This document contains amendments to the Income Tax Regulations (26 CFR part 1), the Employment Taxes and Collection of Income Tax at Source Regulations (26 CFR part 31), and the Procedure and Administration Regulations (26 CFR part 301) regarding statements that are required to be furnished to employees by employers or other persons under sections 6051 and 6052 of the Code. On September 20, 2017, a notice of proposed rulemaking (REG-105004-16) was published in the Federal Register (82 FR 43920). The notice of proposed rulemaking proposed to permit employers to truncate employees’ SSNs to appear in the form of TTINs on copies of Forms W-2 that are furnished to employees. In addition, the notice of proposed rulemaking proposed to amend the regulations under section 6109 to clarify the application of the truncation rules to Forms W-2 and to add an example illustrating the application of these rules. Finally, the notice of proposed rulemaking proposed to delete obsolete provisions and update cross references in the regulations under sections 6051 and 6052. The proposed regulations were proposed to apply to statements required to be filed and furnished under sections 6051 and 6052 after December 31, 2018.

The IRS received comments on the notice of proposed rulemaking, but no public hearing was requested or held. After consideration of the comments, this Treasury decision adopts the proposed regulations without substantive changes to the content of the rules. The applicability date provisions have been changed. The regulations will apply to returns, statements, and other documents required to be filed or furnished after December 31, 2020, except for §31.6051-2, as amended, which will apply as of the date of publication in the Federal Register. A detailed explanation of these regulations can be found in the preamble to the proposed rules. 82 FR 43920.

Seventeen written comments were submitted on the notice of proposed rulemaking. They are available at www.regulations.gov or upon request. Many of the comments recommended adopting the proposed rules. This preamble addresses the substantive comments that were critical of the proposed rules permitting employers to truncate employees’ SSNs to appear in the form of TTINs on copies of Forms W-2 that are furnished to employees or requested clarification of the proposed rule.

Several commenters disagreed with the proposed rules. Commenters stated that not including a complete SSN on the copy of the Form W-2 will make it difficult for employees to verify that the SSN appearing on the copy of the employee’s Form W-2 that is filed with the Social Security Administration (SSA) and the IRS is correct, will make it difficult for employees to identify and correct mistakes in lifetime earnings, will make it more difficult for tax return preparers to verify that the taxpayer has provided the correct SSN, may make it more difficult for employees to provide proof of income to lenders, and will confuse employees who receive multiple Forms W-2, some with truncated SSNs and others with complete SSNs.

The Department of the Treasury (Treasury Department) and the IRS did not adopt these comments. The commenters noted potential, unintended consequences of allowing SSNs to appear in the form of a TTIN on Forms W-2. The Treasury Department and the IRS have determined that the benefit of allowing employers to protect their employees from identity theft by truncating employees’ SSNs to appear in the form of a TTIN outweighs the risk that the unintended consequences identified by the commenters will occur. Additionally, many of the potential consequences noted by the commenters can be mitigated.

First, tax return preparers can use Forms W-2 containing truncated SSNs to verify employee information by using the last four digits of the SSN and the employee’s name and address. Second, preparers can use other documentation to verify employee information. For example, they can verify the accuracy of a taxpayer’s SSN by requesting to see the taxpayer’s social security card. Third, the only comment submitted regarding lender verification questioned whether verification would be more difficult, and the commenter did not represent having any expertise on the topic. No lender submitted comments suggesting the inclusion of a truncated SSN rather than a complete SSN would affect the lenders’ ability to verify income using Forms W-2. If a lender refuses to accept a Form W-2 with a truncated SSN, employees may verify income by other methods, such as providing pay stubs. Fourth, there are many taxpayers who do not receive Forms W-2, and tax return preparers and lenders are able to verify the accuracy of these taxpayers’ information. Methods used to verify information for taxpayers who do not receive a Form W-2 can be used to verify information for taxpayers who received a Form W-2 with a truncated SSN. Similarly, methods used by taxpayers who do not receive a Form W-2 to verify their earnings with SSA can be used by employees who receive Forms W-2 with a truncated SSN if there is an issue using the employees’ Forms W-2. Finally, the instructions to Form W-2 will be updated to reflect these regulations and explain that truncation is not mandatory, which will reduce any potential for confusion for taxpayers receiving multiple Forms W-2.

Several comments addressed potential consequences if state governments do not also allow truncation. One commenter stated that even under the proposed rule, employees’ identities would not be protected because state and local governments will not allow truncation. Another commenter stated that the proposed rules will cause confusion and could cause employees to violate state and local government rules if the state and local governments do not allow for truncation on copies filed with state and local governments. This commenter also stated that the proposed rules will increase the administrative burden on employers with employees who work in multiple states because the employer will have to determine the requirements for each state. Finally, one commenter stated that the proposed rules will make it more difficult for state authorities to process Forms W-2 and to determine if someone is using an SSN that is not his or hers.

The Treasury Department and the IRS have considered these comments and declined to adopt them. Truncation allows employers to actively assist their employees by safeguarding their employees’ identities. The commenters speculate that state or local governments may prevent truncation on the copy of the Forms W-2 submitted to the state. That may be true, but other state and local governments may allow truncation. Truncation, and the identity protection benefits associated with truncation, should not be prohibited for all employees because some state and local governments may not allow truncation. The permissive nature of the rules accommodate the restrictions of individual states. Similarly, the rules accommodate potential burdens imposed on employers by making truncation optional. If employers with employees in multiple states find the process too burdensome, they may choose not to truncate. The Treasury Department and the IRS determined that there is a benefit in allowing for truncation because it will benefit the employees of employers who choose to take advantage of it after considering applicable state and local government rules.

Only one state submitted a comment on its ability to process Forms W-2 with truncated SSNs, and that comment supported the adoption of the proposed rules. At the request of several state tax administrators, the proposed rules provided that the applicable date would not be earlier than December 31, 2018, to give the states sufficient time to make necessary changes to their systems. The final regulations provide that these rules apply to returns, statements, and other documents required to be filed or furnished after December 31, 2020.

Finally, one commenter speculated that software vendors would not allow the option for truncated employee SSNs to appear as IRS TTINs. The Treasury Department and the IRS did not receive any comments from software vendors indicating that they could not or would not truncate SSNs on the Form W-2. Two payroll organizations submitted comments that supported the proposed rule. Further, because truncation is permissive and not mandatory, there is no negative consequence to the employer if a particular software vendor does not allow for truncation.

Commenters also suggested alternatives to the proposed rules. One commenter suggested that a better way to protect employees’ identities would be to require employers to furnish employees’ copies of Forms W-2 electronically. This comment was outside the scope of the proposed rule, and the Treasury Department and the IRS did not adopt this comment. Allowing truncation provides a different benefit to employees than electronic furnishing. Under existing rules, however, employers are allowed to furnish Forms W-2 electronically if the employee consents.

One commenter suggested that employers should be required to furnish one copy of Form W-2 to employees with the employees’ full SSN. The Treasury Department and the IRS did not adopt this comment. As other commenters noted, including one copy of Form W-2 with the employee’s full SSN along with the copies where the employee’s SSN appears as an IRS TTIN defeats the purpose of permitting truncation.

One commenter stated that truncation should be mandatory. The Treasury Department and the IRS did not adopt this comment. As commenters noted, maintaining consistent rules regarding truncation reduces the compliance burden for filers. Under the generally applicable rules for truncation, truncation is permitted, not mandatory. The proposed rules permitting, but not requiring, truncation, conforms to the generally applicable rules for truncation in §301.6109-4. Amending those rules to make truncation mandatory for one particular form would be inconsistent with the general rules and would increase burden on filers. Additionally, as commenters noted, while truncation is an important element of protecting against identity theft, truncation may also have other consequences, both for employers and for employees. Therefore, the Treasury Department and the IRS determined that it should be left to the employers, who furnish the forms, to decide whether to truncate.

Commenters requested clarification regarding the scope of the rules permitting employers to truncate employees’ SSNs to appear in the form of a TTIN on copies of Forms W-2 that are furnished to employees, and the forms to which the rules apply, including Forms W-2c, Forms 1099, Form 1095-C, and the territorial Forms W-2. These regulations permit employers to truncate employees’ SSNs to appear in the form of a TTIN on copies of Forms W-2 that are furnished to employees under sections 6051(a) and (f)(2) and 6052(b). This includes Forms W-2c that are furnished to correct errors on Forms W-2 that are furnished under sections 6051(a) and (f)(2) and 6052(b). The regulations do not apply to any other forms.

In general, under the truncation rules in §301.6109-4(b)(2)(ii), a TTIN may not be used on a statement or document if a statute, regulation, other guidance published in the Internal Revenue Bulletin, form, or instructions, specifically requires use of an SSN, IRS individual taxpayer identification number (ITIN), IRS adoption taxpayer identification number (ATIN), or IRS employer identification number (EIN) and does not specifically permit truncation. If a specific form continues to require an SSN and does not permit truncation, the SSN may not be truncated to appear in the form of an IRS TTIN. The IRS intends to incorporate the revised regulations into forms and instructions, permitting employers to truncate employees’ SSNs to appear in the form of an IRS TTIN on employees’ copies of Forms W-2.

Only positive comments were received regarding the miscellaneous updates to regulations under sections 6051 and 6052, and these rules are also finalized as proposed.

IRS Revenue Procedures, Revenue Rulings notices, and other guidance cited in this preamble are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402, or by visiting the IRS website at www.irs.gov.

These regulations are not subject to review under section 6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget regarding review of tax regulations. Because these regulations do not impose a collection of information on small entities, a regulatory impact 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 that preceded these final regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. No comments were received from the Small Business Administration.

The principal author of these regulations is Eliezer Mishory of the Office of the Associate Chief Counsel (Procedure and Administration).

* * * * *

Accordingly, 26 CFR parts 1, 31 and 301 are amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805, unless otherwise noted.

* * * * *

Par. 2. Section 1.6052-2 is amended by:

The revisions read as follows:

§1.6052-2 Statements to be furnished to employees with respect to wages paid in the form of group-term life insurance.

(a) Requirement. Every employer filing a return under section 6052(a) and §1.6052-1, with respect to group-term life insurance on the life of an employee, shall furnish to the employee whose name is set forth in such return the tax return copy and the employee’s copy of Form W-2. Each copy of Form W-2 must show the information required to be shown on the Form W-2 filed under §1.6052-1. An employer may truncate an employee’s social security number to appear in the form of an IRS truncated taxpayer identification number (TTIN) on copies of Forms W-2 furnished to the employee. For provisions relating to the use of TTINs, see §301.6109-4 of this chapter (Procedure and Administration Regulations). The rules in §31.6051-1 of this chapter (Employment Taxes and Collection of Income Tax at Source Regulations) shall apply with respect to the means and time (including extensions thereof) for furnishing the employee’s copy of Form W-2 required by this section to the employee and making corrections to such form.

* * * * *

(c) Penalty. For provisions relating to the penalty provided for failure to furnish a statement under this section, see section 6722 and the regulations in part 301 under section 6722.

(d) Applicability date. This section is applicable for statements required to be furnished under section 6052 after December 31, 2020.

PART 31—EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

Par. 3. The authority citation for part 31 is amended by adding an entry for §31.6051-3 in numerical order to read in part as follows:

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

Section 31.6051-3 also issued under 26 U.S.C. 6051.

* * * * *

Par. 4. Section 31.6051-1 is amended by:

The revisions and addition read as follows:

§31.6051-1 Statements for employees.

(a) * * *

(1) * * *

(i) * * *

(B) The name, address, and social security number of the employee, which may be truncated to appear in the form of an IRS truncated taxpayer identification number (TTIN) on copies of Forms W-2 that are furnished to the employee (for provisions relating to the use of TTINs, see §301.6109-4 of this chapter (Procedure and Administration Regulations)), if wages as defined in section 3121(a) have been paid or if the Form W-2 is required to be furnished to the employee,

* * * * *

(b) * * *

(1) * * *

(ii) The name, address, and social security number of the employee, which may be truncated to appear in the form of a TTIN on copies of Forms W-2 that are furnished to the employee (for provisions relating to the use of TTINs, see §301.6109-4 of this chapter),

* * * * *

(f) Statements with respect to compensation, as defined in the Railroad Retirement Tax Act—(1) Notification of possible credit or refund. With respect to compensation (as defined in section 3231(e)), every employer (as defined in section 3231(a)) who is required to deduct and withhold from an employee (as defined in section 3231(b)) a tax under section 3201, shall include on or with the statement required to be furnished to such employee under section 6051(a), a notice concerning the provisions of this title with respect to the allowance of a credit or refund of the tax on wages imposed by section 3101(b) and the tax on compensation imposed by section 3201 or 3211, which is treated as a tax on wages imposed by section 3101(b).

(2) Information to be supplied to employees upon request. With respect to compensation (as defined in section 3231(e)), every employer (as defined in section 3231(a)) who is required to deduct and withhold tax under section 3201 from an employee (as defined in section 3231(b)) who has also received wages during such year subject to the tax imposed by section 3101(b), shall upon request of such employee furnish to him or her a written statement showing—

(i) The total amount of compensation with respect to which the tax imposed by section 3101(b) was deducted;

(ii) The total amount of employee tax under section 3201 deducted and withheld (increased by any adjustment in the calendar year for overcollection, or decreased by any adjustment in such year for undercollection, of such tax during any prior year); and

(iii) The proportion thereof (expressed either as a dollar amount, or a percentage of the total amount of compensation as defined in section 3231(e), or as a percentage of the total amount of employee tax under section 3201) withheld as tax under section 3201 for financing the cost of hospital insurance benefits.

(h) * * *

(2) Time for furnishing statement. The statement required by this paragraph (h) for a calendar year shall be furnished—

(i) In the case of an employee who is required to be furnished a Form W-2, Wage and Tax Statement, for the calendar year, within one week of (before or after) the date that the employee is furnished a timely Form W-2 for the calendar year (or, if a Form W-2 is not so furnished, on or before the date by which it is required to be furnished); and

(ii) In the case of an employee who is not required to be furnished a Form W-2 for the calendar year, on or before February 7 of the year succeeding the calendar year.

* * * * *

(i) Cross references. For provisions relating to the penalties provided for the willful furnishing of a false or fraudulent statement, or for the willful failure to furnish a statement, see §31.6674-1 and section 7204. For additional provisions relating to the inclusion of identification numbers and account numbers in statements on Form W-2, see §§31.6109-1 and 31.6109-4. For the penalties applicable to information returns and payee statements, see sections 6721 through 6724 and the regulations in part 301 under sections 6721 through 6724.

* * * * *

(k) Applicability date. This section is applicable for statements required to be furnished under section 6051 after December 31, 2020.

Par. 5. Section 31.6051-2 is amended by revising paragraphs (a) and (c) and adding paragraph (d) to read as follows:

§31.6051-2 Information returns on Form W-3 and Social Security Administration copies of Forms W-2.

(a) In general. Every employer who is required to make a return of tax under §31.6011(a)-1 (relating to returns under the Federal Insurance Contributions Act), §31.6011(a)-4 (relating to returns of income tax withheld from wages), or §31.6011(a)-5 (relating to monthly returns) for a calendar year or any period therein, shall file the Social Security Administration copy of each Form W-2 required under §31.6051-1 to be furnished by the employer with respect to wages paid during the calendar year. An employer may not truncate an employee’s social security number to appear in the form of an IRS truncated taxpayer identification number (TTIN) on copies of Forms W-2 filed with the Social Security Administration. Each Form W-2 and the transmittal Form W-3 shall together constitute an information return to be filed with the Social Security Administration as indicated on the instructions to such forms. For the requirement to submit the information on Form W-2 on magnetic media, see section 6011(e) and §301.6011-2 of this chapter (Procedure and Administration Regulations).

* * * * *

(c) Cross references. For provisions relating to the time for filing the information returns required by this section and to extensions of the time for filing, see sections 6071 and 6081 and the regulations in this part under sections 6071 and 6081. For the penalties applicable to information returns and payee statements, see sections 6721 through 6724 and the regulations in part 301 under sections 6721 through 6724.

(d) Applicability date. This section is applicable for statements required to be filed under section 6051 after July 3, 2019.

Par. 6. Section 31.6051-3 is amended by revising paragraphs (a)(1)(i), (b)(1), (e)(3), and (f) and removing paragraph (g) to read as follows:

§31.6051-3 Statements required in case of sick pay paid by third parties.

(a) * * *

(1) * * *

(i) The name and, if there is withholding from sick pay under section 3402(o) and the regulations in this part under section 3402(o), the social security account number of the payee (the payee’s social security number may not be truncated to appear in the form of an IRS truncated taxpayer identification number (TTIN)),

(b) * * *

(1) All of the information required to be furnished under paragraph (a) of this section, but the employer may truncate the payee’s social security number to appear in the form of a TTIN on copies of Forms W-2 that are furnished to the payee (for provisions relating to the use of TTINs, see §301.6109-4 of this chapter (Procedure and Administration Regulations)).

* * * * *

(e) * * *

(3) The provisions of section 6109 (relating to identifying numbers) and the regulations in this part and part 301 under section 6109 shall be applicable to Form W-2 and to any payee of sick pay to whom a statement on Form W-2 is required by this section to be furnished. The employer must include the social security number of the payee on all copies of Forms W-2. The employer may truncate the payee’s social security number to appear in the form of a TTIN on copies of Forms W-2 that are furnished to the payee. For provisions relating to the use of TTINs, see §301.6109-4 of this chapter.

(f) Applicability date. This section is applicable for statements required to be furnished under section 6051 after December 31, 2020.

PART 301 - PROCEDURE AND ADMINISTRATION

Par. 7. The authority citation for part 301 continues to read in part as follows:

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

Par. 8. Section 301.6109-4 is amended by revising paragraphs (b)(2)(ii) and (iii), (b)(3), and (c) to read as follows:

§301.6109-4 IRS truncated taxpayer identification numbers.

* * * * *

(b) * * *

(2) * * *

(ii) A TTIN may not be used on a statement or document if a statute, regulation, other guidance published in the Internal Revenue Bulletin, form, or instructions, specifically requires use of an SSN, ITIN, ATIN, or EIN and does not specifically state that the taxpayer identifying number may be truncated. For example, a TTIN may not be used on a Form W-8ECI or Form W-8IMY because the forms and/or form instructions specifically prescribe use of an SSN, EIN, or ITIN for the U.S. taxpayer identification number.

(iii) A TTIN may not be used on any return, statement, or other document that is required to be filed with or furnished to the Internal Revenue Service or the Social Security Administration in the case of forms required to be filed with the Social Security Administration under the internal revenue laws.

* * * * *

(3) Examples. The provisions of this paragraph (b) are illustrated by the following examples:

(i) Example 1. Pursuant to section 6051(d) and §31.6051-2(a) of this chapter, Employer files the Social Security Administration copy of Employee’s Form W-2, Wage and Tax Statement, with the Social Security Administration. Employer may not truncate any identifying number on the Social Security Administration copy. Pursuant to section 6051(a) and §31.6051-1(a)(1)(i) of this chapter, Employer furnishes copies of Forms W-2 to Employee. There are no applicable statutes, regulations, other published guidance, forms, or instructions that prohibit use of a TTIN on Form W-2, and §31.6051-1(a)(1)(i) specifically permits truncating employees’ SSNs. Accordingly, Employer may truncate Employee’s SSN to appear in the form of a TTIN on copies of Forms W-2 furnished to Employee. Employer may not truncate its own EIN on copies of Forms W-2 furnished to Employee.

(ii) Example 2. On April 5, year 1, Donor contributes a used car with a blue book value of $1,100 to Charitable Organization. On April 20, year 1, Charitable Organization sends Donor copies B and C of the Form 1098-C as a contemporaneous written acknowledgement of the $1,100 contribution as required by section 170(f)(12). In late-February, year 2, Charitable Organization prepares and files copy A of Form 1098-C with the IRS, reporting Donor’s donation of a qualified vehicle in year 1. Charitable Organization may truncate Donor’s SSN to appear in the form of a TTIN in the Donor’s Identification Number box on copies B and C of the Form 1098-C because copies B and C of the Form 1098-C are documents required by the Internal Revenue Code and regulations to be furnished to another person; there are no applicable statutes, regulations, other published guidance, forms or instructions that prohibit the use of a TTIN on those copies; and there are no applicable statutes, regulations, other published guidance, forms, or instructions that specifically require use of an SSN or other identifying number on those copies. Charitable Organization may not truncate its own EIN on copies B and C of the Form 1098-C because a person cannot truncate its own taxpayer identifying number on any statement or other document the person furnishes to another person. Charitable Organization may not truncate any identifying number on copy A of the Form 1098-C because copy A is required to be filed with the IRS.

(c) Applicability date. This section is applicable to returns, statements, and other documents required to be filed or furnished after December 31, 2020.

Kirsten Wielobob,

Deputy Commissioner for Services and Enforcement.

Approved: May 2, 2019.

David J. Kautter,

Assistant Secretary for Tax Policy.

(Filed by the Office of the Federal Register on July 2, 2019, 8:45 a.m. and published in the issue of the Federal Register for July 3, 2019, 84 F.R. 31717)

This document contains amendments to 26 CFR part 301. Section 301.7701-2(c)(2)(i) of the regulations specifies that, except as otherwise provided, a business entity that has a single owner and is not a corporation under §301.7701-2(b) is disregarded as an entity separate from its owner (a disregarded entity). However, §301.7701-2(c)(2)(iv)(B) treats a disregarded entity as a corporation for purposes of employment taxes imposed under Subtitle C of the Internal Revenue Code (Code). This exception to the treatment of disregarded entities does not apply to taxes imposed under Subtitle A of the Code, including self-employment taxes, and the regulations issued in TD 9670 on June 26, 2014 (79 FR 36204) explicitly provided that the owner of a disregarded entity who is treated as a sole proprietor for income tax purposes is subject to self-employment taxes.

On May 4, 2016, temporary regulations (TD 9766) clarifying the employment tax treatment of partners in a partnership that owns a disregarded entity were published in the Federal Register (81 FR 26693, as corrected July 5, 2016, at 81 FR 43488). Prior to the publication of the temporary regulations, the regulations did not explicitly address situations in which the owner of a disregarded entity is a partnership, and the Department of the Treasury (Treasury Department) and the IRS had been informed that some taxpayers were reading the regulations to permit the treatment of the individual partners in a partnership that owned a disregarded entity (either directly or through tiered partnerships) as employees of the disregarded entity. The Treasury Department and the IRS issued the temporary regulations to clarify that the rule that a disregarded entity is treated as a corporation for employment tax purposes does not apply to the self-employment tax treatment of any individuals who are partners in a partnership that owns a disregarded entity. The temporary regulations, like the final regulations they replaced, continued to explicitly provide that the owner of a disregarded entity who is treated as a sole proprietor for income tax purposes is subject to self-employment taxes. A notice of proposed rulemaking (REG-114307-15) cross-referencing the temporary regulations was published in the Federal Register on the same day (81 FR 26763). No public hearing was requested or held. Comments responding to the notice of proposed rulemaking were received. All comments were considered and are available for public inspection and copying at http://www.regulations.gov or upon request. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury decision, and the corresponding temporary regulations are removed. The public comments are discussed in this preamble.

The Treasury Department and the IRS received two comments in response to the proposed regulations. One commenter requested that the Treasury Department and the IRS consider addressing whether an eligible entity’s election to be classified as an association (and thus a corporation under §301.7701–2(b)(2)) pursuant to the final entity classification regulations under section 7701 of the Code (also known as the “Check-the-Box” regulations) would change the result such that a partner of the upper tier entity could be an employee at the lower tier entity that is treated as a corporation. While the temporary regulations did not address tiered entities, the use of an entity classified as a corporation under the Check-the-Box regulations presents different issues, such as whether, under the facts and circumstances, the partner is an employee of the corporation. However, these issues are outside the scope of these final regulations, and for this reason, these regulations do not address this comment.

In the preamble of TD 9766, the Treasury Department and the IRS requested comments on the appropriate application of the principles of Rev. Rul. 69-184, 1969-1 C.B. 256, to tiered partnership situations, the circumstances in which it may be appropriate to permit partners to also be employees of the partnership, and the impact on employee benefit plans (including, but not limited to, qualified retirement plans, health and welfare plans, and fringe benefit plans) and on employment taxes if Rev. Rul. 69-184 were to be modified to permit partners to also be employees in certain circumstances.

In response to this request, one commenter described the effects of the application of the principles of Rev. Rul. 69-184 in the context of publicly traded partnerships. This commenter noted that one particular concern in the publicly traded partnership context is that the publicly traded partnership may not know which service providers treated as employees (whether at the publicly traded partnership level or at any disregarded entity owned by the publicly traded partnership) hold units since individuals may purchase units on the open market without the knowledge of the publicly traded partnership. If an acquisition of units by the service provider occurs without the publicly traded partnership’s knowledge, then improper tax withholding and benefit plan participation may occur until the publicly traded partnership discovers the error. This commenter also noted a number of negative effects on service providers receiving equity-based compensation from a publicly traded partnership and the ensuing burden required in administering any equity-based compensation plan in the publicly traded partnership context. This commenter requested that the IRS consider an exception to the principles of Rev. Rul. 69-184 for publicly traded partnerships.

As noted in the preamble to TD 9766, these regulations do not address the application of Rev. Rul. 69-184 in tiered partnership situations, but rather clarify that a disregarded entity owned by a partnership is not treated as a corporation for purposes of employing any partner of the partnership. Similarly, these regulations also do not address the application of Rev. Rul. 69-184 to publicly traded partnerships. Accordingly, the final regulations do not provide an exception to the principles of Rev. Rul. 69-184 for publicly traded partnerships. However, the Treasury Department and the IRS will continue to consider the application of Rev. Rul. 69-184, including the specific issue noted by the commenter, and welcome further comments.

The temporary regulations provided that their applicability date would be the later of August 1, 2016, or the first day of the latest-starting plan year following May 4, 2016 of an affected plan (based on the plans adopted before, and the plan years in effect as of, May 4, 2016) sponsored by an entity that is disregarded as an entity separate from its owner for any purpose under §301.7701-2. It has come to the attention of the Treasury Department and the IRS that some taxpayers may have read the applicability date to begin on the first day of the last plan year prior to the termination of an affected plan (as defined in §301.7701-2(e)(8)), which may have been a date after May 4, 2017 . This is not a proper reading of the applicability date.

In the case of an entity with several affected plans that may have different plan years, the applicability date was the first day of the plan year of the affected plan that had the latest plan year beginning after May 4, 2016, and on or before May 4, 2017 (assuming that date is after August 1, 2016). For example, an entity may have had two affected plans, with one plan year that began on September 1, 2016, and another plan year that began on January 1, 2017. In this case, the applicability date for this entity would have been January 1, 2017. The applicability date for any entity affected by these regulations should not have been delayed beyond May 4, 2017 in any case. For this reason, the final regulations clarify in §301.7701-2(e)(8) that the applicability date of §301.7701-2(c)(2)(iv)(C)(2) is the later of August 1, 2016, or the first day of the latest-starting plan year beginning after May 4, 2016, and on or before May 4, 2017, of an affected plan (based on the plans adopted before, and the plan years in effect as of, May 4, 2016) sponsored by an entity that is disregarded as an entity separate from its owner for any purpose under §301.7701-2.

This regulation is not subject to review under section 6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Department of the Treasury and the Office of Management and Budget regarding review of tax regulations. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the NPRM preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

The principal author of these regulations is Andrew Holubeck of the Office of the Associate Chief Counsel (Employee Benefits, Exempt Organizations and Employment Taxes). However, other personnel from the IRS and the Treasury Department participated in their development.

IRS Revenue Procedures, Revenue Rulings, Notices, and other guidance cited in this document are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

* * * * *

Accordingly, 26 CFR part 301 is amended as follows:

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read in part as follows:

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

Par. 2. Section 301.7701-2 is amended by:

1. Revising paragraph (c)(2)(iv)(C)(2).

2. Removing the “(e)” from the “(e)(8)” paragraph designation and revising paragraph (e)(8).

The revisions read as follows:

§301.7701-2 Business entities; definitions.

* * * * *

(c) * * *

(2) * * *

(iv) * * *

(C) * * *

(2) Paragraph (c)(2)(i) of this section applies to taxes imposed under subtitle A of the Code, including Chapter 2—Tax on Self-Employment Income. Thus, an entity that is treated in the same manner as a sole proprietorship under paragraph (a) of this section is not treated as a corporation for purposes of employing its owner; instead, the entity is disregarded as an entity separate from its owner for this purpose and is not the employer of its owner. The owner will be subject to self-employment tax on self-employment income with respect to the entity’s activities. Also, if a partnership is the owner of an entity that is disregarded as an entity separate from its owner for any purpose under this section, the entity is not treated as a corporation for purposes of employing a partner of the partnership that owns the entity; instead, the entity is disregarded as an entity separate from the partnership for this purpose and is not the employer of any partner of the partnership that owns the entity. A partner of a partnership that owns an entity that is disregarded as an entity separate from its owner for any purpose under this section is subject to the same self-employment tax rules as a partner of a partnership that does not own an entity that is disregarded as an entity separate from its owner for any purpose under this section.

* * * * *

(e) ***

(8) Paragraph (c)(2)(iv)(C)(2) of this section applies on the later of–

(i) August 1, 2016; or

(ii) The first day of the latest-starting plan year beginning after May 4, 2016, and on or before May 4, 2017, of an affected plan (based on the plans adopted before, and the plan years in effect as of, May 4, 2016) sponsored by an entity that is disregarded as an entity separate from its owner for any purpose under this section. For rules that apply before the applicability date of paragraph (c)(2)(iv)(C)(2) of this section, see 26 CFR part 301 revised as of April 1, 2016. For the purposes of this paragraph (e)(8)—

(A) An affected plan includes any qualified plan, health plan, or section 125 cafeteria plan if the plan benefits participants whose employment status is affected by paragraph (c)(2)(iv)(C)(2) of this section;

(B) A qualified plan means a plan, contract, pension, or trust described in paragraph (A) or (B) of section 219(g)(5) (other than paragraph (A)(iii)); and

(C) A health plan means an arrangement described under §1.105-5 of this chapter.

*****

§301.7701-2T [Removed]

Par. 3. Section 301.7701-2T is removed.

Kirsten Wielobob,

Deputy Commissioner for Services and Enforcement.

Approved: May 15, 2019.

David J Kautter,

Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on June 28, 2019 at 4:15 p.m. and published in the issue of the Federal Register for July 2, 2019, 84 F.R. 31478)

This document contains proposed regulations under section 4968 of the Internal Revenue Code (Code) to amend part 53 of the Excise Tax Regulations (26 CFR part 53). Section 4968 of the Code, added by section 13701 of the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054, 2167-68, (2017) (TCJA), imposes on each applicable educational institution, as defined in section 4968(b)(1), an excise tax equal to 1.4 percent of the institution’s net investment income, and, as described in section 4968(d), a portion of certain net investment income of certain related organizations, for the taxable year.

Section 4968(b)(1) defines the term “applicable educational institution” as an eligible educational institution (as defined in section 25A(f)(2)) which during the preceding taxable year had at least 500 tuition-paying students, more than 50 percent of whom were located in the United States, is not a state college or university as described in the first sentence of section 511(a)(2)(B), and had assets (other than those assets used directly in carrying out the institution’s exempt purpose) the aggregate fair market value of which was at least $500,000 per student of the institution.

Section 4968(b)(2) provides that, for purposes of section 4968(b)(1), the number of students of an institution (including for purposes of determining the number of students at a particular location) shall be based on the daily average number of full-time students attending such institution (with part-time students taken into account on a full-time student equivalent basis).

Section 4968(c) provides that, for purposes of section 4968, “net investment income” shall be determined under rules similar to the rules of section 4940(c).

Section 4968(d)(1) provides that, for purposes of determining aggregate fair market value of an educational institution’s assets not used directly in carrying out its exempt purpose¹ and for purposes of determining an institution’s net investment income, the assets and net investment income of any related organization with respect to the institution shall be treated as assets and net investment income, respectively, of the educational institution, with two exceptions. First, no such amount shall be taken into account with respect to more than one educational institution. Second, unless such organization is controlled by such institution or is described in section 509(a)(3) (relating to supporting organizations) with respect to such institution for the taxable year, assets and net investment income which are not intended or available for the use or benefit of the educational institution shall not be taken into account.

Section 4968(d)(2) provides that the term “related organization,” with respect to an educational institution, means (1) any organization which controls, or is controlled by, such institution; (2) is controlled by one or more persons that also control such institution; or (3) is a supported organization (as defined in section 509(f)(3)), or a supporting organization (as described in section 509(a)(3)), during the taxable year with respect to the educational institution.

The Conference Report for the TCJA, H. Rept. 115-466, 115th Cong., 1st sess., December 15, 2017 (Conference Report), at 555, states that Congress intended that the Secretary of the Treasury promulgate regulations to carry out the intent of section 4968, including regulations that describe: (1) Assets that are used directly in carrying out an educational institution’s exempt purpose; (2) the computation of net investment income; and (3) assets that are intended or available for the use or benefit of an educational institution.

In June 2018, the Treasury Department and the IRS issued Notice 2018-55 (2018-26 I.R.B. 773) (Notice) to provide interim guidance on certain issues related to the application of the tax imposed by section 4968. Specifically, Notice 2018-55 states that, in the case of property held on December 31, 2017, and continuously thereafter to the date of its disposition, the Treasury Department and the IRS intend to propose regulations stating that basis for purposes of determining gain (but not loss) shall be deemed to be not less than the fair market value of such property on December 31, 2017, plus or minus all adjustments after December 31, 2017, and before the date of disposition consistent with the regulations under section 4940(c). The Notice provides that, if the disposition of an asset would result in a capital loss, basis rules that are consistent with the regulations under section 4940(c) will apply. Accordingly, if the value of the asset declines after December 31, 2017, the taxpayer will recognize no gain; however, the taxpayer will recognize a loss only if the proceeds from the sale of the asset are less than the basis of the property as calculated without the special rule in the Notice to increase the basis to fair market value on December 31, 2017. The Notice additionally states that the Treasury Department and the IRS expect the proposed regulations to provide that losses from sales or other dispositions of property generally shall be allowed only to the extent of gains, with no capital loss carryovers or carrybacks, and that losses from sales or other dispositions of property by related organizations will be allowed to offset overall net gains from other related organizations or the applicable educational institution. The Notice provides that applicable educational institutions may rely on the Notice before the issuance of the proposed regulations. Finally, the Notice requests comments on any of the issues addressed in the Notice and on any additional guidance that is needed and whether, and what type of, transitional relief may be necessary.

The Treasury Department and the IRS received two comments in response to Notice 2018-55, which were considered in drafting these proposed regulations. The comments are available at http://www.regulations.gov or upon request.

1. Institutions Subject to the Tax

Section 4968(a) imposes a 1.4 percent excise tax on the net investment income of each applicable educational institution. Section 4968(b) provides that an applicable educational institution is an “eligible educational institution” (as defined in section 25A(f)(2)) if: (i) it had at least 500 tuition-paying students during the preceding taxable year; (ii) more than 50 percent of its tuition-paying students are located in the United States; (iii) it is not a state college or university as described in the first sentence of section 511(a)(2)(B); and (iv) the aggregate fair market value of its assets (other than those assets used directly in carrying out the institution’s exempt purpose) was at least $500,000 per student of the institution at the end of the preceding taxable year. Section 53.4968-1(a) of these proposed regulations sets forth definitions to determine whether an entity is an applicable educational institution that is subject to the tax.

Although, pursuant to section 4968(a), the tax on net investment income for each taxable year is based on the net investment income of an applicable educational institution for such taxable year, for purposes of determining whether an institution is an “applicable educational institution” subject to the tax, section 4968(b) provides that the number of an institution’s tuition-paying students and the aggregate fair market value of the institution’s assets (and the assets of any related organization) are based on the preceding taxable year’s number and value.

A. Eligible Educational Institution Defined in Section 25A(f)(2)

Section 4968(b)(1) defines “applicable educational institution,” in part, as an eligible educational institution defined in section 25A(f)(2). In accordance with section 4968(b), the proposed regulations provide that an applicable educational institution must be described in section 25A(f)(2) and the regulations thereunder. Section 25A(f)(2) provides that, for purposes of the allowance of American Opportunity and Lifetime Learning credits, the term “eligible educational institution” means an institution (1) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088) (HEA), as in effect on the enactment of section 25A (1997), and (2) which is eligible to participate in a program under title IV of the HEA (relating to the United States federal student financial aid programs). The Treasury Department and the IRS anticipate that colleges and universities already know whether they are described in section 25A, but request comments on whether further guidance is needed for purposes of applying section 4968.

B. Student

i. In General

Section 4968(b)(1) defines “applicable educational institution,” in part, by reference to the number of its students and the amount of its assets per student. Section 4968 does not define the term “student.” However, section 4968(b)(2) does provide that the number of students of an institution shall be based on the daily average number of full-time students attending an institution, with part-time students taken into account on a full-time student equivalent basis. As described in part 1(A) of this Explanation of Provisions section, the definition of the term “applicable educational institution” in section 4968(b), which references students in some of its definitional criteria, relies on the definition of “eligible educational institution” as defined in section 25A(f)(2).

For purposes of section 25A, the term “eligible student” is defined in section 25A(b)(3) to mean a student who (1) meets the requirements of section 484(a)(1) of the HEA (20 U.S.C. 1091(a)(1)), and (2) is carrying at least half the normal full-time work load for the course of study the student is pursuing. Section 484(a)(1) of the HEA (20 U.S.C. 1091(a)(1)) provides that, in order to receive any grant, loan, or work assistance under the general provisions relating to student assistance programs under the HEA, a student must be enrolled or accepted for enrollment in a degree, certification, or other program (including a program of study abroad approved for credit by the eligible institution at which such student is enrolled) leading to a recognized educational credential at an institution of higher education that is an eligible institution in accordance with the provisions of section 1094 of title 20 of the U.S. Code, except as provided in section 1091(b)(3) and (4) of the HEA,² and not enrolled in an elementary or secondary school.

The Treasury Department and the IRS consider the definition of eligible student under section 25A to be an appropriate basis for the definition of student for purposes of section 4968; however, the requirement found in section 25A(b)(3)(B) that a student must carry at least half the normal full-time work load for the course of study the student is pursuing is not relevant for purposes of section 4968. Section 4968(b)(2) does not contain a requirement that a student must carry at least half the normal full-time work load to be considered a student for purposes of the asset measurement requirement; instead, it states that part-time students are taken into account on a full-time student equivalent basis.

Furthermore, section 4968(b)(2) contains a requirement that the number of students of an institution be based on the daily average number of students attending the institution. Therefore, the Treasury Department and the IRS do not view the portion of the rule found in Section 484(a)(1) of the HEA that is incorporated into the definition of “student” in section 25A(b)(3)(B) and includes an individual merely “accepted for enrollment” as appropriate to the application of section 4968 since such an individual may not yet be attending the institution.

Accordingly, the proposed regulations generally follow the standard in section 484(a)(1) of the HEA referenced by section 25A(b)(3)(A) to provide that the term “student” for section 4968 purposes means a person enrolled in a degree, certification, or other program (including a program of study abroad approved for credit by the eligible institution at which such student is enrolled) leading to a recognized educational credential at an eligible educational institution, and not enrolled in an elementary or secondary school. See proposed §53.4968-1(a)(3)(i). However, the proposed definition of student does not include individuals merely accepted for enrollment, nor does it contain a requirement that the student have at least half the normal full-time work load. Furthermore, the time limitations in section 25A(b)(2) (such as that the American Opportunity Tax Credit is allowed only for 4 taxable years) are not part of the definition of “eligible student” and thus are not incorporated into the definition of student for section 4968 purposes.

Putting together the section 4968(b)(2) requirement that a student be “attending” an institution and the proposed definition that a student is an individual enrolled in a degree, certification, or other program leading to a recognized educational credential at an eligible educational institution, in applying the requirements under section 4968(b)(1), the proposed regulations require that a student be both enrolled at and attending the institution. The Treasury Department and the IRS request comments on whether further guidance is needed on the definitions of “student,” “enrolled,” or “attending.”

Consistent with section 4968(b)(1)(D), the proposed regulations provide that an educational institution determines the fair market value of assets per student based upon the total number of all students, as defined in proposed §53.4968-1(a)(3)(i), attending an eligible educational institution, not just the number of tuition-paying students.

ii. Tuition-paying

Section 4968(b)(1) defines “applicable educational institution,” in part, with respect to how many tuition-paying students attend the institution. Specifically, under section 4968(b)(1)(A) an institution must have had at least 500 tuition-paying students during the preceding taxable year, and under 4968(b)(1)(B), more than 50 percent of its tuition-paying students must have been located in the United States. Section 4968 does not define the term “tuition-paying.”

As described in part 1(A) of this Explanation of Provisions section, section 25A provides certain education credits relating to qualified tuition and related expenses paid by certain eligible students. Section 25A(f)(1) and §1.25A-2(d) provide, in relevant part, that the term “qualified tuition and related expenses” means tuition and fees required for the enrollment or attendance at an eligible educational institution for courses of instruction at such institution. Such term does not include expenses with respect to any course or other education involving sports, games, or hobbies, unless such course or other education is part of the individual’s degree program.

The Treasury Department and the IRS propose to base the definition of “tuition-paying” for purposes of section 4968 on the definition of qualified tuition and related expenses that is provided in section 25A(f)(1) and the regulations thereunder, without regard to section 25A(f)(1)(D). Thus, the proposed regulations provide that tuition-paying means the payment of tuition and fees required for the enrollment or attendance of a student for courses of instruction at an eligible educational institution but does not include any separate payment for supplies or equipment required during a specific course once a student is enrolled in and attending the course (for example, art supplies). Tuition-paying also does not include payment of room and board or other personal living expenses, and if a student is required to pay a fee (such as a comprehensive fee or a bundled fee) to an eligible educational institution that combines charges for tuition with charges for personal expenses such as room and board, then the student is a tuition-paying student. The Treasury Department and the IRS note that, notwithstanding the reference to “enrollment” for purposes of identifying tuition and fees, the tuition-paying student must also be attending the educational institution for purposes of determining if there are at least 500 tuition-paying students.

For purposes of section 4968, the proposed regulations also provide that whether a student is “tuition-paying” is determined after taking into account any scholarships provided directly by the educational institution and any work study programs operated directly by the educational institution. However, scholarship payments provided by third parties, even if administered by the institution, are considered payments of tuition on behalf of the student. Accordingly, a student will be considered a tuition-paying student for purposes of section 4968 if payment of any tuition or a fee is required for the enrollment or attendance of the student for courses of instruction after the application of any scholarships offered directly by the institution or work study program operated directly by the institution.

iii. Located in the United States

Section 4968(b)(1)(B) provides, in part, that at least 50 percent of an applicable educational institution’s tuition-paying students attending the institution must have been located in the United States. The statute clearly refers to the location of the students, not the location of the educational institution or an instructor. Accordingly, the proposed regulations provide that a student is considered to have been located in the United States if the student resided in the United States for at least a portion of the time the student attended the educational institution. Like the other requirements of section 4968(b), this measurement is based on the applicable educational institution’s preceding taxable year.

For example, a student that attended an educational institution in the preceding taxable year who is citizen of a foreign country is considered to have been a student located in the United States if the student resided in the United States for at least a portion of the time the student attended the educational institution. Furthermore, a student attending the educational institution in the preceding taxable year who was studying abroad in a foreign country is considered to have been a student located in the United States if the student resided in the United States for at least a portion of the time the student attended the educational institution. However, if a student did not reside in the United States for any portion of the time the student attended the education institution during the preceding taxable year, then that student would not be considered to have been located in the United States for purposes of section 4968(b)(1)(B) (although he or she may still be considered a student for purposes of section 4968(b)(1)(D)). The Treasury Department and the IRS request comments on whether further guidance is needed relating to whether a student is considered to have been located in the United States in a preceding taxable year.

iv. Full-time Students and Part-time Equivalents

Section 4968(b)(2) provides, in part, that the number of students of an applicable educational institution (including for purposes of determining the number of students at a particular location) is based on the daily average number of full-time students attending such institution, with part-time students taken into account on a full-time student equivalent basis. Section 4968 does not define the terms “full-time” and “part-time” for purposes of the full-time equivalent rule in section 4968(b)(2), nor does it provide how to determine a full-time student equivalent or a daily average. Section 1.25A-3(d)(1)(ii) of the Income Tax Regulations provides for section 25A purposes that the standard for what is half the normal full-time work load is determined by each eligible educational institution; however, the standard for half-time may not be lower than the applicable standard for half-time established by the HEA.

Unlike section 25A, section 4968 does not require that a student be carrying at least half the normal full-time work load for the course of study the student is pursuing in order to be considered a student. However, the Treasury Department and the IRS otherwise view the standard provided in §1.25A-3(d)(1)(ii) as a helpful model in applying the full-time equivalent requirement in section 4968(b)(2) and propose to follow a similar approach.

Accordingly, these proposed regulations provide that, for purposes of section 4968(b)(2), the determinations of full-time students, part-time students, full-time student equivalents, and daily average of students attending the institution are made by each applicable educational institution as long as the determinations are consistent with the institution’s practices in determining full-time and part-time status for other purposes. For example, it may be reasonable for an institution to determine that two students, each carrying half a full-time load, are equivalent to one full-time student. However, the standards an institution uses may not be lower than the applicable standards established by the Department of Education under the HEA.

The Treasury Department and the IRS seek comments on whether more specific guidance is required concerning the determination of full-time student, part-time student, full-time equivalent, or daily average number of full-time students attending the institution.

C. Assets Used Directly in Carrying out an Institution’s Exempt Purpose

i. In General

To be included within the definition of applicable educational institution under section 4968(b)(1), an institution must have assets (other than those assets which are used directly in carrying out the institution’s exempt purpose) the aggregate fair market value of which is at least $500,000 per student. The phrase “assets which are used directly in carrying out the institution’s exempt purpose” is not defined in section 4968, but a similar phrase is used in section 4942.

For purposes of section 4942, a private foundation must determine its minimum investment return as part of its calculation of its distributable amount for any taxable year. Minimum investment return is defined in section 4942(e) as 5 percent of the excess of the aggregate fair market value of all assets of the foundation “other than those which are used (or held for use) directly in carrying out the foundation’s exempt purpose,” over the acquisition indebtedness with respect to such assets.

Since section 4968 contains a phrase similar to the language used in section 4942 (other than the omission of the parenthetical “or held for use”), the Treasury Department and the IRS propose generally to follow §53.4942(a)-2(c) for purposes of determining whether an educational institution’s assets are used directly in carrying out the institution’s exempt purpose, without regard to provisions relating to private foundation assets “held for use.” The Treasury Department and the IRS seek comments on whether the use of the principles of the section 4942 regulations for this purpose creates any concerns.

Consistent with section 4942, the proposed regulations provide in §53.4968-1(a)(4)(i) that an asset is used directly in carrying out an institution’s exempt purpose only if the asset is actually used by the institution in carrying out its exempt purpose. Administrative assets, real estate, and physical property used by the institution directly in its exempt activities are all examples of such exempt purpose assets. In addition, a reasonable cash balance necessary to cover current administrative expenses and other normal and current disbursements directly connected with the educational institution’s exempt activities is considered to be used directly in carrying out the institution’s exempt purpose. For section 4942 purposes, a reasonable cash balance is defined as 1.5 percent of the fair market value of the private foundation’s non-charitable use assets (i.e., assets not actually used by an institution in carrying out its exempt purpose), determined without regard to the reduction for the reasonable cash balance. For consistency with the 4942 rules, the Treasury Department and the IRS propose that a cash balance of 1.5 percent of the fair market value of the educational institution’s non-charitable use assets, determined without regard to the deduction for the reasonable cash balance, will be deemed to be a reasonable cash balance for purposes of section 4968. However, the Treasury Department and the IRS note that the 1.5 percent standard in the section 4942 context is an average monthly amount over the entire taxable year and thus has to take into account fluctuations in cash needs. Thus, in light of the differences in the exempt activities of an educational institution and the section 4968 requirement to measure the assets only at the end of the taxable year, the Treasury Department and the IRS request comments on whether another percentage or other measurement should be deemed to be a reasonable cash balance at the end of the taxable year. The Treasury Department and the IRS specifically request comments supporting why any such other amount would be reasonable, and how utilizing a different amount would be administrable.

The proposed regulations do not address whether a functionally-related business would be considered an exempt use asset for the purposes of this test. Although functionally-related businesses are included as an illustration of an exempt use asset in the section 4942 regulations, it is not clear how the concept of a functionally-related business would apply to an educational institution. The Treasury Department and the IRS request comments on whether and how educational institutions use functionally related businesses in conducting their operations and whether functionally-related businesses should be explicitly included or excluded as examples of exempt use assets in the final regulations.

Whether an asset is used directly by an educational institution to carry out its exempt purpose is determined based on the facts and circumstances. In addition, where property is used both for charitable, educational, or other similar exempt purposes and for other purposes, if the exempt use represents 95 percent or more of the total use, the property is considered to be used exclusively for a charitable, educational, or other similar exempt purpose. If the exempt use represents less than 95 percent of the total use, the institution must make a reasonable allocation between the exempt and nonexempt use.

ii. Exceptions

Similar to the rules under section 4942, the proposed regulations deem certain assets to not be used directly in carrying out an institution’s exempt purpose, including assets that are held for the production of income or for investment (for example, stocks, bonds, interest-bearing notes, endowment funds, or, generally, leased real estate), even if the income from such assets is used to carry out the exempt purpose. Similarly, non-exempt use assets include property used for managing endowment funds of the institution.

iii. Valuation of Assets not Used Directly in Carrying out an Institution’s Exempt Purpose

For purposes of section 4968(b)(1)(D), the value of an institution’s non-exempt use assets must be determined as of the last day of each taxable year for which a valuation must be made. In contrast, section 4942(e)(2)(A) provides generally that a foundation’s securities for which market quotations are readily available shall be determined on a monthly basis, and that the values of other assets shall be determined at such times and in such manner as the Secretary shall by regulations prescribe.

Section 53.4942(a)-2(c)(4) provides that a private foundation may use any reasonable method to determine the fair market value on a monthly basis of securities for which market quotations are readily available, as long as such method is consistently used, and provides additional valuation guidelines for assets that are not market securities.

Consistent with the proposed rules for determining whether an asset is used directly in carrying out an institution’s exempt purpose, the Treasury Department and the IRS propose that, for purposes of valuing the institution’s non-exempt use assets, institutions use rules similar to the rules of section 4942(e) and §53.4942(a)-2(c)(4), with two modifications. First, the phrase “applicable educational institution” is substituted for “private foundation” or “foundation” every place they appear. Second, an institution will have to make such adjustments as are reasonable and necessary to obtain the fair market value of non-exempt use assets as of the last day of the valuation taxable year, rather than any other frequency provided by the section 4942 regulations.

The Treasury Department and the IRS request comments on valuing exempt use assets using the principles of section 4942, as modified by this special timing rule.

2. Determination of Net Investment Income and Basis of Property

A. In General

Section 4968(a) imposes on each applicable educational institution a tax equal to 1.4 percent of its net investment income for the taxable year. Section 4968(c) provides that net investment income is determined under rules similar to the rules of section 4940(c). Accordingly, the proposed regulations provide in §53.4968-1(b) that an institution must calculate its net investment income under the rules of section 4940(c) and §53.4940-1(c) through (f), with certain modifications explained in part 2(B) of this Explanation of Provisions section.

Section 4940(c)(1) defines net investment income as the amount by which the sum of the gross investment income and the capital gain net income exceeds certain specified allowable deductions. Section 4940(c)(1) also states that, except to the extent inconsistent with the provisions of section 4940, net investment income is determined under the principles of subtitle A of the Code.

Section 4940(c)(2) provides that, for purposes of section 4940(c)(1), gross investment income means the gross amount of income from interest, dividends, rents, payments with respect to securities loans (as defined in section 512(a)(5)), and royalties, but not including any such income to the extent included in computing the unrelated business income tax imposed by section 511. The term gross investment income also includes income from sources similar to those specifically listed in the preceding sentence.

Section 4940(c)(3) provides that, for purposes of section 4940(c)(1), there is allowed as a deduction all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of such income, determined with the following modifications: (1) the deduction provided by section 167 is allowed, but only on the basis of the straight line method of depreciation; and (2) the deduction for depletion provided by section 611 is allowed, but is determined without regard to section 613 (relating to percentage depletion).

Section 4940(c)(4) provides that, for purposes of determining capital gain net income under section 4940(c)(1), (1) no gain or loss from the sale or other disposition of property is taken into account to the extent that any such gain or loss is taken into account for purposes of computing the tax imposed by section 511 on unrelated business taxable income; (2) in the case of property held by a private foundation on December 31, 1969, and continuously thereafter to the date of its disposition, the basis for determining gain is deemed to be not less than the fair market value of such property on December 31, 1969; (3) losses from sales or other dispositions of property are allowed only to the extent of gains from such sales or other dispositions, without capital loss carryovers or carrybacks; and (4) except to the extent provided by regulation, under rules similar to the rules of section 1031 (including the exception under subsection (a)(2) thereof relating to exchanges of real property held primarily for sale), no gain or loss is taken into account with respect to any portion of property used for a period of not less than 1 year for a purpose or function constituting the basis of the private foundation’s exemption if the entire property is exchanged immediately following such period solely for property of like kind which is to be used primarily for a purpose or function constituting the basis for such foundation’s exemption.

Section 4940(c)(5) provides that, for purposes of section 4940, net investment income is determined by applying section 103 (relating to State and local bonds) and section 265 (relating to expenses and interest relating to tax-exempt income).

Section 4968 does not expressly provide that the tax on net investment income is limited to net investment income derived from assets that are not used directly in carrying out an applicable educational institution’s exempt purpose. This lack of a limitation is in contrast to the specific language in section 4968(b)(1)(D) that excludes assets used directly in carrying out an institution’s exempt purpose in determining whether the educational institution is an applicable educational institution. Instead, section 4968(c) provides that net investment income shall be determined under rules similar to the rules of section 4940(c). Accordingly, these proposed regulations adopt the rules provided in section 4940(c) and the regulations thereunder, including §53.4940-1(d)(1), which specifies that “gross investment income” means the gross amounts of income from interest, dividends, rents, royalties (including overriding royalties), and capital gain net income received by a private foundation from all sources, but does not include such income to the extent included in computing the tax imposed by section 511. Under this definition, consistent with specific language in §53.4940-1(d), interest, dividends, rents, and royalties derived from assets devoted to charitable activities are includible in gross investment income. Therefore, for example, interest received on a student loan would be includible.

The Treasury Department and the IRS request comments on whether specific types of income should be excluded from gross investment income under section 4968 because taxing those types of income would not achieve the congressional intent in enacting section 4968. In explaining why each such type of income should be excluded, please state specifically how the proposed exclusion is still “similar to” the rules of section 4940(c) and the specific characteristics of each type of such income that would warrant deviating from the rules provided in section 4940 and the regulations thereunder.

For example, the rules of section 4940(c) specifically include student loan interest as net investment income. However, the Treasury Department and the IRS recognize that student loans provided directly by an applicable educational institution to its students can be seen as helping the applicable educational institution fulfill its mission of educating its students. Unlike private foundations, colleges and universities educate students and charge tuition as part of their primary exempt activities. Student loans provided by an applicable educational institution to its students arguably can be viewed as a form of deferred tuition which will be paid when the student enters the workforce. Under this rationale, the interest on the student loan may arguably be distinguished from investment income, depending on the interest rate. If the interest is at a market (or higher) rate, it would be difficult to distinguish the interest on the student loan and interest on assets acquired for investment purposes. However, if the interest rate is set at a substantially below-market rate, the difference between the market interest rate and the interest rate on the student loan might be viewed as similar to a scholarship from the school to the student. Under these circumstances, the remaining, below-market rate interest income might be considered distinguishable from income derived from assets acquired primarily for investment purposes.

Any exception for student loan interest that is premised on the utilization of an interest rate that is substantially lower than a market rate would potentially present tax administrative challenges for both the IRS and taxpayers in determining the relevant market-rate and an acceptable lower rate, and in adjusting to rate changes during the course of the loan. Comments advocating an exception for the interest received on student loans should explain how these concerns could be addressed. It would be helpful if such comments also provide information regarding the number of student loans applicable educational institutions make each year, how they set the interest rates on those loans, and whether the rates are set below market, or at market rates.

Allowing an exception from net investment income for certain categories of student loan interest would raise the question of why only those categories of exempt function income are excluded from net investment income. Many other categories of income derived from exempt functions also help an applicable educational institution fulfill its exempt purposes. Private foundations might also argue that many of their types of income help them fulfill their exempt purposes. The Treasury Department and the IRS request comments on why interest income on student loans provided by an applicable educational institution to its students is a logical place to draw the line at the type of income that should be excluded from the net investment income tax, especially given the reference to student loan income in §1.4940-1(d).

Similarly, under section 4940(c), net investment income includes rents. The Treasury Department and the IRS recognize that colleges and universities offer various types of housing (such as dormitories or apartments) for use by students, non-students (for example, during the summer), and faculty. The Treasury Department and the IRS request comments on the differences, if any, among the housing arrangements, whether any of the arrangements include the signing of leases, the various amounts charged by a college or university related to provision of housing and meals, and particular factors that distinguish room and board payments from students living in a dormitory from rental income that institutions receive.

Consistent with the requirement in section 4968(c) to calculate net investment income under rules similar to the rules under section 4940(c), these proposed regulations generally follow the rules for determining gain upon the sale or other disposition of property that have been used for section 4940(c) purposes since 1969. Section 4940(c)(1) provides that, except to the extent inconsistent with the provisions of section 4940, net investment income is determined under the principles of subtitle A. Subtitle A encompasses all of the income tax provisions (sections 1 through 1564) of the Code, including the basis rules in section 1015 (basis of property acquired by gift is generally the same as the donor’s basis). Accordingly, under the proposed regulations, an applicable education institution computes gain on the sale or disposition of donated property using the donor’s basis. The Treasury Department and the IRS request comments on whether a special rule excluding any appreciation in a gift of donated property that occurred before the date of receipt by the applicable educational institution should be included in the final regulations and how such a special rule would be consistent with the statutory language of section 4968.

B. Special Rules

The proposed regulations provide in §53.4968-1(b)(3) that an institution should substitute “applicable educational institution” for “private foundation” or “foundation” every place it appears in §53.4940-1(c) through (f). In addition, the proposed regulations provide that the rule in §53.4940-1(d)(3) does not apply because it is narrowly focused on section 302 stock redemptions by corporations that are disqualified persons when the redemptions are part of a transaction designed to reduce section 4943 excess business holdings. Colleges and universities are not subject to section 4943, so they cannot have excess business holdings that could be the subject of a section 302 stock redemption by a disqualified person corporation.

As provided by section 3 of Notice 2018-55 (2018-26 I.R.B. 773), in following the rule in section 4940(c)(4), the proposed regulations substitute “December 31, 2017” for “December 31, 1969” every place it occurs. In addition, in response to a comment requesting clarification of the basis rules for assets held in a partnership on December 31, 2017, these proposed regulations also provide that if an applicable educational institution held an interest in a partnership (including through one or more tiers of partnerships) on December 31, 2017, and continuously thereafter, and the partnership held assets on December 31, 2017, and continuously thereafter to the date of disposition, the partnership’s basis in its assets with respect to the applicable educational institution for purposes of determining the applicable educational institution’s share of gain upon sale or disposition of the assets shall be not less than the fair market value of such asset on December 31, 2017, plus or minus all adjustments after December 31, 2017, and before the date of disposition. For purposes of applying this special partnership basis rule, an institution must obtain documentation from the partnership to substantiate the claim.

Finally, consistent with section 4 of Notice 2018-55 and section 4940(c)(4)(C), the proposed regulations provide that in applying §53.4940-1(f), overall net losses from sales or other dispositions of property by one related organization (or by the applicable educational institution) shall reduce (but not below zero) overall net gains from such sales or other dispositions by other related organizations (or by the applicable educational institution).

3. Related Organizations

Section 4968(d)(1) provides, in part, that for purposes of determining the aggregate fair market value of the assets and net investment income of an educational institution, the assets and net investment income of any related organization with respect to the educational institution shall be treated as assets and net investment income, respectively, of the educational institution.

For this purpose, the statute provides two special rules: (1) no such amount shall be taken into account with respect to more than 1 educational institution, and (2) unless such organization is controlled by such institution or is described in section 509(a)(3) (relating to supporting organizations) with respect to such institution for the taxable year, assets and net investment income which are not intended or available for the use or benefit of the educational institution shall not be taken into account. Section 53.4968-1(c) of these proposed regulations provides definitions and special rules relating to related organizations.

A. Definition of Related Organization

Section 4968(d)(2) provides that the term “related organization” means, with respect to an applicable educational institution, any organization which (1) controls, or is controlled by, such institution; (2) is controlled by 1 or more persons which also control such institution; or (3) is a supported organization (as defined in section 509(f)(3)) or a supporting organization (as described in section 509(a)(3)) during the taxable year with respect to such institution.

Section 4968(d)(2) does not define the term “control.” The concept of controlled entities is found in numerous other areas of the Code, including section 4960, which was enacted at the same time as section 4968. Consistent with the position taken in Notice 2019-09, “Interim Guidance Under Section 4960” (2019-04 I.R.B. 403), for purposes of defining “control” within the meaning of section 4968(d), these proposed regulations provide rules based on the definition of control under section 512(b)(13)(D) and the regulations thereunder, which includes the constructive ownership rules of section 318, and that generally align with the definition of related organization for purposes of the annual reporting requirements on Form 990. The Treasury Department and the IRS request comments on whether there are any circumstances in which this definition of control should be modified in the context of section 4968.

Thus, the proposed regulations provide in §53.4968-1(c)(1) that the term “control” means (1) in the case of a corporation, ownership (by vote or value) of more than 50 percent of the stock of the corporation; (2) in the case of a partnership, ownership of more than 50 percent of the profits interests or capital interests in such partnership; (3) in the case of a trust with beneficial interests, ownership of more than 50 percent of the beneficial interests in the trust; or (4) in the case of a nonprofit organization or other organization without owners or persons having beneficial interests (nonstock organization), including a governmental entity, that more than 50 percent of the directors or trustees of the applicable educational institution or nonstock organization are either representatives of, or are directly or indirectly controlled by, the other entity or that more than 50 percent of the directors or trustees of the nonstock organization are either representatives of, or are directly or indirectly controlled by, one or more persons that control the applicable educational institution. For purposes of this paragraph, a “representative” means a trustee, director, agent, or employee, and control includes the power to remove a trustee or director and designate a new trustee or director. Finally, section 318, which contains rules for determining constructive ownership of stock, applies for purposes of determining ownership of stock in a corporation, and similar principles apply for purposes of determining ownership of an interest in any other entity. The Treasury Department and the IRS do not propose to adopt the test for control under section 414(b) and (c), which generally uses the same test for control of a nonprofit organization as section 512(b)(13)(D) except that it replaces the 50-percent threshold with an 80-percent threshold. Instead, the proposed regulations adopt the control test under section 512(b)(13)(D) to align more closely with other exempt organization control tests and to ensure consideration of available assets consistent with congressional intent that would not occur under the higher 80 percent control threshold that was established for qualified plans.

Since the net investment that a taxable entity provides to an applicable educational institution has already been taxed under section 1, the Treasury Department and the IRS do not consider it consistent with congressional intent to tax the income again under section 4968. Furthermore, with regard to the assets of a taxable entity that is a related organization defined in section 4968(d)(2)(A) or (B), the institution likely already has included the value of the stock in its non-exempt use assets; however, the stock value may differ from the value of the taxable entity’s underlying assets. The Treasury Department and the IRS request comments on how to account for this difference without double-counting the assets, as well as comments on the treatment of taxable entities that are related organizations for purposes of section 4968.

B. Assets and Net Income Treated as Assets and Net Income of Only One Educational Institution

As noted above, section 4968(d)(1)(A) provides, in part, that for purposes of determining the aggregate fair market value of an institution’s assets and its net investment income, the assets and net investment income of any related organization with respect to the educational institution shall be treated as assets and net investment income, respectively, of the educational institution. However section 4968(d)(1)(A) provides an exception under which no such amount shall be taken into account with respect to more than 1 educational institution.

In order to effectuate section 4968(d)(1)(A), the proposed regulations provide in §53.4968-1(c)(2)(ii)(A) that, in any case in which an organization is a related organization with respect to more than 1 educational institution, the assets and net investment income of the related organization must be allocated between the educational institutions being supported by the related organization. The proposed regulations provide that such allocation must be made in a reasonable manner, taking into account all facts and circumstances, and must be consistently applied across all related organizations. The Treasury Department and the IRS request comments on whether more specific guidance is required concerning the allocation of a related organization’s assets and net investment income between multiple educational institutions being supported by the same related organization, and if so, what such additional guidance should provide.

C. Assets and Net Investment income “Not Intended or Available for the Use or Benefit of” an Educational Institution

For purposes of attributing assets and net investment income of related organizations to applicable educational institutions, section 4968(d)(1)(B) provides that, unless a related organization is controlled by the educational institution or is described in section 509(a)(3) with respect to such institution for the taxable year, assets and net investment income of the related organization that are not intended or available for the use or benefit of the educational institution shall not be taken into account. Put another way, if a related organization controls the educational institution or is controlled by 1 or more persons which also control such institution but is not described in section 509(a)(3) with respect to the educational institution for the taxable year, then the assets and net investment income of the related organization are taken into account as assets and net investment income of the educational institution only if the assets and net investment income are intended or available for the use and benefit of the educational institution. However, if a related organization is either controlled by the educational institution or is described in section 509(a)(3) with respect to such institution for the taxable year, then all the assets and net investment income of the related organization are considered assets and net investment income of the educational institution, except as provided below.

The Conference Report description of section 4968 repeats section 4968(d)(1)(B) and adds, “[f]or example, assets of a related organization that are earmarked or restricted for (or fairly attributable to) the educational institution would be treated as assets of the educational institution, whereas assets of a related organization that are held for unrelated purposes (and are not fairly attributable to the educational institution) would be disregarded.” H. Rept. 115-466, 115th Cong., 1st sess., at 555 (December 15, 2017).

Thus, the proposed regulations provide in §53.4968-1(c)(2)(ii)(B) that when a related organization controls an educational institution or is controlled by 1 or more persons which also control such institution and is not described in section 509(a)(3) with respect to the educational institution, the assets and net investment income of a related organization must be allocated between those intended or available for the use and benefit of an educational institution and those not intended or not available for the use and benefit of that educational institution. Such allocation must be made in a reasonable manner, taking into account all facts and circumstances, and must be consistently applied across all related organizations.

The proposed regulations further explain that assets and net investment income of such a related organization are intended or available for the use and benefit of an educational institution if such assets and net investment income are specifically earmarked or restricted for the benefit of, or are otherwise fairly attributable to, the educational institution. Conversely, assets and net investment income of a related organization are not intended or available for the use and benefit of an educational institution if such assets and net investment income are specifically earmarked or restricted for another entity or for unrelated purposes or are otherwise not fairly attributable to the educational institution. For purposes of this required allocation, the Treasury Department and the IRS request comments on situations in which an organization’s assets or net investment income is not specifically earmarked or restricted for the benefit of any particular organization but is otherwise fairly attributable to the educational institution or to another organization. For example, absent any earmarking or restriction, should total distributions from a related organization to an applicable educational institution in one taxable year establish a presumption for section 4968 purposes that at least an equal amount is fairly attributable to the applicable educational institution for the following taxable year, absent demonstrated facts and circumstances supporting attribution of a lesser amount?

Because section 4968(d)(1)(B) carves out organizations that are controlled by an institution or are described in section 509(a)(3) with respect to such institution for the taxable year from this special rule, the proposed regulations provide that if the related organization is controlled by the educational institution or is described in section 509(a)(3) with respect to the educational institution, the assets and net investment income of the related organization must be taken into account as assets and net investment income of the educational institution, regardless of whether the assets and net investment income are earmarked or restricted for the benefit of, or otherwise fairly attributable to, the educational institution and even if they are specifically earmarked or restricted for another entity or for unrelated purposes or are otherwise not fairly attributable to the educational institution. However, the special rule in section 4968(d)(1)(A) continues to apply, such that the assets and net investment income of the related organization are not taken into account by more than one educational institution. See part 3(B) of the Explanation of Provisions section.

In recognition that section 509(a)(3) Type III supporting organizations, unlike section 509(a)(3) Type I and Type II supporting organizations, are not controlled by their supported organizations,³ and because applicable educational institutions may not be able to get information from their Type III supporting organizations, the proposed regulations provide a special rule in §53.4968-1(c)(2)(ii)(B)(3)(ii) for related organizations of an educational institution that were Type III supporting organizations with respect to the applicable educational institution on December 31, 2017. The proposed regulations provide that an applicable educational institution with a related organization that was a Type III supporting organization with respect to the applicable educational institution on December 31, 2017, may take into account only the assets and net investment income of the related Type III supporting organization that are intended or available for the use and benefit of the applicable educational institution, as described in this part 3(C) of the Explanation of Provisions section. An applicable educational institution can determine whether the assets and net investment income of such a Type III supporting organization are intended or available for the use and benefit of the applicable educational institution using any reasonable method. A method using all the distributions received from the Type III supporting organization subject to this special rule as net investment income of the applicable educational institution each year will be deemed to be reasonable. Similarly, a method using the distributions received from the Type III supporting organization to calculate the percentage of the Type III supporting organization’s total net income that was distributed to the applicable educational institution, and using the same percentage to calculate the value of the underlying assets of the Type III supporting organization that are intended or available for the use and benefit of the applicable educational institution each year, will be deemed to be reasonable. The Treasury Department and the IRS request comments on whether additional guidance pertaining to Type III supporting organizations is needed.

Executive Orders 12866 and 13563 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility.

The proposed regulations have been designated by the Office of Management and Budget’s (OMB) Office of Information and Regulatory Affairs (OIRA) as subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and OMB regarding review of tax regulations. OIRA has determined that the proposed rulemaking is significant and subject to review under Executive Order 12866 and section 1(b) of the Memorandum of Agreement. Accordingly, the proposed regulations have been reviewed by OMB.

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are timely submitted to the IRS as prescribed in the preamble under the ADDRESSES section. All comments submitted will be made available at https://www.regulations.gov or upon request.

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 hearing will be published in the Federal Register.

The principal authors of these regulations are Melinda Williams and Amber L. MacKenzie, Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Tax). However, other personnel from the Treasury Department and the IRS participated in their development.

IRS Revenue Procedures, Revenue Rulings, Notices, and other guidance cited in this document are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

* * * * *

Accordingly, 26 CFR part 53 is proposed to be amended as follows:

Paragraph 1. The authority citation for part 53 continues to read, in part, as follows:

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

Par. 2. Section 53.4968-1 is added to read as follows:

§53.4968-1 Excise tax based on investment income of certain private colleges and universities.

(a) Excise tax on the investment income of certain private colleges and universities—(1) In general. For taxable years beginning after December 31, 2017, section 4968 imposes a tax equal to 1.4 percent of the net investment income (as defined in section 4968(c) and paragraph (b) of this section) of an applicable educational institution (as defined in section 4968(b)(1) and paragraph (a)(2) of this section).

(2) Applicable educational institution. Under section 4968(b)(1) and for purposes of this section, the term applicable educational institution means any eligible educational institution as defined in section 25A(f)(2) and §1.25A-2(b) of this chapter—

(i) Which had at least 500 tuition-paying students attending the institution during the preceding taxable year;

(ii) More than 50 percent of the tuition-paying students attending the institution are located in the United States;

(iii) Which is not described in the first sentence of section 511(a)(2)(B) (relating to state colleges and universities); and

(iv) The aggregate fair market value of the assets of which at the end of such preceding taxable year (other than those assets that are used directly in carrying out the institution’s exempt purpose) is at least $500,000 per student attending the institution.

(3) Student—(i) In general. For purposes of section 4968 and paragraph (a) of this section, the term student means a person enrolled in a degree, certification, or other program (including a program of study abroad approved for credit by the eligible institution at which such student is enrolled) leading to a recognized educational credential at an institution, and who is not enrolled in an elementary or secondary school.

(ii) Tuition-paying—(A) In general. For purposes of section 4968 and paragraph (a) of this section, the term tuition-paying means the payment of any tuition or fees required for the enrollment or attendance of a student for a course of instruction at an educational institution. The term tuition-paying does not include payment for supplies or equipment required during a specific course once a student is enrolled in and attending the course or the payment of room and board or other personal living expenses.

(B) Treatment of a comprehensive or bundled fee. If a student is required to pay a fee (such as a comprehensive fee or a bundled fee) to an educational institution that combines charges for tuition with charges for personal expenses such as room and board, the student is a tuition-paying student.

(C) Scholarships and work study programs operated directly by the applicable educational institution. Whether a student is tuition-paying is determined after taking into account any scholarships provided directly by the educational institution and any work study programs operated directly by the institution. Scholarship payments provided by third parties, even if administered by the institution, are considered payments of tuition on behalf of the student. Accordingly, a student will be considered a tuition-paying student if payment of tuition or a fee is required for the enrollment or attendance of the student for courses of instruction after the application of any scholarships offered directly by the institution or work study program operated directly by the institution.

(iii) Located in the United States. For purposes of section 4968 and paragraph (a) of this section, the term located in the United States refers to the location of a student. A student is considered to have been located in the United States if the student resided in the United States for at least a portion of the time the student attended the institution during the applicable educational institution’s preceding taxable year.

(iv) Full-time/part-time students. For purposes of section 4968 and paragraph (a) of this section, the number of students of an educational institution (including for purposes of determining the number of students at a particular location) is based on the daily average number of full-time students attending such institution (with part-time students taken into account on a full-time student equivalent basis). The standards for determining part-time students, full-time students, full-time equivalents, and daily average are determined by each educational institution. However, the standards may not be lower than the applicable standards established by the Department of Education under the Higher Education Act of 1965 (20 U.S.C. 1088).

(4) Assets used directly in carrying out an institution’s exempt purpose—(i) In general. For purposes of section 4968 and this paragraph (a)(4), an asset is used directly in carrying out an educational institution’s exempt purpose only if the asset is actually used by the institution in carrying out its exempt purpose. Whether an asset is used directly by the institution to carry out its exempt purpose must be determined based on all the facts and circumstances. If property is used for an exempt purpose and for other purposes, and the exempt use represents 95 percent or more of the total use, the property is considered to be used exclusively for an exempt purpose. If the exempt use of such property represents less than 95 percent of the total use, the institution must make a reasonable allocation between such exempt and nonexempt uses.

(ii) Illustrations. Examples of assets that are used directly in carrying out an institution’s exempt purpose include, but are not limited to, the following—

(A) Administrative assets, such as office equipment and supplies used by the institution directly in the administration of its exempt activities;

(B) Real estate or the portion of any building used by the institution directly in its exempt activities;

(C) Physical property such as paintings or other works of art owned by the institution which are on public display, fixtures and equipment in classrooms, research facilities and related equipment which under the facts and circumstances serve a useful purpose in the conduct of the institution’s exempt activities;

(D) The reasonable cash balances necessary to cover current administrative expenses and other normal and current disbursements directly connected with the educational institution’s exempt activities. For purposes of this paragraph (a)(4)(ii)(D), the portion of an educational institution’s actual cash balances at the end of a year that does not exceed 1.5 percent of the fair market value of the institution’s non-charitable use assets, determined without regard to any reduction for reasonable cash balances, will be deemed to be a reasonable cash balance; and

(E) Any property the educational institution leases to other persons at no cost (or at a nominal rent) to the lessee in furtherance of the institution’s exempt purposes.

(iii) Exceptions. The following assets are examples of assets not used directly in carrying out an institution’s exempt purpose—

(A) Assets that are held for the production of income or for investment (for example, stocks, bonds, interest-bearing notes, endowment funds, or leased real estate), even if the income from such assets is used to carry out such exempt purpose; and

(B) Property (such as offices) used for the purpose of managing the institution’s endowment funds.

(iv) Valuation of assets not used directly in carrying out an institution’s exempt purpose—(A) In general. The valuation of assets not used directly in carrying out an institution’s exempt purpose is determined under the rules of section 4942(e) and §53.4942(a)-2(c)(4), as modified by paragraph (a)(4)(iv)(B) of this section.

(B) Special rules. In applying the rules of §53.4942(a)-2(c)(4), an educational institution must—

(1) Substitute “educational institution” for “private foundation” or “foundation” every place they appear; and

(2) Make such adjustments as are reasonable and necessary to obtain the fair market value of any and all assets as of the last day of the preceding taxable year, rather than any other times permitted or required by §53.4942(a)-2(c)(4).

(b) Net investment income—(1) In general. An applicable educational institution described in paragraph (a)(2) of this section is subject to the 1.4 percent tax on its net investment income, and, as described in paragraph (c) of this section, also on certain amounts of net investment income of certain related organizations, for the taxable year.

(2) Calculation of net investment income. For purposes of paragraph (b)(1) of this section, net investment income will be determined under the rules of section 4940(c) and §53.4940-1(c) through (f), as modified by paragraph (b)(3) of this section.

(3) Special rules. In applying §53.4940-1(c) through (f):

(i) Substitute “Applicable educational institution” for “private foundation” and “foundation” each place they appear.

(ii) Section 53.4940-1(d)(3), relating to certain distributions in redemption of stock, does not apply.

(iii) Substitute “December 31, 2017” for “December 31, 1969” each place it appears.

(iv) If an applicable educational institution held an interest in a partnership (including through one or more tiers of partnerships) on December 31, 2017, and continuously thereafter, and the partnership held assets on December 31, 2017 and continuously thereafter to the date of disposition, the partnership’s basis in its assets with respect to the applicable educational institution for purposes of determining the applicable educational institution’s share of gain upon sale or disposition of the assets is not less than the fair market value of such asset on December 31, 2017, plus or minus all adjustments as provided under §53.4940-1(f)(2)(i) after December 31, 2017, and before the date of disposition. To avail itself of this special partnership basis rule, an institution must obtain documentation from the partnership to substantiate the basis used.

(v) For purposes of §53.4940-1(f), overall net losses from sales or other dispositions of property by one related organization (or by the applicable educational institution) reduce (but not below zero) overall net gains from such sales or other dispositions by other related organizations (or by the applicable educational institution).

(c) Related organizations—(1) Definition of related organization—(i) In general. The term “related organization” means, with respect to an applicable educational institution, any organization which—

(A) Controls, or is controlled by, such institution;

(B) Is controlled by one or more persons which also control such institution; or

(C) Is a supported organization (as defined in section 509(f)(3)) or a supporting organization (as described in section 509(a)(3)) during the taxable year with respect to such institution.

(ii) Control. The term control generally means—

(A) Stock corporation. In the case of a corporation, ownership (by vote or value) of more than 50 percent of the stock of the corporation;

(B) Partnership. In the case of a partnership, ownership of more than 50 percent of the profits interests or capital interests in such partnership; or

(C) Trust. In the case of a trust with beneficial interests, ownership of more than 50 percent of the beneficial interests in the trust.

(D) Nonstock organization. In the case of a nonprofit organization or other organization without owners or persons having beneficial interests (nonstock organization), including a governmental entity, control means that—

(1) More than 50 percent of the directors or trustees of the applicable educational institution or nonstock organization are either representatives of, or are directly or indirectly controlled by, the other entity; or

(2) More than 50 percent of the directors or trustees of the nonstock organization are either representatives of, or are directly or indirectly controlled by, one or more persons that control the applicable educational institution. For purposes of this paragraph (c)(1)(ii)(D)(2), a “representative” means a trustee, director, agent, or employee, and control includes the power to remove a trustee or director and designate a new trustee or director.

(iii) Constructive ownership. The principles of section 318 apply for purposes of determining ownership of stock in a corporation, and similar principles apply for purposes of determining ownership of interest in any other entity.

(2) Assets and net investment income of related organizations—(i) In general. For purposes of determining the aggregate fair market value of the assets and net investment income of an educational institution, the assets and net investment income of any related organization are treated as the assets and net investment income, respectively, of the institution unless an exception provided in paragraph (c)(2)(ii) of this section applies.

(ii) Exceptions. For purposes of section 4968 and this paragraph (c)(2)—

(A) No amount taken into account with respect to more than one educational institution. In determining the aggregate fair market value of the assets and net investment income of an educational institution, assets and net investment income of a related organization are not taken into account with respect to more than one educational institution. Thus, in any case in which an organization is a related organization with respect to more than one educational institution, the assets and net investment income of the related organization must be allocated between the educational institutions being supported by the related organization. Such allocation must be made in a reasonable manner, taking into account all facts and circumstances, and must be used consistently across all related organizations.

(B) Not intended or available for the use or benefit of the educational institution—(1) In general. Except as provided by paragraph (c)(2)(ii)(B)(3) of this section, for purposes of determining the aggregate fair market value of the assets and net investment income of an educational institution, the assets and net investment income of a related organization are taken into account as assets and net investment income of the educational institution unless the assets and net investment are not intended or available for the use and benefit of the educational institution.

(2) Determining whether assets and net investment income of a related organization are intended or available for the use and benefit of an educational institution. Assets and net investment income of a related organization are intended or available for the use and benefit of an educational institution if such assets and net investment income are specifically earmarked or restricted for the benefit of, or are otherwise fairly attributable to, the educational institution. Conversely, assets and net investment income of a related organization are not intended or available for the use and benefit of an educational institution if such assets and net investment income are specifically earmarked or restricted for another entity or for unrelated purposes or are otherwise not fairly attributable to the educational institution. The assets and net investment income of a related organization must be allocated between those intended or available for the use and benefit of an educational institution and those not intended or not available for the use and benefit of an educational institution. Such allocation must be made in a reasonable manner, taking into account all facts and circumstances, and must be used consistently across all related organizations.

(3) Organizations controlled by the institution or described in section 509(a)(3) with respect to the institution for the taxable year—(i) In general. If a related organization is controlled, as defined in paragraph (c)(1) of this section, by an educational institution, or is a supporting organization described in section 509(a)(3) with respect to the educational institution, the assets and net investment income of the related organization are taken into account as assets and net investment income of the educational institution regardless of whether the assets and net investment income are earmarked or restricted for the benefit of, or otherwise fairly attributable to, the educational institution and even if they are specifically earmarked or restricted for another entity or for unrelated purposes or are otherwise not fairly attributable to the educational institution, subject to paragraph (c)(2)(ii)(A) of this section.

(ii) Special rule for Type III supporting organizations with respect to such institution as of December 31, 2017. An educational institution with a related organization that was a Type III supporting organization with respect to the educational institution on December 31, 2017, takes into account only the assets and net investment income of such Type III supporting organization that are intended or available for the use and benefit of, or otherwise fairly attributable to, the educational institution, as described in paragraph (c)(2)(ii)(B)(2) of this section. An educational institution may determine whether the assets and net investment income of such Type III supporting organization are intended or available for the use and benefit of, or otherwise fairly attributable to, the educational institution using any reasonable method. A method treating all the distributions received from such Type III supporting organization as net investment income of the school each year is deemed to be reasonable. Similarly, a method using the distributions received from the Type III supporting organization to calculate the percentage of the Type III supporting organization’s total net income that was distributed to the educational institution, and then using the same percentage to calculate the value of the underlying assets of the Type III supporting organization that are intended or available for the use and benefit of the educational institution each year, will be deemed to be reasonable.

(d) Applicability date. The rules of this section apply to taxable years beginning after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. A taxpayer may rely on these regulations for taxable years beginning before publication of final regulations.

Kirsten Wielobob,

Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on June 28, 2019, 4:15 p.m. and published in the issue of the Federal Register for July 3, 2019, 84 F.R. 31795)

¹ Section 4968(d)(1) erroneously cross references section 4968(b)(1)(C). The correct cross reference should be to section 4968(b)(1)(D). See Joint Committee on Taxation, “General Explanation of Public Law No. 115-97” (JCS-1-18), December 2018, at 290, n. 1357.

² Subsections (b)(3) and (4) of 20 U.S.C. 1091 provide exceptions to section 484(a)(1) of the HEA that allows students to be eligible for certain grant programs even if the student does not qualify under section 484(a)(1). Under the exceptions, the student must be carrying at least one-half the normal full-time work load for the course of study that the student is pursuing, as determined by an eligible institution, and be enrolled in a course of study necessary for enrollment in a program leading to a degree, certificate, professional credential or certification from a State that is required for employment as a teacher in an elementary or secondary school in that State.

³ Organizations described in section 509(a)(3) are known as “supporting organizations.” Supporting organizations achieve their public charity status by providing support to one or more organizations described in section 509(a)(1) or (2), which, in this context, are referred to as “supported organizations.” To be described in section 509(a)(3), an organization must satisfy several tests, including having one of three “relationships” with one or more supported organizations. A supporting organization that is operated, supervised or controlled by one or more supported organizations is known as a “Type I” supporting organization. A supporting organization that is supervised or controlled in connection with one or more supported organizations is known as a “Type II” supporting organization. A supporting organization that is operated in connection with one or more supported organizations is known as a “Type III” supporting organization. The relationship of a Type III supporting organization with its supported organization(s) is much more attenuated than the other two types.

⁴ In June 2018, the Treasury Department and the IRS issued Notice 2018-55 (2018-26 I.R.B. 773) to provide clarification regarding the calculation of net investment income for purposes of section 4968(c). The Notice stated that the Treasury Department and the IRS intended to issue proposed regulations relating to those and other issues.

⁵ Levine, Phillip. “The University Endowment Income Tax: Who Will Pay it and Why Was it Implemented?”, Econofact, January 25, 2018, available at https://econofact.org/the-university-endowment-tax-who-will-pay-it-and-why-was-it-implemented, accessed April 29, 2019.

⁶ Hinrichs, Peter. “College Endowments.” Economic Commentary 2018-04 (May 17, 2018), Federal Reserve Bank of Cleveland, Table 1.

⁷ U.S. Department of Education, National Center for Education Statistics (2018). Digest of Education Statistics, 2016 (NCES 2017-094).

This document sets forth proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 413(c) of the Internal Revenue Code (Code). Section 413(c) provides rules for the qualification of a plan maintained by more than one employer.¹ A section 413(c) plan is often referred to as a multiple employer plan (MEP).

Final regulations under section 413 were published in the Federal Register on November 9, 1979, 44 FR 65061 (the final section 413 regulations). The final section 413 regulations apply to multiple employer plans described in section 413(c) and to collectively bargained plans described in section 413(b) (plans that are maintained pursuant to certain collective-bargaining agreements between employee representatives and one or more employers).

Pursuant to section 413(c) and the final section 413 regulations, all of the employers maintaining a MEP (participating employers) are treated as a single employer for purposes of certain section 401(a) qualification requirements. For example:

Under section 413(c)(1) and §1.413-2(b), the rules for participation under section 410(a) and the regulations thereunder are applied as if all employees of each of the employers who maintain the plan are employed by a single employer;

Under section 413(c)(2) and §1.413-2(c), in determining whether a MEP is, with respect to each participating employer, for the exclusive benefit of its employees (and their beneficiaries), all of the employees participating in the plan are treated as employees of each such employer; and

Under section 413(c)(3) and §1.413-2(d), the minimum vesting standards under section 411 are applied as if all employers who maintain the plan constitute a single employer.

Other rules are applied separately to each participating employer.² For example, under §1.413-2(a)(3)(ii), the minimum coverage requirements of section 410(b) generally are applied to a MEP on an employer-by-employer basis.

A plan is not described in section 413(c) unless it is maintained by more than one employer³ and is a single plan under section 414(l).⁴See §§1.413-2(a)(2)(i) and 1.413-1(a)(2). Under §1.414(l)-1(b), a plan is a single plan if and only if, on an ongoing basis, all of the plan assets are available to pay benefits to employees who are covered by the plan and their beneficiaries.

Under §1.413-2(a)(3)(iv) (sometimes referred to as the “unified plan rule”), the qualification of a MEP is determined with respect to all employers maintaining the MEP. Consequently, §1.413-2(a)(3)(iv) provides that “the failure by one employer maintaining the plan (or by the plan itself) to satisfy an applicable qualification requirement will result in the disqualification of the MEP for all employers maintaining the plan.” Section 1.416-1, Q&A G-2, includes a similar rule relating to the qualification of a MEP, providing that a failure by a MEP to satisfy section 416 with respect to employees of one participating employer means that all participating employers in the MEP are maintaining a plan that is not a qualified plan.⁵

Section 1101(a) of the Pension Protection Act of 2006 (PPA ’06), Public Law 109-280 (120 Stat. 780 (2006)), provides that the Secretary has full authority to establish and implement EPCRS⁶ (or any successor program) and any other employee plans correction policies, including the authority to waive income, excise, or other taxes to ensure that any tax, penalty, or sanction is not excessive and bears a reasonable relationship to the nature, extent, and severity of the failure. Section 1101(b) of PPA ’06 provides that the Secretary shall continue to update and improve EPCRS (or any successor program), giving special attention to a number of items, including special concerns and circumstances that small employers face with respect to compliance and correction of compliance failures. EPCRS has been updated and expanded several times, most recently in Rev. Proc. 2019-19, 2019-19 I.R.B. 1086. In addition, as provided for in Section 1101 of PPA ’06, the Treasury Department and the IRS are authorized to establish and implement other employee plans correction policies, outside of EPCRS.

On August 31, 2018, President Trump issued Executive Order 13847 (83 FR 45321 (Sept. 6, 2018)), titled “Strengthening Retirement Security in America” (Executive Order). The Executive Order states that it shall be the policy of the Federal Government to expand access to workplace retirement plans for American workers and that enhancing workplace retirement plan coverage is critical to ensuring that American workers will be financially prepared to retire. The Executive Order also states that, “[e]xpanding access to [MEPs], under which employees of different private-sector employers may participate in a single retirement plan, is an efficient way to reduce administrative costs of retirement plan establishment and maintenance and would encourage more plan formation and broader availability of workplace retirement plans, especially among small employers.”⁷

The Executive Order directs the Secretary of the Treasury to “consider proposing amendments to regulations or other guidance, consistent with applicable law and the policy set forth in ... this order, regarding the circumstances under which a MEP may satisfy the tax qualification requirements ..., including the consequences if one or more employers that sponsored or adopted the plan fails to take one or more actions necessary to meet those requirements.”⁸ The Executive Order further directs the Secretary of the Treasury to consult with the Secretary of Labor in advance of issuing any such proposed guidance, and the Secretary of Labor to take steps to facilitate the implementation of any guidance, as appropriate and consistent with applicable law.

Stakeholders have expressed concerns about the risk that the actions of one or more participating employers might disqualify a MEP⁹ and that some employers are reluctant to join MEPs without an exception to the unified plan rule. In particular, they have said that the cooperation of participating employers is needed for compliance and when a participating employer refuses to take the steps needed to maintain qualification, the entire plan is at risk of being disqualified. Stakeholders assert that without an exception to the unified plan rule, many employers perceive that the benefits of joining a MEP are outweighed by the risk of plan disqualification based on the actions of an uncooperative participating employer.

These regulations generally are proposed to apply on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. Until regulations finalizing these proposed regulations are issued, taxpayers may not rely on the rules set forth in these proposed regulations.

For copies of recently issued revenue procedures, revenue rulings, notices and other guidance published in the Internal Revenue Bulletin, please visit the IRS website at www.irs.gov or contact the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the Treasury Department and the IRS as prescribed in this preamble under the “ADDRESSES” heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules. Comments specifically are requested on the following topics:

Also, consistent with the Executive Order, comments are specifically requested on any steps that the Secretary of Labor should take to facilitate the implementation of these proposed regulations. The Department of Labor has informed the Treasury Department and the IRS that a section 413(c) plan administrator implementing a spinoff-termination may have concerns about its fiduciary responsibility both to the MEP and to the spun-off plan, as well as potential prohibited transaction issues. Commenters are encouraged to provide feedback on these issues and address the need for additional interpretive guidance or prohibited transaction exemptions from the Department of Labor to facilitate the implementation of these regulations.²⁶ Copies of comments on these topics will be forwarded to the Department of Labor.

All comments will be available for public inspection and copying at www.regulations.gov or upon request. A public hearing will be scheduled if requested in writing by any person who timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place of the public hearing will be published in the Federal Register.

The principal authors of these regulations are Jamie Dvoretzky and Pamela Kinard, Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes (EEE)). However, other personnel from the IRS and the Treasury Department participated in the development of these regulations.

* * * * *

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

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

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

Par. 2. Section 1.413-2 is amended by:

The additions read as follows:

§1.413-2 Special rules for plans maintained by more than one employer.

* * * * *

(e) [Reserved]

(f) [Reserved]

(g) Qualification of a section 413(c) plan—(1) General rule. Except as provided in paragraph (g)(2) of this section, the qualification of a section 413(c) plan under section 401(a) or 403(a), taking into account the rules of section 413(c) and this section, is determined with respect to all participating employers. Consequently, the failure by one participating employer (or by the plan itself) to satisfy an applicable qualification requirement will result in the disqualification of the section 413(c) plan for all participating employers.

(2) Exception to general rule for participating employer failures—(i) In general. A section 413(c) plan that is a defined contribution plan will not be disqualified on account of a participating employer failure, provided that the following conditions are satisfied—

(A) The section 413(c) plan satisfies the eligibility requirements of paragraph (g)(3) of this section;

(B) The section 413(c) plan administrator satisfies the notice requirements described in paragraph (g)(4) of this section;

(C) If the unresponsive participating employer fails to take appropriate remedial action with respect to the participating employer failure, as described in paragraph (g)(5)(ii) of this section, the section 413(c) plan administrator implements a spinoff described in paragraph (g)(2)(ii) of this section; and

(D) The section 413(c) plan administrator complies with any information request that the IRS or a representative of the spun-off plan makes in connection with an IRS examination of the spun-off plan, including any information request related to the participation of the unresponsive participating employer in the section 413(c) plan for years prior to the spinoff.

(ii) Spinoff. A spinoff is described in this paragraph (g)(2)(ii) if it satisfies either of the following requirements—

(A) The spinoff is initiated by the unresponsive participating employer, as described in paragraph (g)(5)(iii) of this section, and implemented by the section 413(c) plan administrator, as described in paragraph (g)(6)(ii) of this section; or

(B) The spinoff is a spinoff-termination pursuant to plan terms, as described in paragraph (g)(7) of this section.

(iii) Definitions. The following definitions apply for purposes of this paragraph (g):

(A) Employee. An employee is a current or former employee of a participating employer.

(B) Known qualification failure. A known qualification failure is a failure to satisfy a qualification requirement with respect to a section 413(c) plan that is identified by the section 413(c) plan administrator and is attributable solely to an unresponsive participating employer. For purposes of this paragraph (g)(2)(iii)(B), an unresponsive participating employer includes any employer that is treated as a single employer with that unresponsive participating employer under section 414(b), (c), (m), or (o).

(C) Participating employer. A participating employer is one of the employers maintaining a section 413(c) plan.

(D) Participating employer failure. A participating employer failure is a known qualification failure or a potential qualification failure.

(E) Potential qualification failure. A potential qualification failure is a failure to satisfy a qualification requirement with respect to a section 413(c) plan that the section 413(c) plan administrator reasonably believes might exist, but the section 413(c) plan administrator is unable to determine whether the qualification requirement is satisfied solely due to an unresponsive participating employer’s failure to provide data, documents, or any other information necessary to determine whether the section 413(c) plan is in compliance with the qualification requirement as it relates to the participating employer. For purposes of this paragraph (g)(2)(iii)(E), an unresponsive participating employer includes any employer that is treated as a single employer with that unresponsive participating employer under section 414(b), (c), (m), or (o).

(F) Section 413(c) plan administrator. A section 413(c) plan administrator is the plan administrator of a section 413(c) plan, determined under the rules of section 414(g).

(G) Unresponsive participating employer. An unresponsive participating employer is a participating employer in a section 413(c) plan that fails to comply with reasonable and timely requests from the section 413(c) plan administrator for information needed to determine compliance with a qualification requirement or fails to comply with reasonable and timely requests from the section 413(c) plan administrator to take actions that are needed to correct a failure to satisfy a qualification requirement as it relates to the participating employer.

(3) Eligibility for exception to general rule—(i) In general. To be eligible for the exception described in paragraph (g)(2) of this section, a section 413(c) plan must satisfy the following requirements—

(A) Practices and procedures. The section 413(c) plan administrator has established practices and procedures (formal or informal) that are reasonably designed to promote and facilitate overall compliance with applicable Code requirements, including procedures for obtaining information from participating employers.

(B) Plan language. The section 413(c) plan document describes the procedures that would be followed to address participating employer failures, including the procedures that the section 413(c) plan administrator would follow if the unresponsive participating employer does not take appropriate remedial action or initiate a spinoff pursuant to paragraph (g)(5) of this section.

(C) Not under examination. At the time the first notice described in paragraph (g)(4)(i) of this section is provided to the unresponsive participating employer, the section 413(c) plan is not under examination under the rules of paragraph (g)(3)(ii) of this section.

(ii) Under examination. For purposes of this section, a plan is under examination if—

(A) The plan is under an Employee Plans examination (that is, an examination of a Form 5500 series or other examination by the Employee Plans Office of the Tax Exempt and Government Entities Division of the IRS (Employee Plans) (or any successor IRS office that has jurisdiction over qualified retirement plans));

(B) The plan is under investigation by the Criminal Investigation Division of the IRS (or its successor); or

(C) The plan is treated as under an Employee Plans examination under the rules of paragraph (g)(3)(iii) of this section.

(iii) Certain plans treated as under an Employee Plans examination—(A) Notification of pending examination. For purposes of this section, a plan is treated as under an Employee Plans examination if the section 413(c) plan administrator, or an authorized representative, has received verbal or written notification from Employee Plans of an impending Employee Plans examination, or of an impending referral for an Employee Plans examination. A plan is also treated as under an Employee Plans examination if it has been under an Employee Plans examination and the plan has an appeal pending with the IRS Office of Appeals (or its successor), or is in litigation with the IRS, regarding issues raised in an Employee Plans examination.

(B) Pending determination letter application—(1) Possible failures identified by IRS. For purposes of this section, a section 413(c) plan is treated as under an Employee Plans examination if a Form 5300, “Application for Determination for Employee Benefit Plan,” Form 5307, “Application for Determination for Adopters of Modified Volume Submitter Plans,” or Form 5310, “Application for Determination for Terminating Plan” (or any successor form for one or more of these forms) has been submitted with respect to the plan and the IRS agent notifies the applicant of possible qualification failures, whether or not the applicant is officially notified of an examination. This includes a case in which, for example, a determination letter on plan termination had been submitted with respect to the plan, and an IRS agent notifies the applicant that there are partial termination concerns. In addition, if, during the review process, the IRS agent requests additional information that indicates the existence of a failure not previously identified by the applicant, then the plan is treated as under an Employee Plans examination (even if the determination letter application is subsequently withdrawn).

(2) Failures identified by determination letter applicant. For purposes of paragraph (g)(3)(iii)(B)(1) of this section, an IRS agent is not treated as notifying a determination letter applicant of a possible qualification failure if the applicant (or the authorized representative) has identified the failure, in writing, to the reviewing IRS agent before the agent recognizes the existence of the failure or addresses the failure in communications with the applicant. For purposes of this paragraph (g)(3)(iii)(B)(2), submission of a determination letter application does not constitute an identification of a failure to the IRS.

(C) Aggregated plans. For purposes of this section, a plan is treated as under an Employee Plans examination if it is aggregated for purposes of satisfying the nondiscrimination requirements of section 401(a)(4), the minimum participation requirements of section 401(a)(26), the minimum coverage requirements of section 410(b), or the requirements of section 403(b)(12)(A)(i), with any plan that is under an Employee Plans examination. In addition, a plan is treated as under an Employee Plans examination with respect to a failure of a qualification requirement (other than those described in the preceding sentence) if the plan is aggregated with another plan for purposes of satisfying that qualification requirement (for example, section 401(a)(30), 415, or 416) and that other plan is under an Employee Plans examination. For purposes of this paragraph (g)(3)(iii)(C), the term aggregation does not include consideration of benefits provided by various plans for purposes of the average benefits test set forth in section 410(b)(2).

(4) Notice requirements. The section 413(c) plan administrator satisfies the notice requirements with respect to a participating employer failure if it satisfies the requirements of this paragraph (g)(4).

(i) First notice. The section 413(c) plan administrator must provide notice to the unresponsive participating employer describing the participating employer failure, the remedial actions the employer would need to take to remedy the failure, and the employer’s option to initiate a spinoff of plan assets and account balances attributable to participants who are employees of that employer. In addition, the notice must explain the consequences under plan terms if the unresponsive participating employer neither takes appropriate remedial action with respect to the participating employer failure nor initiates a spinoff, including the possibility that a spinoff of assets and account balances attributable to participants who are employees of that employer would occur, followed by a termination of that plan.

(ii) Second notice. If, by the end of the 90-day period following the date the first notice described in paragraph (g)(4)(i) of this section is provided, the unresponsive participating employer neither takes appropriate remedial action with respect to the participating employer failure nor initiates a spinoff, then the section 413(c) plan administrator must provide a second notice to the employer. The second notice must be provided no later than 30 days after the expiration of the 90-day period described in the preceding sentence. The second notice must include the information required to be included in the first notice and must also specify that if, within 90 days following the date the second notice is provided, the employer neither takes appropriate remedial action with respect to the participating employer failure nor initiates a spinoff, a notice describing the participating employer failure and the consequences of not correcting that failure will be provided to participants who are employees of the unresponsive participating employer (and their beneficiaries) and to the Department of Labor.

(iii) Third notice. If, by the end of the 90-day period following the date the second notice described in paragraph (g)(4)(ii) of this section is provided, the unresponsive participating employer neither takes appropriate remedial action with respect to the participating employer failure nor initiates a spinoff, then the section 413(c) plan administrator must provide a third notice to that employer. The third notice must be provided no later than 30 days after the expiration of the 90-day period described in the preceding sentence. Within this time period, the third notice must also be provided to participants who are employees of that employer (and their beneficiaries) and to the Office of Enforcement of the Employee Benefits Security Administration in the Department of Labor (or its successor office). The third notice must include the information required to be included in the first notice, the deadline for employer action, and an explanation of any adverse consequences to participants in the event that a spinoff-termination occurs, and state that the notice is being provided to participants who are employees of the unresponsive participating employer (and their beneficiaries) and to the Department of Labor.

(5) Actions by unresponsive participating employer—(i) In general. An unresponsive participating employer takes appropriate remedial action with respect to a participating employer failure for purposes of paragraph (g)(2)(i)(C) of this section if it satisfies the requirements of paragraph (g)(5)(ii) of this section. Alternatively, an unresponsive participating employer initiates a spinoff with respect to a participating employer failure for purposes of paragraph (g)(2)(ii)(A) of this section if the employer satisfies the requirements of paragraph (g)(5)(iii) of this section. The final deadline for an unresponsive participating employer to take one of these actions is 90 days after the third notice is provided. See paragraph (g)(7) of this section for the consequences of the employer’s failure to meet this deadline.

(ii) Appropriate remedial action—(A) Appropriate remedial action with respect to potential qualification failure. An unresponsive participating employer takes appropriate remedial action with respect to a potential qualification failure if the employer provides data, documents, or any other information necessary for the section 413(c) plan administrator to determine whether a qualification failure exists. If the unresponsive participating employer provides this information, the section 413(c) plan administrator determines that, based on this information, a qualification failure exists that is attributable solely to that employer, and the participating employer fails to comply with reasonable and timely requests from the section 413(c) plan administrator to take actions that are needed to correct that qualification failure, then the qualification failure becomes a known qualification failure. In that case, the section 413(c) plan will be eligible for the exception in paragraph (g)(2) of this section with respect to the known qualification failure by satisfying the conditions set forth in paragraph (g)(2) of this section with respect to that known qualification failure, taking into account the rules of paragraph (g)(6)(i) of this section.

(B) Appropriate remedial action with respect to known qualification failure. An unresponsive participating employer takes appropriate remedial action with respect to a known qualification failure if the employer takes action, such as making corrective contributions, that corrects, or enables the section 413(c) plan administrator to correct, the known qualification failure.

(iii) Employer-initiated spinoff. An unresponsive participating employer initiates a spinoff pursuant to this paragraph (g)(5)(iii) if, after receiving a notice described in paragraph (g)(4) of this section, the employer directs the section 413(c) plan administrator to spin off plan assets and account balances held on behalf of its employees to a separate single-employer plan established and maintained by that employer in a manner consistent with plan terms.

(6) Actions by section 413(c) plan administrator—(i) Rules for a potential qualification failure that becomes a known qualification failure. For purposes of applying paragraph (g)(2) of this section to a potential qualification failure that becomes a known qualification failure, actions taken (including notices provided) when the failure was a potential qualification failure are not taken into account. For example, a notice that the section 413(c) plan administrator provided in connection with the potential qualification failure would not satisfy the notice requirements for the known qualification failure. However, in determining whether the section 413(c) plan is under examination, as described in paragraph (g)(3)(iii) of this section, as of the date of the first notice describing the known qualification failure, the section 413(c) plan administrator will be treated as providing that notice on the date the first notice was provided with respect to the related potential qualification failure, but only if the following conditions are satisfied—

(A) After determining that a qualification failure exists, the section 413(c) plan administrator makes a reasonable and timely request to the participating employer to take actions that are needed to correct the failure, and

(B) As soon as reasonably practicable after the participating employer fails to respond to that request, the section 413(c) plan administrator provides the first notice described in paragraph (g)(4)(i) of this section with respect to the known qualification failure.

(ii) Implementing employer-initiated spinoff. If an unresponsive participating employer initiates a spinoff pursuant to paragraph (g)(5)(iii) of this section by directing the section 413(c) plan administrator to spin off the assets and account balances held on behalf of its employees to a separate single-employer plan established and maintained by the employer, the section 413(c) plan administrator must implement and complete a spinoff of the assets and account balances held on behalf of the employees of the employer that are attributable to their employment by the employer within 180 days of the date on which the unresponsive participating employer initiates the spinoff. The section 413(c) plan administrator must report the spinoff to the IRS (in the manner prescribed by the IRS in forms, instructions, and other guidance).

(7) Spinoff-termination—(i) Spinoff. If the unresponsive participating employer neither takes appropriate remedial action described in paragraph (g)(5)(ii) of this section nor initiates a spinoff pursuant to paragraph (g)(5)(iii) of this section, then, in accordance with plan language, the section 413(c) plan administrator must take the following steps as soon as reasonably practicable after the deadline described in paragraph (g)(5)(i) of this section—

(A) Send notification of spinoff-termination to participants who are employees of the unresponsive participating employer (and their beneficiaries) as described in paragraph (g)(7)(iii) of this section;

(B) Stop accepting contributions from the unresponsive participating employer;

(C) Implement a spinoff, in accordance with the transfer requirements of section 414(l) and the anti-cutback requirements of section 411(d)(6), of the plan assets and account balances held on behalf of employees of the unresponsive participating employer that are attributable to their employment by that employer to a separate single-employer plan and trust that has the same plan administrator, trustee, and substantive plan terms as the section 413(c) plan; and

(D) Terminate the spun-off plan and distribute assets of the spun-off plan to plan participants (and their beneficiaries) as soon as reasonably practicable after the plan termination date.

(ii) Termination of spun-off plan. In terminating the spun-off plan, the section 413(c) plan administrator must—

(A) Reasonably determine whether, and to what extent, the survivor annuity requirements of sections 401(a)(11) and 417 apply to any benefit payable under the plan and take reasonable steps to comply with those requirements (if applicable);

(B) Provide each participant and beneficiary with a nonforfeitable right to his or her accrued benefits as of the date of plan termination, subject to income, expenses, gains, and losses between that date and the date of distribution; and

(C) Notify the participants and beneficiaries of their rights under section 402(f).

(iii) Contents of the notification of spinoff-termination. For the notice required to be provided in paragraph (g)(7)(i)(A), the section 413(c) plan administrator must provide information relating to the spinoff-termination to participants who are employees of the unresponsive participating employer (and their beneficiaries), including the following—

(A) Identification of the section 413(c) plan and contact information for the section 413(c) plan administrator;

(B) The effective date of the spinoff-termination;

(C) A statement that no more contributions will be made to the section 413(c) plan;

(D) A statement that as soon as practicable after the spinoff-termination, participants and beneficiaries will receive a distribution from the spun-off plan; and

(E) A statement that before the distribution occurs, participants and beneficiaries will receive additional information about their options with respect to that distribution.

(iv) Reporting spinoff-termination. The section 413(c) plan administrator must report a spinoff-termination pursuant to this paragraph (g)(7) to the IRS (in the manner prescribed by the IRS in forms, instructions, and other guidance).

(8) Other rules—(i) Form of notices. Any notice provided pursuant to paragraph (g)(4) or (g)(7)(i)(A) of this section may be provided in writing or in electronic form. For notices provided to participants and beneficiaries, see generally §1.401(a)–21 for rules permitting the use of electronic media to provide applicable notices to recipients with respect to retirement plans.

(ii) Qualification of spun-off plan—(A) In general. In the case of any plan that is spun off in accordance with paragraph (g)(6)(ii) or (g)(7) of this section, any participating employer failure that would have affected the qualification of the section 413(c) plan, but for the application of the exception set forth in paragraph (g)(2) of this section, will be a qualification failure with respect to the spun-off plan.

(B) Favorable tax treatment upon termination. Notwithstanding paragraph (g)(8)(ii)(A) of this section, distributions made from a spun-off plan that is terminated in accordance with paragraph (g)(7) of this section will not, solely because of the participating employer failure, fail to be eligible for favorable tax treatment accorded to distributions from qualified plans (including that the distributions will be treated as eligible rollover distributions under section 402(c)(4)), except as provided in paragraph (g)(8)(ii)(C) of this section.

(C) Exception for responsible parties. The IRS reserves the right to pursue appropriate remedies under the Code against any party (such as the owner of the participating employer) who is responsible for the participating employer failure. The IRS may pursue appropriate remedies against a responsible party even in the party’s capacity as a participant or beneficiary under the spun-off plan that is terminated in accordance with paragraph (g)(7) of this section (such as by not treating a plan distribution made to the responsible party as an eligible rollover distribution).

(iii) Additional guidance. The Commissioner may provide additional guidance in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin, or in forms and instructions, that the Commissioner determines to be necessary or appropriate with respect to the requirements of this paragraph (g).

(9) Applicability date. This paragraph (g) applies on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

Kirsten Wielobob,

Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on July 2, 2019, 8:45 a.m. and published in the issue of the Federal Register for July 3, 2019, 84 F.R. 31777)

¹ Section 210 of the Employee Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)), as amended (ERISA), also provides rules relating to plans maintained by more than one employer. Similar to section 413(c) of the Code, section 210(a) of ERISA states that the minimum participation standards, minimum vesting standards, and benefit accrual requirements under sections 202, 203, and 204 of ERISA, respectively, shall be applied as if all employees of each of the employers were employed by a single employer. Under section 101 of Reorganization Plan No. 4 of 1978 (43 FR 47713), the Secretary of the Treasury has interpretive jurisdiction over section 413 of the Code, as well as ERISA section 210.

² Proposed rules at §1.413-2(e) and (f) (47 FR 54093) were issued in 1982. Proposed §1.413-2(e) would have provided that the minimum funding standard for a MEP is determined as if all participants in the plan were employed by a single employer, and proposed §1.413-2(f) would have provided rules relating to liability for the excise tax on a failure to meet the minimum funding standards. Because these rules were proposed in 1982, they do not reflect 1988 changes to section 413(c)(4) that were made by section 6058(a) of the Technical and Miscellaneous Revenue Act of 1988, Public Law 100-647 (102 Stat. 3342) (TAMRA). As amended by TAMRA, section 413(c)(4) generally provides that in the case of a plan established after December 31, 1988, and in the case of a plan established before that date for which an election was made, each employer is treated as maintaining a separate plan for purposes of the minimum funding standards. The proposed rules at §1.413-2(e) and (f) are outside the scope of these proposed regulations. Therefore, paragraphs (e) and (f) are “Reserved” for future rulemaking. The Treasury Department and the IRS note that taxpayers must take into account the statutory changes made after the issuance of the proposed regulations as of the effective dates of the relevant legislation.

³ Section 1.413-2(a)(2), issued in 1979, provides that for purposes of determining the number of employers maintaining a plan, any employers described in section 414(b) that are members of a controlled group of corporations or any employers described in section 414(c) that are trades or businesses under common control, whichever is applicable, are treated as if those employers are a single employer. Because §1.413-2(a)(2) was issued in 1979, it does not address section 414(m), which was added in 1980 by section 201(a) of the Miscellaneous Revenue Act of 1980, Public Law 96-605 (94 Stat. 3521). Section 414(m) provides that all employers in an affiliated service group shall be treated as a single employer. Although amendments to §1.413-2(a)(2) are outside the scope of these proposed regulations, the Treasury Department and the IRS note that taxpayers must take into account the statutory changes made after the issuance of the proposed regulations as of the effective dates of the relevant legislation.

⁴ On October 23, 2018, proposed Department of Labor regulations were published in the Federal Register (83 FR 53534) clarifying the circumstances in which employer groups or associations and professional employer organizations can constitute “employers” within the meaning of section 3(5) of ERISA for purposes of establishing or maintaining an individual account “employee pension benefit plan” within the meaning of ERISA section 3(2). Those proposed regulations state that an “employee pension benefit plan” under section 3(2) of ERISA must be established by an “employer,” defined in section 3(5) of ERISA to include an “entity acting indirectly in the interest of an employer in relation to an employee benefit plan.” The proposed Department of Labor regulations define the terms “bona fide group or association of employers” and “bona fide professional employer organization” and state that, with respect to a “multiple employer defined contribution pension plan,” these entities “shall be deemed to be able to act in the interest of an employer” provided that certain conditions are met. See proposed rules at 29 CFR 2510.3-55(a). The proposed Department of Labor regulations solicit comments on, but do not address, other types of entities that may be an employer under ERISA section 3(5).

⁵ This rule is based on the unified plan rule in §1.413-2(a)(3)(iv). Therefore, if a defined contribution MEP has an unresponsive employer that fails to satisfy section 416 and the defined contribution MEP meets the conditions for the exception to the unified plan rule in these proposed regulations, the defined contribution MEP will not be disqualified for the section 416 failure. For further information, see the discussion in part II of the Explanation of Provisions section entitled Conditions for Application of Exception to the Unified Plan Rule. The rules in §1.416-1 are outside the scope of these proposed regulations, but the Treasury Department and the IRS intend to address the topic in a broader guidance project updating the regulations under section 416.

⁶ The Employee Plans Compliance Resolution System (EPCRS) is a comprehensive system of correction programs for sponsors of certain retirement plans, including plans that are intended to satisfy the qualification requirements of section 401(a). EPCRS provides procedures for an employer to correct a plan’s failure to satisfy an applicable qualification requirement so that the failure does not result in disqualification of the plan.

⁷Id. at 45321.

⁸Id. at 45322.

⁹See also, U.S. Gov’t Accountability Office, GAO-12-665, “Federal Agencies Should Collect Data and Coordinate Oversight of Multiple Employer Plans” (September 2012) (https://www.gao.gov/assets/650/648285.pdf) (identifying the unified plan rule as a potential problem for MEPs).

¹⁰ Once final regulations are issued, the Treasury Department and the IRS intend to publish guidance in the Internal Revenue Bulletin setting forth model language that may be used for this purpose.

¹¹ If the notices relate to a potential qualification failure, and the potential qualification failure becomes a known qualification failure, then a new series of notices may be required.

¹² The notice to the Department of Labor should be mailed to the Employee Benefits Security Administration’s Office of Enforcement (or its successor office). The Office of Enforcement is currently located at 200 Constitution Ave., NW, Suite 600, Washington, DC 20210.

¹³ The Pension Benefit Guaranty Corporation’s Missing Participants Program provides a mechanism for distributing assets to plan participants in a terminating plan. See 29 CFR 4050.201 through 4050.207. Use of the Pension Benefit Guaranty Corporation’s Missing Participants Program is optional for defined contribution plans. Under the program, the Pension Benefit Guaranty Corporation locates participants and beneficiaries who were missing when their plans terminated. When found, depending on arrangements made by the plan, the Pension Benefit Guaranty Corporation either provides the benefit or information about where the participant’s account is being held.

¹⁴ In addition, a participating employer failure could either be a known qualification failure or a potential qualification failure. Treating distributions from a spun-off and terminated plan relating to a potential qualification failure as ineligible for tax-favored treatment does not bear a reasonable relationship to the nature of the failure.

¹⁵ Based on tabulations from the Office of Tax Analysis’ microsimulation model.

¹⁶ Deloitte Consulting and Investment Company Institute, “Inside the Structure of Defined Contribution/401(k) Plan Fees, 2013: A Study Assessing the Mechanics of the ‘All-in’ Fee” (Aug. 2014) (available at https://www2.deloitte.com/content/dam/Deloitte/us/Documents/human-capital/us-cons-401k-fee-study-2013-082014.pdf).

¹⁷ See https://www.thayerpartnersllc.com/blog/the-hidden-costs-of-a-401k-audit. However, in a comment letter received by the Department of Labor in response to its October 23, 2018 (83 FR 53534), proposed rule clarifying the circumstances under which an employer group or association or PEO may sponsor a MEP, an association reported that the cost of its MEP audit was $24,000. See comment letter #6 Employers Association of New Jersey, EANJ at https://www.dol.gov/sites/default/files/ebsa/laws-and-regulations/rules-and-regulations/public-comments/1210-AB88/00006.pdf.

¹⁸ However, self-employed participants, like all participants in small plans, would benefit from these enhanced audit and reporting requirements.

¹⁹ See DOL Field Assistance Bulletin 2008-04, https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2008-04.

²⁰ U.S. Bureau of Labor Statistics, National Compensation Survey, Employee Benefits in the U.S. (March 2018).

²¹ Id.

²² Plan Sponsor Council of America, “61st Annual Survey of Profit Sharing and 401(k) Plans, Reflecting 2017 Plan Experience” (2018), Table 111.

²³ (83 FR 53534) (October 23, 2018).

²⁴ This calculation uses data from the 2016 Form 5500, “Annual Return/Report of Employee Benefit Plan.” As noted earlier, these filings indicate that there are approximately 4,630 defined contribution MEPs.

²⁵ The Small Business Administration, Office of Advocacy, 2018 Small Business Profile. https://www.sba.gov/sites/default/files/advocacy/2018-Small-Business-Profiles-US.pdf. Last accessed 03/28/2019. For purposes of the 2018 Small Business Profile, small businesses are defined as firms employing fewer than 500 employees.

²⁶ For an example of this type of interpretative guidance and a related prohibited transaction exemption in the context of a terminating abandoned plan, see 29 CFR 2578.1 (establishing procedures for qualified termination administrators to terminate abandoned plans and distribute benefits with limited liability under title I of ERISA) and Prohibited Transaction Exemption 2006-06 (71 FR 20856, Apr. 21, 2006).