The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1903. Responses to this collection of information are required to obtain the benefit of the section 59(e) election.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number assigned by the Office of Management and Budget.

The estimated annual burden per respondent is one hour.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

This document contains amendments to 26 CFR part 1 under section 59(e) of the Code. Section 59(e)(1) allows taxpayers to elect to deduct any qualified expenditure ratably over a 10-year period (3-year period in the case of circulation expenditures described in section 173) beginning with the taxable year in which the expenditure was made (or, in the case of a qualified expenditure under section 263(c), over the 60-month period beginning with the month in which such expenditure was paid or incurred). Section 59(e)(2) defines qualified expenditure as any amount that, but for an election under section 59(e), would have been allowed as a deduction (determined without regard to section 291) for the taxable year in which paid or incurred under section 173 (relating to circulation expenditures), section 174 (relating to research and experimental expenditures), section 263(c) (relating to intangible drilling and development expenditures), section 616(a) (relating to development expenditures), or section 617(a) (relating to mining exploration expenditures).

Section 59(e)(4)(A) states that an election under section 59(e) (section 59(e) election) may be made with respect to any portion of any qualified expenditure. The legislative history of section 59(e) suggests that this allows a section 59(e) election to be made “dollar for dollar.” See H.R. Rep. 99-426, 99th Cong., 1st Sess. 327 (1985), 1986-3 (Vol. 2) C.B. 1, 327; S. Rep. No. 99-313, 99th Cong., 2d Sess. 539 (1986), 1986-3 (Vol. 3) C.B. 1, 539.

Section 59(e)(4)(B) states that a section 59(e) election may only be revoked with the consent of the Secretary.

Provisions similar to those currently contained in section 59(e) were originally enacted as section 58(i) under the Tax Equity and Fiscal Responsibility Act of 1982 (Public Law 97-248; 96 Stat. 324). Under section 58(i)(1), the optional 10-year writeoff was available only to individuals. Section 58(i)(5)(C) directed the Secretary to promulgate regulations governing the time and manner for making an election under section 58(i) (section 58(i) election).

Section 5f.0(a)(2)(i)(A) and (B) of the temporary Income Tax Regulations that were promulgated under section 58(i) required that a section 58(i) election be made by the later of the due date (including extensions) of the income tax return for the taxable year for which the election was to be effective, or April 15, 1983. T.D. 7870, 1983-1 C.B. 13 [48 FR 1486]. Section 5f.0(a)(3) provided that a section 58(i) election was made by attaching a statement to the income tax return (or amended return) for the taxable year in which the election was made. Section 5f.0 was redesignated as §301.9100-5T by T.D. 8435, 1992-2 C.B. 324 [57 FR 43893], on October 15, 1992.

Section 59(e) was enacted as part of the Tax Reform Act of 1986 (Public Law 99-514; 100 Stat. 2085) and, unlike section 58(i), is not limited to individuals. While both the Senate Finance Committee Report and the House Ways and Means Committee Report state that the time and manner of the election would be governed by regulations, Congress did not include a provision similar to former section 58(i)(5)(C) directing the Secretary to promulgate regulations governing the time and manner for making a section 59(e) election. See H.R. Rep. No. 99-426, 99th Cong., 1st Sess. 327 (1985), 1986-3 (Vol. 2) C.B. 1, 327; S. Rep. No. 99-313, 99th Cong., 2d Sess. 539 (1986), 1986-3 (Vol. 3) C.B. 1, 539.

A notice of proposed rulemaking (REG-124405-03, 2004-35 I.R.B. 394 [69 FR 43367]) was published in the Federal Register on July 20, 2004. Two requests for a public hearing were received. A public hearing was held on December 7, 2004. The IRS received written and electronic comments responding to the notice of proposed rulemaking. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury decision. The revisions are discussed below.

Several commentators recommended changes regarding the information taxpayers would be required to submit as part of their section 59(e) election. Specifically, commentators requested that the IRS reconsider §1.59-1(b)(1)(ii) and (iii) of the proposed regulations, which would require taxpayers to identify (i) the type and amount, for each activity or project, of qualified expenditures identified in section 59(e)(2) the taxpayer elects to deduct ratably over the applicable period described in section 59(e)(1), and (ii) a description of each specific activity or project to which the qualified expenditures relate. The commentators suggest that the majority of taxpayers who incur research and experimentation expenditures under section 174(a) and make a section 59(e) election with respect to such expenditures do not currently maintain records on a project-by-project basis. As a result, the commentators stated that requiring taxpayers to account for their section 59(e) qualified expenditures on a project-by-project basis would be a financial and administrative burden. Some of the commentators also discussed section 1016(a)(20), which provides that proper adjustment in respect of the property shall in all cases be made for amounts allowed as deductions under section 59(e) (relating to optional 10-year writeoff of certain tax preferences). Compliance with section 1016(a)(20) requires that taxpayers be able to account for their section 59(e) expenditures through appropriate basis adjustments for each property, project, or activity.

Sections 1.59-1(b)(1)(ii) and (iii) of the proposed regulations were intended to improve compliance with section 1016(a)(20) by requiring that section 59(e) qualified expenditures be allocated among the properties, projects or activities to which they relate. Comments received regarding this provision indicate that, for taxpayers incurring section 174(a) expenditures, the basis rules of section 1016(a)(20) are only of importance when a project to which a section 59(e) election relates is disposed of, and that it is rare for a research project to be disposed of prior to the full amortization of the allocable section 59(e) qualified expenditures. As such, the commentators argue that the burden of requiring taxpayers to identify on a section 59(e) election the type and amount of qualified expenditures for each activity or project greatly exceeds the potential harm caused by non-compliance with section 1016(a)(20).

Having fully considered all comments received, the final regulations are modified to reflect the comments discussed above. Taxpayers making a section 59(e) election will not be required to identify on the election the type and amount of qualified expenditures for each activity or project nor will they be required to provide a description of each specific activity or project to which the qualified expenditures relate. Instead, taxpayers will be required only to identify the type and amount of qualified expenditures identified in section 59(e)(2) that the taxpayer elects to deduct ratably over the applicable period described in section 59(e)(1). However, taxpayers remain responsible for full compliance with the requirements of section 1016(a)(20). Specifically, taxpayers who allocate their section 59(e) expenditures to reduce the gain otherwise recognized on the disposition of a property, project, or activity must maintain books and records sufficient to support that allocation.

The preamble to the proposed regulations stated that, with respect to an otherwise valid section 59(e) election filed for a taxable year ending prior to the effective date of the final regulations, such election would not be challenged by the IRS merely because the election was made later than the date prescribed by law for filing the taxpayer’s original income tax return (including any extensions of time) for the taxable year in which the amortization of the qualified expenditures subject to the section 59(e) election begins. One commentator requested guidance on what the IRS considers an otherwise valid section 59(e) election filed for a tax year ending prior to the effective date of the final regulations. Although the IRS will treat a section 59(e) election prepared in a manner described in the final regulations as sufficient for a tax year ending prior to the effective date of the final regulations, because the final regulations only apply prospectively the final regulations do not provide guidance on what constitutes an otherwise valid section 59(e) election filed for a tax year prior to the effective date of the final regulations.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that the reporting burden, as discussed earlier in this preamble, is expected to be insignificant. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

(a) In general. Section 59(e) allows any qualified expenditure to which an election under section 59(e) applies to be deducted ratably over the 10-year period (3-year period in the case of circulation expenditures described in section 173) beginning with the taxable year in which the expenditure was made (or, in the case of intangible drilling and development costs deductible under section 263(c), over the 60-month period beginning with the month in which the expenditure was paid or incurred).

(b) Election—(1) Time and manner of election. An election under section 59(e) shall only be made by attaching a statement to the taxpayer’s income tax return (or amended return) for the taxable year in which the amortization of the qualified expenditures subject to the section 59(e) election begins. The statement must be filed no later than the date prescribed by law for filing the taxpayer’s original income tax return (including any extensions of time) for the taxable year in which the amortization of the qualified expenditures subject to the section 59(e) election begins. Additionally, the statement must include the following information —

(i) The taxpayer’s name, address, and taxpayer identification number; and

(ii) The type and amount of qualified expenditures identified in section 59(e)(2) that the taxpayer elects to deduct ratably over the applicable period described in section 59(e)(1).

(2) Elected amount. A taxpayer may make an election under section 59(e) with respect to any portion of any qualified expenditure paid or incurred by the taxpayer in the taxable year to which the election applies. An election under section 59(e) must be for a specific dollar amount and the amount subject to an election under section 59(e) may not be made by reference to a formula. The amount elected under section 59(e) is properly chargeable to a capital account under section 1016(a)(20), relating to adjustments to basis of property.

(c) Revocation—(1) In general. An election under section 59(e) may be revoked only with the consent of the Commissioner. Such consent will only be granted in rare and unusual circumstances. The revocation, if granted, will be effective in the first taxable year in which the section 59(e) election was applicable. However, if the period of limitations for the first taxable year the section 59(e) election was applicable has expired, the revocation, if granted, will be effective in the earliest taxable year for which the period of limitations has not expired.

(2) Time and manner for requesting consent. A taxpayer requesting the Commissioner’s consent to revoke a section 59(e) election must submit the request prior to the end of the taxable year the applicable amortization period described in section 59(e)(1) ends. The application for consent to revoke the election must be submitted to the Internal Revenue Service in the form of a letter ruling request.

(3) Information to be provided. A request to revoke a section 59(e) election must contain all of the information necessary to demonstrate the rare and unusual circumstances that would justify granting revocation.

(4) Treatment of unamortized costs. The unamortized balance of the qualified expenditures subject to the revoked section 59(e) election as of the first day of the taxable year the revocation is effective is deductible in the year the revocation is effective (subject to the requirements of any other provision under the Code, regulations, or any other published guidance) and the taxpayer will be required to amend any federal income tax returns affected by the revocation.

(d) Effective date. These regulations apply to a section 59(e) election made for a taxable year ending, or a request to revoke a section 59(e) election submitted, on or after December 22, 2004.

Par. 3. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 4. In §602.101, paragraph (b) is amended by adding an entry in numerical order to the table to read as follows:

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1871.The collections of information (disclosure requirements) in these final regulations are in §10.35(e). Section 10.35(e) requires a practitioner providing a covered opinion to make certain disclosures in the beginning of marketed opinions, limited scope opinions and opinions that fail to conclude at a confidence level of at least more likely than not. In addition, certain relationships between the practitioner and a person promoting or marketing a tax shelter must be disclosed. A practitioner may be required to make one or more disclosures. The collection of this material helps to ensure that taxpayers who receive a tax shelter opinion are informed of any facts or circumstances that might limit the use of the opinion. The collection of information is mandatory.

Estimated total annual disclosure burden is 13,333 hours.

Estimated annual burden per disclosing practitioner varies from 5 to 10 minutes, depending on individual circumstances, with an estimated average of 8 minutes.

Estimated number of disclosing practitioners is 100,000.

Estimated annual frequency of responses is on occasion.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503. Books or records relating to a collection of information must be retained as long as their contents might become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Section 330 of title 31 of the United States Code authorizes the Secretary of the Treasury to regulate practice before the Treasury Department. The Secretary has published the regulations in Circular 230 (31 CFR part 10). On December 30, 2003, the Treasury Department and the IRS published in the Federal Register (68 FR 75186) proposed amendments to the regulations (REG-122379-02, 2004-5 I.R.B. 392) (the proposed regulations) to set forth best practices for tax advisors providing advice to taxpayers relating to Federal tax issues or submissions to the IRS and to modify the standards for certain tax shelter opinions. A public hearing was held on February 19, 2004. Written public comments responding to the proposed regulations were received. After thorough consideration of the public comments, the proposed regulations are adopted as revised by this Treasury decision.

Tax advisors play a critical role in the Federal tax system, which is founded on principles of compliance and voluntary self-assessment. The tax system is best served when the public has confidence in the honesty and integrity of the professionals providing tax advice. To restore, promote, and maintain the public’s confidence in those individuals and firms, these final regulations set forth best practices applicable to all tax advisors. These regulations also provide mandatory requirements for practitioners who provide covered opinions. The scope of these regulations is limited to practice before the IRS. These regulations do not alter or supplant other ethical standards applicable to practitioners.

On October 22, 2004, the President signed the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418) (the Act), which amended section 330 of title 31 of the United States Code to clarify that the Secretary may impose standards for written advice relating to a matter that is identified as having a potential for tax avoidance or evasion. The Act also authorizes the Treasury Department and the IRS to impose a monetary penalty against a practitioner who violates any provision of Circular 230. These final regulations do not reflect amendments made by the Act. The Treasury Department and the IRS expect to propose additional regulations implementing the Act’s provisions.

To eliminate any adverse impact that the adoption of the new requirements for covered opinions or other written advice could have on pending or imminent transactions, the applicability date of the standards for covered opinions under §10.35 and other written advice under §10.37 (and the procedures to ensure compliance as they relate to covered opinions under §10.36) is June 20, 2005.

It has been determined that this final rule is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. Persons authorized to practice before the IRS have long been required to comply with certain standards of conduct. The added disclosure requirements for tax shelter opinions imposed by these regulations will not have a significant economic impact on a substantial number of small entities because, as previously noted, the estimated burden of disclosures is minimal. Practitioners have the information needed to determine whether any of the disclosures will be required before the opinion is prepared and, for some disclosures, the regulations provide practitioners with the language to be included in the opinion. Therefore, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the proposed regulations preceding these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Paragraph 1. The authority citation for subtitle A, part 10 continues to read as follows:

[Authority: Sec. 3, 23 Stat. 258, secs. 2-12, 60 Stat. 237 et seq.; 5 U.S.C. 301, 500, 551-559; 31 U.S.C. 330, as amended by P.L. 108-357, 118 Stat. 1418; Reorg. Plan No. 26 of 1950, 15 FR 4935, 64 Stat. 1280, 3 CFR, 1949-1953 Comp., P. 1017.]

Par. 2. Section 10.33 is revised to read as follows:

Under the General Utilities doctrine, see General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), a C corporation, in certain cases, could distribute appreciated assets to its shareholders or sell appreciated assets without recognizing gain. Section 1374 of the Internal Revenue Code of 1986 (Code), amended in the Tax Reform Act of 1986 (TRA) as part of the repeal of the General Utilities doctrine, prevents a corporation from circumventing General Utilities repeal by converting to S corporation status before distributing appreciated assets to its shareholders or selling appreciated assets.

Section 1374 generally imposes a corporate level tax on an S corporation’s net recognized built-in gain attributable to assets that it held on the date it converted from a C corporation to an S corporation. This tax is imposed on built-in gain recognized during the 10-year period beginning on the first day the corporation is an S corporation. Section 1374(d)(8), which was added by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), imposes a corporate level tax on an S corporation’s net recognized built-in gain attributable to assets that it acquired in a carryover basis transaction from a C corporation for the 10-year recognition period beginning on the day of the carryover basis transaction.

Under section 1374(d)(9), which also was added by TAMRA, any reference in section 1374 to the first taxable year the corporation was an S corporation is a reference to the first taxable year it was an S corporation pursuant to its most recent S corporation election under section 1362.

Section 1019 of TAMRA states that, except as otherwise provided, any amendments made by TAMRA are effective as if included in the provision of TRA to which such amendment relates.

The current version of section 1374 replaced a prior version of section 1374 that generally only taxed income or gain recognized within the three year period following the date the corporation converted from C to S status. Section 633 of TRA, as amended by TAMRA, provides the effective dates of the current version of section 1374. Specifically, section 633(b)(1) of TRA, as amended by TAMRA, provides that the amendments to section 1374 apply to taxable years beginning after December 31, 1986, but only in cases where the return for the taxable year is filed pursuant to an S election made after December 31, 1986. Section 633(d)(8) of TRA, as amended by TAMRA, provides a transition rule granting a limited postponement of the above effective date for “qualified corporations”, which are certain small corporations as defined in that section. Under the transition rule, if a C corporation that is a qualified corporation makes an election to be an S corporation under section 1362 before January 1, 1989, then it is subject to former section 1374 for dispositions of long-term capital gain assets and current section 1374 for dispositions of short-term capital gain assets and ordinary income assets, without regard to whether such corporation is completely liquidated.

As discussed above, the general effective date of current section 1374, which is contained in section 633(b)(1) of the TRA, as amended by TAMRA, provides that current section 1374 applies to tax years beginning after December 31, 1986, but only in cases where the return for the taxable year is filed pursuant to an S election made after December 31, 1986. In TAMRA, Congress added subsection (d)(8) to section 1374, and provided that the provision was effective as if included in TRA.

Section 1.1374-8 provides regulations interpreting section 1374(d)(8). Example 1 of §1.1374-8(d) applies section 1374(d)(8) to a merger of a C corporation into an S corporation that elected S status before the effective date of TRA amendments, as further amended by TAMRA, to section 1374. Section 1.1374-10(a) provides that §1.1374-8 applies for taxable years ending on or after December 27, 1994, but only in cases where the corporation’s tax return is filed pursuant to an S election or a section 1374(d)(8) transaction occurring after December 27, 1994 (emphasis added).

Despite the provisions of §1.1374-8 and the effective date provisions of §1.1374-10, the IRS understands that some taxpayers contend that section 1374(d)(8) does not apply to carryover basis transfers from C corporations to S corporations that filed S elections before January 1, 1987, because the provisions in TAMRA that added section 1374(d)(8) indicated that the amendment was effective only if the return for the taxable year was filed pursuant to an S election made after December 31, 1986.

Section 337(d)(1) authorizes the Secretary to prescribe regulations to prevent the circumvention of the purposes of the repeal of the General Utilities doctrine through the use of any provision of law or regulations. The Treasury Department and the IRS believe that these temporary regulations are necessary to implement General Utilities repeal to prevent the use of corporations with pre-1987 S elections as a method for C corporations to transfer appreciated assets out of C corporation solution without gain recognition. Accordingly, these regulations confirm that section 1374(d)(8) applies to any transaction described in that section that occurs on or after December 27, 1994, the effective date of §1.1374-8, regardless of the date of the S corporation’s election under section 1362.

As discussed above, section 633(d)(8) of TRA, as amended by TAMRA, provides a transition rule granting a limited postponement of the general effective date of current section 1374 for qualified corporations that make an election to be an S corporation under section 1362 before January 1, 1989. In Colorado Gas Compression, Inc. v. Commissioner, 366 F.3d 863 (10^th Cir. 2004), reversing and remanding 116 T.C. 1 (2001), a qualified corporation eligible for the special transition rule elected S corporation status on February 1, 1988 (before the extended effective date of January 1, 1989), revoked S status on December 1, 1989, and subsequently re-elected S status effective on January 1, 1994. During the years 1994 through 1996, the taxpayer sold assets. The Tax Court held that such sales were subject to current section 1374, and that the transition rule did not preclude the application of current section 1374 because the taxpayer’s most recent S election was made after 1989. The Tax Court concluded that section 1374(d)(9) requires that the 1994 election, the taxpayer’s most recent election, be the election considered for effective date purposes. The Tenth Circuit reversed the Tax Court, holding that, because the 1988 election was made before the extended effective date, the corporation was exempt from current section 1374 despite the intervening revocation of S status.

The Treasury Department and the IRS believe that the Tenth Circuit’s holding is inconsistent with the legislative history and underlying policy of section 633 of TRA, as amended by TAMRA, and believe the Tax Court was correct in holding that a corporation’s most recent S election must have been made before the deadline of the transition rule (i.e., before January 1, 1989) in order for the corporation to be entitled to the benefit of the transition rule. As indicated above, section 337(d)(1) authorizes the Secretary to prescribe regulations to prevent the circumvention of the purposes of the repeal of the General Utilities doctrine through the use of any provision of law or regulations. The Treasury Department and the IRS believe that these temporary regulations are necessary to implement General Utilities repeal to prevent avoidance of corporate level tax on appreciation in the assets of a C corporation attributable to periods after the extended effective date of January 1, 1989. Accordingly, these regulations provide that the transition rule regarding qualified corporations in section 633(d)(8) of TRA, as amended by TAMRA, applies only if the corporation’s most recent S election was made before January 1, 1989. Although these regulations apply to built-in gain recognized in taxable years beginning after December 22, 2004, the IRS will continue to assert this position for prior taxable years.

In summary, the temporary regulations provide that (1) section 1374(d)(8) applies to any transaction described in that section that occurs on or after December 27, 1994, regardless of the date of the S corporation’s election under section 1362, and (2) for purposes of section 633(d)(8) of TRA, as amended by TAMRA, a corporation’s most recent S election, not an earlier election that has been revoked or terminated, determines whether or not it is subject to current section 1374.

It has been determined that this temporary regulation is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to §1.1374-8T(a)(2) of these regulations. With respect to §1.1374-10T(c) of these regulations, it has been determined, pursuant to 5 U.S.C. 553(b)(B), that it would be contrary to the public interest to issue the regulations with notice and public procedure and, pursuant to 5 U.S.C. 553(d)(3), that good cause exists to dispense with a delayed effective date. The regulations are necessary to provide immediate guidance to taxpayers with respect to the application of the transition rule regarding qualified corporations in section 633(d)(8) of TRA, as amended by TAMRA, and, accordingly, with respect to the application of current section 1374 to asset dispositions which occur during taxable years beginning after December 22, 2004. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analysis section of the Notice of Proposed Rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Code, these temporary regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.1374-8T also issued under 26 U.S.C. 337(d) and 1374(e).* * *

Section 1.1374-10T also issued under 26 U.S.C. 337(d) and 1374(e).* * *

Par. 2. Section 1.1374-8 is amended by redesignating paragraph (a) as paragraph (a)(1) and adding paragraph (a)(2) to read as follows:

Temporary Regulations in this issue of the Bulletin amend 26 CFR Part 1 relating to section 1374. The temporary regulations provide that (a) section 1374(d)(8) applies to any transaction described in that section that occurs on or after December 27, 1994, regardless of the date of the S corporation’s election under section 1362, and (b) for purposes of section 633(d)(8) of the Tax Reform Act of 1986, as amended by the Technical and Miscellaneous Revenue Act of 1988, a corporation’s most recent S election, not an earlier election that has been revoked or terminated, determines whether or not it is subject to current section 1374. The text of those regulations also serves as the text of these proposed regulations. The preamble to the temporary regulations explains the amendments.

It has been determined that this proposed regulation is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to §1.1374-8(a)(2) of these regulations. Because §1.1374-8(a)(2) does not impose a collection of information on small entities, it is not subject to the provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6). It is hereby certified that §1.1374-10(c) of this regulation will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that §1.1374-10(c) of this regulation addresses an uncommon fact situation not likely to affect a significant number of small entities. Therefore, a regulatory flexibility analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, these proposed regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department specifically request comments on the clarity of the proposed rules and how they may be made easier to understand. All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register.

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

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.1374-8 is amended by redesignating paragraph (a) as paragraph (a)(1) and adding paragraph (a)(2) to read as follows:

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by February 18, 2005. Comments are specifically requested concerning:

Whether the proposed collection of information and retention is necessary for the proper performance of the Office of Professional Responsibility, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proper collection and retention of information (see below);

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection and retention of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in these proposed regulations is in §10.39. This information is required to ensure practitioners comply with minimum standards when writing a State or local bond opinion. This information will assist the Commissioner, through the Office of Professional Responsibility, to ensure that practitioners properly advise taxpayers regarding state or local bonds. The collection of information is mandatory. The likely recordkeepers and respondents are individuals.

To comply with §10.39, a practitioner may provide a single State or local bond opinion or may provide a combination of documents, but only if the documents, taken together, satisfy the requirements of §10.39. The estimates below are based on an average of 10 opinions given by a practitioner per year with an average increased time of 1 to 3 hours per opinion.

Estimated total recordkeeping and reporting burden is 30,000 hours.

Estimated annual burden per practitioner varies from 10 to 30 hours, depending on individual circumstances, with an estimated average of 20 hours.

Estimated number of affected practitioners is 1,500.

Estimated annual frequency of responses (providing a State or local bond opinion or a combination of documents) is on occasion.

An agency may not conduct or sponsor, and a person is not required to respond to a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by section 6103 of the Internal Revenue Code.

Section 330 of title 31 of the United States Code authorizes the Secretary of the Treasury to regulate the practice of representatives before the Treasury Department. The Secretary has published the regulations governing standards of practice in Circular 230 (31 CFR part 10). Municipal bond opinions have been excluded from the standards for tax shelter opinions since the Treasury Department and the IRS first published standards for tax shelter opinions in Circular 230. On December 30, 2003, the Treasury Department and the IRS proposed amendments to the standards of practice that would have eliminated the exclusion for municipal bond opinions. See 68 FR 75186 (REG-122379-02, 2004-5 I.R.B. 392). Public comments were submitted in response to the proposed amendments addressing the special characteristics of the market for municipal bond opinions.

After careful consideration, the Treasury Department and the IRS have concluded that practitioners rendering opinions concerning the tax treatment of municipal bonds should be subject to the same professional standards that are applicable to other practitioners. Recognizing the special characteristics of the bond market, the Treasury Department and the IRS are proposing regulations that provide standards of practice for practitioners rendering municipal bond opinions.

The proposed regulations are substantially similar to the standards of practice for covered opinions that were promulgated on December 20, 2004, which included final regulations providing best practices for tax advisors, minimum standards for covered opinions and other written advice and procedures to ensure compliance with the minimum standards. Under the final regulations, a practitioner providing a covered opinion must comply with the minimum standards set forth in §10.35. Specifically, a practitioner providing a covered opinion must: (1) identify and ascertain all relevant facts; (2) relate the applicable law to the relevant facts; (3) evaluate each significant Federal tax issue; and (4) provide an overall conclusion. In addition, covered opinions may be required to contain certain disclosures provided in §10.35(e), if applicable. Under §10.35, the definition of a covered opinion excludes State or local bond opinions. The definition of a State or local bond opinion contemplates opinions that issuers routinely receive at the time bonds are issued. Specifically, a State or local bond opinion is written advice that is included in the offering materials for the issuance of a State or local bond and that concerns only the excludability of interest on a State or local bond from gross income under section 103, the application of section 55, the status of the bond as a qualified tax-exempt obligation under section 265(b)(3), the status of the bond as a qualified zone academy bond under section 1397E, or any combination of these issues. Offering materials include any written material delivered to a purchaser of a State or local bond in connection with the issuance of the bond in a private or public placement (bond offering materials).

Under §10.35(b)(2)(ii)(B)(2), a covered opinion does not include a State or local bond opinion. Under proposed §10.35(b)(9), a State or local bond opinion is written advice, included in bond offering materials for the issuance of a State or local bond, if (1) the written advice as to Federal tax matters addressed in the bond offering materials consists only of advice that concerns specified issues under section 103, section 55, section 265(b)(3), or section 1397E, or any combination of those issues; and (2) the practitioner separately provides to the issuer of the bond, and includes in the transcript of proceedings if one is prepared, written advice that satisfies the requirements set forth in §10.39.

An opinion is a State or local bond opinion even if the written advice addresses matters not directly related to a Federal tax issue, e.g., a State law issue. An opinion also is a State or local bond opinion if the opinion is redelivered unchanged, e.g., if the opinion is redelivered with a qualified tender bond that is tendered to the remarketing agent and remarketed. If the State or local bond opinion with respect to that bond issue is changed or otherwise updated after bonds are issued, the altered opinion is not a State or local bond opinion, and is subject to the requirements of §10.35.

The Treasury Department and the IRS recognize the special characteristics of the market for municipal bonds and are proposing amendments to the requirements of Circular 230 that take into account these characteristics. The manner in which practitioners provide State or local bond opinions suggests that the form of these bond opinions should be more flexible than §10.35 permits. The proposed regulations exclude a State or local bond opinion from the requirements of §10.35, if the practitioner provides the issuer with separate written advice that satisfies the requirements of §10.39.

Proposed §10.39 sets forth the minimum requirements for a State or local bond opinion. Although the minimum requirements are substantially similar to those of §10.35(c), §10.39 is tailored to take into account the customary practice and special circumstances of the market for municipal bonds. Furthermore, the proposed regulations provide practitioners flexibility in determining how the separate written advice should be conveyed. The practitioner may provide the separate written advice in a tax certificate that customarily would be prepared for inclusion in the transcript of proceedings, or in a tax certificate and an additional memorandum or letter, or in any other combination of documents that are made available to the issuer and included in the transcript of proceedings, if one is prepared. The requirements for all State or local bond opinions include: (1) identifying and considering all relevant facts and not relying on unreasonable factual assumptions or unreasonable representations; (2) relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts and not relying on any unreasonable legal assumptions, representations or conclusions; and (3) considering all significant Federal tax issues relevant to reaching the overall conclusion with respect to the Federal tax treatment of the bonds and reaching a conclusion, supported by the facts and the law, with respect to each significant Federal tax issue. As provided in §10.35(b)(3), a Federal tax issue is significant if the Internal Revenue Service has a reasonable basis for a successful challenge and its resolution could have a significant impact, whether beneficial or adverse and under any reasonably foreseeable circumstance, on the overall Federal tax treatment of the transaction(s) or matter(s) addressed in the opinion.

A practitioner must not base the written advice on an assumption or factual representation, statement or finding of any person unless the practitioner has exercised due diligence in identifying and ascertaining the relevant facts. Even if a third party has certified a representation, the practitioner is responsible for exercising due diligence. For example, a practitioner may not rely on a representation, certified or otherwise, to conclude that the requirements of the safe harbor for establishing the fair market value of a guaranteed investment contract in 26 CFR 1.148-5(d)(6)(iii) were met if the representation does not include a specific description of how those requirements were satisfied or if the practitioner knows or should know that the representation was incorrect or incomplete.

Proposed §10.39 permits a practitioner to incorporate the facts, factual assumptions, and findings, representations and statements of any person by reference to another document, such as a tax certificate, provided that the document is included in the transcript of proceedings. Similarly, the legal analysis may be appended or included in a tax certificate or similar document, provided that it is clear that the practitioner provided the written advice. Unlike §10.35(e) with respect to covered opinions, proposed §10.39 does not require any disclosures in the written advice.

Proposed §§10.35(b)(9) and 10.39 will require that the written advice the practitioner is required to provide separately to the issuer of a state or local bond be included in the transcript of proceedings if one is prepared or in a document available to the issuer if no transcript is prepared. Inclusion of the written advice in the transcript of proceedings is intended to ensure that the practitioner’s written advice is made available to the issuer and is intended to be consistent with the current practice of including the tax certificate and other documents supporting the State or local bond opinion in the transcript of proceedings. The Treasury Department and the IRS request comments regarding this requirement.

Consistent with Announcement 2004-29, 2004-17 I.R.B. 828 (April 26, 2004), these proposed regulations will be applicable no sooner than 120 days after the final regulations are published in the Federal Register.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. Persons authorized to practice before the IRS have long been required to comply with certain standards of conduct. Therefore, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Before the regulations are adopted as final regulations, consideration will be given to any written comments and electronic comments that are submitted timely to the IRS. The Treasury Department and the IRS specifically request comments on the clarity of the proposed regulations and how they can be made easier to understand. All comments will be available for public inspection and copying.

The public hearing is scheduled for March 22, 2005, at 10:00 a.m., and will be held in the Internal Revenue Service auditorium on the seventh floor. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. All visitors must present photo identification to enter the building. Visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments and submit an outline of the topics to be discussed and the time to be devoted to each topic by March 1, 2005. A period of 10 minutes will be allocated to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for subtitle A, part 10 continues to read as follows:

[Authority: Sec. 3, 23 Stat. 258, secs. 2-12, 60 Stat. 237 et seq.; 5 U.S.C. 301, 500, 551-559; 31 U.S.C. 330; Reorg. Plan No. 26 of 1950, 15 FR 4935, 64 Stat. 1280, 3 CFR, 1949-1953 Comp., P. 1017.]

Par. 2. Section 10.35 is amended by revising paragraph (b)(9) to read as follows: