign Personal Holding Company.            S.P.R.—Statement of Procedural Rules.
BE—Beneficiary.
                                                 F.R.—Federal Register.                           Stat.—Statutes at Large.
BK—Bank.
B.T.A.—Board of Tax Appeals.                     FUTA—Federal Unemployment Tax Act.               T—Target Corporation.
                                                 FX—Foreign corporation.                          T.C.—Tax Court.
C—Individual.
                                                 G.C.M.—Chief Counsel’s Memorandum.               T.D. —Treasury Decision.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.                 GE—Grantee.                                      TFE—Transferee.
                                                 GP—General Partner.                              TFR—Transferor.
CI—City.
                                                 GR—Grantor.                                      T.I.R.—Technical Information Release.
COOP—Cooperative.
Ct.D.—Court Decision.                            IC—Insurance Company.                            TP—Taxpayer.
                                                 I.R.B.—Internal Revenue Bulletin.                TR—Trust.
CY—County.
                                                 LE—Lessee.                                       TT—Trustee.
D—Decedent.
DC—Dummy Corporation.                            LP—Limited Partner.                              U.S.C.—United States Code.
                                                 LR—Lessor.                                       X—Corporation.
DE—Donee.
                                                 M—Minor.                                         Y—Corporation.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.   Nonacq.—Nonacquiescence.                         Z —Corporation.
                                                 O—Organization.
DR—Donor.
                                                 P—Parent Corporation.
E—Estate.
EE—Employee.                                     PHC—Personal Holding Company.
                                                 PO—Possession of the U.S.
E.O.—Executive Order.
                                                 PR—Partner.


2005–47 I.R.B.                                                         i                                         November 21, 2005
Numerical Finding List1                                       Notices— Continued:                                            Revenue Procedures— Continued:

Bulletins 2005–27 through 2005–47                             2005-59, 2005-35 I.R.B. 443                                    2005-40, 2005-28 I.R.B. 83
                                                              2005-60, 2005-39 I.R.B. 606                                    2005-41, 2005-29 I.R.B. 90
Announcements:                                                2005-61, 2005-39 I.R.B. 607                                    2005-42, 2005-30 I.R.B. 128
                                                              2005-62, 2005-35 I.R.B. 443                                    2005-43, 2005-29 I.R.B. 107
2005-46, 2005-27 I.R.B. 63
                                                              2005-63, 2005-35 I.R.B. 448                                    2005-44, 2005-29 I.R.B. 110
2005-47, 2005-28 I.R.B. 71
                                                              2005-64, 2005-36 I.R.B. 471                                    2005-45, 2005-30 I.R.B. 141
2005-48, 2005-29 I.R.B. 111
                                                              2005-65, 2005-39 I.R.B. 607                                    2005-46, 2005-30 I.R.B. 142
2005-49, 2005-29 I.R.B. 119
                                                              2005-66, 2005-40 I.R.B. 620                                    2005-47, 2005-32 I.R.B. 269
2005-50, 2005-30 I.R.B. 152
                                                              2005-67, 2005-40 I.R.B. 621                                    2005-48, 2005-32 I.R.B. 271
2005-51, 2005-32 I.R.B. 283
                                                              2005-68, 2005-40 I.R.B. 622                                    2005-49, 2005-31 I.R.B. 165
2005-52, 2005-31 I.R.B. 257
                                                              2005-69, 2005-40 I.R.B. 622                                    2005-50, 2005-32 I.R.B. 272
2005-53, 2005-31 I.R.B. 258
                                                              2005-70, 2005-41 I.R.B. 694                                    2005-51, 2005-33 I.R.B. 296
2005-54, 2005-32 I.R.B. 283
                                                              2005-71, 2005-44 I.R.B. 863                                    2005-52, 2005-34 I.R.B. 326
2005-55, 2005-33 I.R.B. 317
                                                              2005-72, 2005-47 I.R.B. 976                                    2005-53, 2005-34 I.R.B. 339
2005-56, 2005-33 I.R.B. 318
                                                              2005-73, 2005-42 I.R.B. 723                                    2005-54, 2005-34 I.R.B. 353
2005-57, 2005-33 I.R.B. 318
                                                              2005-74, 2005-42 I.R.B. 726                                    2005-55, 2005-34 I.R.B. 367
2005-58, 2005-33 I.R.B. 319
                                                              2005-75, 2005-45 I.R.B. 929                                    2005-56, 2005-34 I.R.B. 383
2005-59, 2005-37 I.R.B. 524
                                                              2005-76, 2005-46 I.R.B. 947                                    2005-57, 2005-34 I.R.B. 392
2005-60, 2005-35 I.R.B. 455
                                                              2005-77, 2005-46 I.R.B. 951                                    2005-58, 2005-34 I.R.B. 402
2005-61, 2005-36 I.R.B. 495
                                                              2005-78, 2005-46 I.R.B. 952                                    2005-59, 2005-34 I.R.B. 412
2005-62, 2005-36 I.R.B. 495
                                                              2005-79, 2005-46 I.R.B. 952                                    2005-60, 2005-35 I.R.B. 449
2005-63, 2005-36 I.R.B. 496
                                                              2005-80, 2005-46 I.R.B. 953                                    2005-61, 2005-37 I.R.B. 507
2005-64, 2005-37 I.R.B. 537
                                                              2005-81, 2005-47 I.R.B. 977                                    2005-62, 2005-37 I.R.B. 507
2005-65, 2005-38 I.R.B. 587
                                                              2005-82, 2005-47 I.R.B. 978                                    2005-63, 2005-36 I.R.B. 491
2005-66, 2005-39 I.R.B. 613
                                                              2005-84, 2005-46 I.R.B. 959                                    2005-64, 2005-36 I.R.B. 492
2005-67, 2005-40 I.R.B. 678
                                                              2005-85, 2005-46 I.R.B. 961                                    2005-65, 2005-38 I.R.B. 564
2005-68, 2005-39 I.R.B. 613
                                                                                                                             2005-66, 2005-37 I.R.B. 509
2005-69, 2005-40 I.R.B. 681                                   Proposed Regulations:
                                                                                                                             2005-67, 2005-42 I.R.B. 729
2005-70, 2005-40 I.R.B. 682
                                                              REG-106030-98, 2005-42 I.R.B. 739                              2005-68, 2005-41 I.R.B. 694
2005-71, 2005-41 I.R.B. 714
                                                              REG-144615-02, 2005-40 I.R.B. 625                              2005-69, 2005-44 I.R.B. 864
2005-72, 2005-41 I.R.B. 692
                                                              REG-150088-02, 2005-43 I.R.B. 774                              2005-70, 2005-47 I.R.B. 979
2005-73, 2005-41 I.R.B. 715
                                                              REG-150091-02, 2005-43 I.R.B. 780                              2005-71, 2005-47 I.R.B. 985
2005-74, 2005-42 I.R.B. 764
2005-75, 2005-42 I.R.B. 764                                   REG-131739-03, 2005-36 I.R.B. 494                              Revenue Rulings:
2005-76, 2005-42 I.R.B. 765                                   REG-130241-04, 2005-27 I.R.B. 18
2005-77, 2005-44 I.R.B. 855                                   REG-138362-04, 2005-33 I.R.B. 299                              2005-38, 2005-27 I.R.B. 6
2005-78, 2005-44 I.R.B. 918                                   REG-138647-04, 2005-41 I.R.B. 697                              2005-39, 2005-27 I.R.B. 1
2005-79, 2005-45 I.R.B. 941                                   REG-149436-04, 2005-35 I.R.B. 454                              2005-40, 2005-27 I.R.B. 4
2005-80, 2005-46 I.R.B. 967                                   REG-156518-04, 2005-38 I.R.B. 582                              2005-41, 2005-28 I.R.B. 69
2005-81, 2005-45 I.R.B. 941                                   REG-158080-04, 2005-43 I.R.B. 786                              2005-42, 2005-28 I.R.B. 67
2005-82, 2005-45 I.R.B. 941                                   REG-104143-05, 2005-41 I.R.B. 708                              2005-43, 2005-29 I.R.B. 88
2005-83, 2005-45 I.R.B. 941                                   REG-105847-05, 2005-47 I.R.B. 987                              2005-44, 2005-29 I.R.B. 87
                                                              REG-111257-05, 2005-42 I.R.B. 759                              2005-45, 2005-30 I.R.B. 123
Notices:                                                      REG-114371-05, 2005-45 I.R.B. 930                              2005-46, 2005-30 I.R.B. 120
                                                              REG-114444-05, 2005-45 I.R.B. 934                              2005-47, 2005-32 I.R.B. 261
2005-48, 2005-27 I.R.B. 9
                                                              REG-121584-05, 2005-37 I.R.B. 523                              2005-48, 2005-32 I.R.B. 259
2005-49, 2005-27 I.R.B. 14
                                                              REG-122857-05, 2005-39 I.R.B. 609                              2005-49, 2005-30 I.R.B. 125
2005-50, 2005-27 I.R.B. 14
                                                              REG-129782-05, 2005-40 I.R.B. 675                              2005-50, 2005-30 I.R.B. 124
2005-51, 2005-28 I.R.B. 74
                                                              REG-133578-05, 2005-39 I.R.B. 610                              2005-51, 2005-31 I.R.B. 163
2005-52, 2005-28 I.R.B. 75
                                                                                                                             2005-52, 2005-35 I.R.B. 423
2005-53, 2005-32 I.R.B. 263                                   Revenue Procedures:
                                                                                                                             2005-53, 2005-35 I.R.B. 425
2005-54, 2005-30 I.R.B. 127
                                                              2005-35, 2005-28 I.R.B. 76                                     2005-54, 2005-33 I.R.B. 289
2005-55, 2005-32 I.R.B. 265
                                                              2005-36, 2005-28 I.R.B. 78                                     2005-55, 2005-33 I.R.B. 284
2005-56, 2005-32 I.R.B. 266
                                                              2005-37, 2005-28 I.R.B. 79                                     2005-56, 2005-35 I.R.B. 427
2005-57, 2005-32 I.R.B. 267
                                                              2005-38, 2005-28 I.R.B. 81                                     2005-57, 2005-36 I.R.B. 466
2005-58, 2005-33 I.R.B. 295
                                                              2005-39, 2005-28 I.R.B. 82                                     2005-58, 2005-36 I.R.B. 465

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2005–1 through 2005–26 is in Internal Revenue Bulletin
2005–26, dated June 27, 2005.


November 21, 2005                                                                         ii                                                              2005–47 I.R.B.
Revenue Rulings— Continued:
2005-59, 2005-37 I.R.B. 505
2005-60, 2005-37 I.R.B. 502
2005-61, 2005-38 I.R.B. 538
2005-62, 2005-38 I.R.B. 557
2005-63, 2005-39 I.R.B. 603
2005-64, 2005-39 I.R.B. 600
2005-65, 2005-41 I.R.B. 684
2005-66, 2005-41 I.R.B. 686
2005-67, 2005-43 I.R.B. 771
2005-68, 2005-44 I.R.B. 853
2005-69, 2005-44 I.R.B. 852
2005-70, 2005-45 I.R.B. 919
2005-71, 2005-45 I.R.B. 923
2005-72, 2005-46 I.R.B. 944

Social Security Contribution and Benefit
Base; Domestic Employee Coverage
Threshold:

2005-85, 2005-46 I.R.B. 961

Tax Conventions:

2005-47, 2005-28 I.R.B. 71
2005-72, 2005-41 I.R.B. 692
2005-77, 2005-44 I.R.B. 855

Treasury Decisions:

9208, 2005-31 I.R.B. 157
9209, 2005-31 I.R.B. 153
9210, 2005-33 I.R.B. 290
9211, 2005-33 I.R.B. 287
9212, 2005-35 I.R.B. 429
9213, 2005-35 I.R.B. 440
9214, 2005-35 I.R.B. 435
9215, 2005-36 I.R.B. 468
9216, 2005-36 I.R.B. 461
9217, 2005-37 I.R.B. 498
9218, 2005-37 I.R.B. 503
9219, 2005-38 I.R.B. 538
9220, 2005-39 I.R.B. 596
9221, 2005-39 I.R.B. 604
9222, 2005-40 I.R.B. 614
9223, 2005-39 I.R.B. 591
9224, 2005-41 I.R.B. 688
9225, 2005-42 I.R.B. 716
9226, 2005-43 I.R.B. 772
9227, 2005-45 I.R.B. 924
9228, 2005-47 I.R.B. 972




2005–47 I.R.B.                             iii   November 21, 2005
Finding List of Current Actions on                               Proposed Regulations— Continued:                               Revenue Procedures— Continued:
Previously Published Items1                                      REG-142686-01
                                                                 Withdrawn by                                                   Section 7 superseded by
Bulletins 2005–27 through 2005–47
                                                                 Ann. 2005-55, 2005-33 I.R.B. 317                               Rev. Proc. 2005-58, 2005-34 I.R.B. 402
Announcements:                                                                                                                  Section 8 superseded by
                                                                 REG-100420-03
                                                                                                                                Rev. Proc. 2005-59, 2005-34 I.R.B. 412
84-26                                                            Corrected by
                                                                 Ann. 2005-57, 2005-33 I.R.B. 318                               90-31
Obsoleted by
                                                                                                                                Section 4 superseded by
REG-149436-04, 2005-35 I.R.B. 454                                REG-102144-04
                                                                                                                                Rev. Proc. 2005-52, 2005-34 I.R.B. 326
2004-72                                                          Corrected by
                                                                                                                                Section 5 superseded by
Updated and superseded by                                        Ann. 2005-56, 2005-33 I.R.B. 318
                                                                                                                                Rev. Proc. 2005-54, 2005-34 I.R.B. 353
Ann. 2005-59, 2005-37 I.R.B. 524                                 Revenue Procedures:                                            Section 6 superseded by
2005-36                                                                                                                         Rev. Proc. 2005-55, 2005-34 I.R.B. 367
                                                                 64-54                                                          Section 7 superseded by
Modified by
                                                                 Obsoleted by                                                   Rev. Proc. 2005-56, 2005-34 I.R.B. 383
Rev. Proc. 2005-66, 2005-37 I.R.B. 509
                                                                 Rev. Rul. 2005-43, 2005-29 I.R.B. 88                           Section 8 superseded by
2005-53
                                                                 66-33                                                          Rev. Proc. 2005-58, 2005-34 I.R.B. 402
Corrected by                                                                                                                    Section 9 superseded by
                                                                 Obsoleted by
Ann. 2005-61, 2005-36 I.R.B. 495                                                                                                Rev. Proc. 2005-59, 2005-34 I.R.B. 412
                                                                 Rev. Rul. 2005-43, 2005-29 I.R.B. 88
Notices:                                                                                                                        93-22
                                                                 69-13
                                                                 Obsoleted by                                                   Obsoleted by
89-111
                                                                 Rev. Rul. 2005-43, 2005-29 I.R.B. 88                           Rev. Proc. 2005-44, 2005-29 I.R.B. 110
Amplified by
Notice 2005-61, 2005-39 I.R.B. 607                               70-8                                                           98-18
                                                                 Modified by                                                    Obsoleted by
2001-42
                                                                 Rev. Proc. 2005-46, 2005-30 I.R.B. 142                         Rev. Proc. 2005-45, 2005-30 I.R.B. 141
Modified by
Rev. Proc. 2005-66, 2005-37 I.R.B. 509                           71-1                                                           99-39
                                                                 Obsoleted by                                                   Superseded by
2004-57
                                                                 Rev. Rul. 2005-43, 2005-29 I.R.B. 88                           Rev. Proc. 2005-60, 2005-35 I.R.B. 449
Superseded by
Notice 2005-79, 2005-46 I.R.B. 952                               72-22                                                          2000-27
                                                                 Obsoleted by                                                   Modified and superseded by
2005-4
                                                                 Rev. Rul. 2005-43, 2005-29 I.R.B. 88                           Rev. Proc. 2005-66, 2005-37 I.R.B. 509
Modified by
Notice 2005-62, 2005-35 I.R.B. 443                               83-77                                                          2000-31
Notice 2005-80, 2005-46 I.R.B. 953                               Superseded by                                                  Superseded by
                                                                 Rev. Proc. 2005-63, 2005-36 I.R.B. 491                         Rev. Proc. 2005-60, 2005-35 I.R.B. 449
2005-10
Clarified by                                                     87-8                                                           2000-49
Notice 2005-64, 2005-36 I.R.B. 471                               Obsoleted by                                                   Superseded by

2005-38                                                          Rev. Proc. 2005-44, 2005-29 I.R.B. 110                         Rev. Proc. 2005-41, 2005-29 I.R.B. 90

Modified by                                                      87-9                                                           2001-9
Notice 2005-64, 2005-36 I.R.B. 471                               Obsoleted by                                                   Superseded by
                                                                 Rev. Proc. 2005-44, 2005-29 I.R.B. 110                         Rev. Proc. 2005-60, 2005-35 I.R.B. 449
2005-51
Modified and superseded by                                       89-20                                                          2001-16
Notice 2005-57, 2005-32 I.R.B. 267                               Superseded by                                                  Superseded by
                                                                 Rev. Proc. 2005-52, 2005-34 I.R.B. 326                         Rev. Proc. 2005-42, 2005-30 I.R.B. 128
2005-60
Superseded by                                                    90–11                                                          2002-9
Notice 2005-84, 2005-46 I.R.B. 959                               Modified by                                                    Modified and amplified by

2005-66                                                          Rev. Proc. 2005-40, 2005-28 I.R.B. 83                          Rev.   Rul. 2005-42, 2005-28 I.R.B. 67
                                                                                                                                Rev.   Proc. 2005-35, 2005-28 I.R.B. 76
Supplemented by                                                  90-30                                                          Rev.   Proc. 2005-43, 2005-29 I.R.B. 107
Notice 2005-81, 2005-47 I.R.B. 977                               Section 4 superseded by                                        Rev.   Proc. 2005-47, 2005-32 I.R.B. 269
Proposed Regulations:                                            Rev. Proc. 2005-54, 2005-34 I.R.B. 353                         2002-49
                                                                 Section 5 superseded by
                                                                                                                                Modified, amplified, and superseded by
REG-108524-00                                                    Rev. Proc. 2005-55, 2005-34 I.R.B. 367
                                                                                                                                Rev. Proc. 2005-62, 2005-37 I.R.B. 507
Corrected by                                                     Section 6 superseded by
Ann. 2005-68, 2005-39 I.R.B. 613                                 Rev. Proc. 2005-56, 2005-34 I.R.B. 383


1   A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2005–1 through 2005–26 is in Internal Revenue Bulletin 2005–26, dated June 27, 2005.


November 21, 2005                                                                           iv                                                               2005–47 I.R.B.
Revenue Procedures— Continued:           Treasury Decisions:
2004-50
                                         9149
Superseded by
                                         Removed by
Rev. Proc. 2005-49, 2005-31 I.R.B. 165
                                         T.D. 9221, 2005-39 I.R.B. 604
2004-54
                                         9186
Superseded by
                                         Corrected by
Rev. Proc. 2005-65, 2005-38 I.R.B. 564
                                         Ann. 2005-53, 2005-31 I.R.B. 258
2004-58
                                         9193
Superseded by
                                         Corrected by
Rev. Proc. 2005-69, 2005-44 I.R.B. 864
                                         Ann. 2005-62, 2005-36 I.R.B. 495
2004-59
                                         9205
Modified by
                                         Corrected by
Rev. Proc. 2005-71, 2005-47 I.R.B. 985
                                         Ann. 2005-63, 2005-36 I.R.B. 496
2004-64
                                         9206
Modified by
                                         Corrected by
Ann. 2005-71, 2005-41 I.R.B. 714
                                         Ann. 2005-49, 2005-29 I.R.B. 119
2005-1
                                         9207
Amplified by
                                         Corrected by
Rev. Proc. 2005-68, 2005-41 I.R.B. 694
                                         Ann. 2005-52, 2005-31 I.R.B. 257
2005-3
                                         9210
Amplified by
                                         Corrected by
Rev. Proc. 2005-61, 2005-37 I.R.B. 507
                                         Ann. 2005-64, 2005-37 I.R.B. 537
Rev. Proc. 2005-68, 2005-41 I.R.B. 694

2005-6
Modified by
Rev. Proc. 2005-66, 2005-37 I.R.B. 509

2005-10
Superseded by
Rev. Proc. 2005-67, 2005-42 I.R.B. 729

2005-16
Modified by
Rev. Proc. 2005-66, 2005-37 I.R.B. 509

2005-65
Corrected by
Ann. 2005-78, 2005-44 I.R.B. 918

Revenue Rulings:

65-109
Obsoleted by
Rev. Rul. 2005-43, 2005-29 I.R.B. 88

68-549
Obsoleted by
Rev. Rul. 2005-43, 2005-29 I.R.B. 88

74-203
Revoked by
Rev. Rul. 2005-59, 2005-37 I.R.B. 505

82-29
Modified and clarified by
Rev. Proc. 2005-39, 2005-28 I.R.B. 82

2005-41
Corrected by
Ann. 2005-50, 2005-30 I.R.B. 152




2005–47 I.R.B.                                                  v           U.S. GPO: 2005—320–797/20032   November 21, 2005

								
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