INCOME TAXRev. Rul. 97–16, page 4.Low-income housing credit; satisfactory bond; ‘‘bondfactor’’ amounts for the period January throughMarch 1997. This ruling announces the monthly bondfactor amounts to be used by taxpayers who dispose ofqualified low-income buildings or interests therein duringthe period January through March 1997.

T.D. 8710, page 4.Final regulations relate to the consistency rules undersection 338 of the Code that apply to certain casesinvolving controlled foreign corporations.

REG–209709–94, page 12.Proposed regulations under sections 167 and 197 ofthe Code relate to the amortization of certain intangibleproperty. A public hearing will be held on May 15, 1997.

EXEMPT ORGANIZATIONSAnnouncement 97–27, page 30.A list is given of organizations now classified as privatefoundations.

EXCISE TAXES

Notice 97–22, page 9.A determination has been made to add diglycidyl etherof bisphenol-A to the list of taxable substances insection 4672(a)(3) of the Code.

ADMINISTRATIVE

Rev. Proc. 97–22, page 9.Books and records; electronic storage; imaging. Guid-ance is provided for taxpayers that use an electronicstorage system (such as an imaging system) to maintainbooks and records for purposes of section 6001 of theCode.

Page 32.Scenarios of disciplinary actions. The Office of Direc-tor of Practice sets forth scenarios of disciplinaryactions involving individuals who represent taxpayersbefore the Internal Revenue Service. The Service invitescomments.

Finding Lists begin on page 35.Announcement of Disbarments and Suspensions begins on page 33.

Bulletin No. 1997–13March 31, 1997

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not be reliedupon as authoritative interpretations.

Mission of the Service

The purpose of the Internal Revenue Service is tocollect the proper amount of tax revenue at the leastcost; serve the public by continually improving the

quality of our products and services; and perform in amanner warranting the highest degree of publicconfidence in our integrity, efficiency and fairness.

Statement of Principlesof Internal RevenueTax AdministrationThe function of the Internal Revenue Service is toadminister the Internal Revenue Code. Tax policyfor raising revenue is determined by Congress.

With this in mind, it is the duty of the Service tocarry out that policy by correctly applying the lawsenacted by Congress; to determine the reasonablemeaning of various Code provisions in light of theCongressional purpose in enacting them; and toperform this work in a fair and impartial manner,with neither a government nor a taxpayer point of view.

At the heart of administration is interpretation of theCode. It is the responsibility of each person in theService, charged with the duty of interpreting thelaw, to try to find the true meaning of the statutoryprovision and not to adopt a strained construction inthe belief that he or she is ‘‘protecting the revenue.’’The revenue is properly protected only when we as-certain and apply the true meaning of the statute.

The Service also has the responsibility of applyingand administering the law in a reasonable,practical manner. Issues should only be raised byexamining officers when they have merit, neverarbitrarily or for trading purposes. At the sametime, the examining officer should never hesitateto raise a meritorious issue. It is also importantthat care be exercised not to raise an issue or toask a court to adopt a position inconsistent withan established Service position.

Administration should be both reasonable andvigorous. It should be conducted with as littledelay as possible and with great cour tesy andconsiderateness. It should never try to overreach,and should be reasonable within the bounds of lawand sound administration. It should, however, bevigorous in requiring compliance with law and itshould be relentless in its attack on unreal taxdevices and fraud.

2

Introduction

The Internal Revenue Bulletin is the authoritative instru-ment of the Commissioner of Internal Revenue forannouncing official rulings and procedures of the Inter-nal Revenue Service and for publishing Treasury Deci-sions, Executive Orders, Tax Conventions, legislation,court decisions, and other items of general interest. It ispublished weekly and may be obtained from the Superin-tendent of Documents on a subscription basis. Bulletincontents of a permanent nature are consolidated semi-annually into Cumulative Bulletins, which are sold on asingle-copy basis.

It is the policy of the Service to publish in the Bulletin allsubstantive rulings necessary to promote a uniformapplication of the tax laws, including all rulings thatsupersede, revoke, modify, or amend any of thosepreviously published in the Bulletin. All published rulingsapply retroactively unless otherwise indicated. Proce-dures relating solely to matters of internal managementare not published; however, statements of internalpractices and procedures that affect the rights andduties of taxpayers are published.

Revenue rulings represent the conclusions of the Ser-vice on the application of the law to the pivotal factsstated in the revenue ruling. In those based on positionstaken in rulings to taxpayers or technical advice toService field offices, identifying details and informationof a confidential nature are deleted to prevent unwar-ranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do nothave the force and effect of Treasury DepartmentRegulations, but they may be used as precedents.Unpublished rulings will not be relied on, used, or citedas precedents by Service personnel in the disposition ofother cases. In applying published rulings and proce-dures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be consid-ered, and Service personnel and others concerned arecautioned against reaching the same conclusions inother cases unless the facts and circumstances aresubstantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based onprovisions of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows:Subpart A, Tax Conventions, and Subpart B, Legislationand Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts andSubparts. Also included in this part are Bank SecrecyAct Administrative Rulings. Bank Secrecy Act Administra-tive Rulings are issued by the Department of theTreasury’s Office of the Assistant Secretary (Enforce-ment).

Part IV.—Items of General Interest.With the exception of the Notice of Proposed Rulemak-ing and the disbarment and suspension list included inthis part, none of these announcements are consoli-dated in the Cumulative Bulletins.

The first Bulletin for each month includes an index forthe matters published during the preceding month.These monthly indexes are cumulated on a quarterly andsemiannual basis, and are published in the first Bulletinof the succeeding quarterly and semi-annual period,respectively.

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

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

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986Section 42.—Low-Income HousingCredit

Low-income housing credit; satis-factory bond; ‘‘bond factor’’ amountfor the period January throughMarch 1997. This ruling announces themonthly bond factor amounts to be usedby taxpayers who dispose of qualifiedlow-income buildings or interests thereinduring the period January throughMarch 1997.

Rev. Rul. 97–16

In Rev. Rul. 90–60, 1990–2 C.B. 3,the Internal Revenue Service providedguidance to taxpayers concerning thegeneral methodology used by the Trea-sury Department in computing the bondfactor amounts used in calculating theamount of bond considered satisfactoryby the Secretary under § 42(j)(6) of theInternal Revenue Code. It further an-nounced that the Secretary would pub-

lish in the Internal Revenue Bulletin atable of ‘‘bond factor’’ amounts fordispositions occurring during each cal-endar month.This revenue ruling provides in Table

1 the bond factor amounts for calculat-ing the amount of bond consideredsatisfactory under § 42(j)(6) for disposi-tions of qualified low-income buildingsor interests therein during the periodJanuary through March 1997.

Table 1Rev. Rul. 97–16

Monthly Bond Factor Amounts for Dispositions ExpressedAs a Percentage of Total Credits

Calendar Year Building Placed in Serviceor, if Section 42(f)(1) Election Was Made,

the Succeeding Calendar Year

Month ofDisposition 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Jan ’97 79.70 82.08 84.67 87.70 91.25 95.32 99.53 103.58 107.56 111.85 112.52Feb ’97 79.46 81.83 84.41 87.43 90.96 95.00 99.17 103.18 107.11 111.28 112.52Mar ’97 79.23 81.59 84.15 87.16 90.67 94.69 98.83 102.81 106.69 110.79 112.52

For a list of bond factor amountsapplicable to dispositions occurring dur-ing other calendar years, see the follow-ing revenue rulings: Rev. Rul. 90–60,1990–2 C.B. 3, for dispositions occur-ring during calendar years 1987, 1988,and 1989; Rev. Rul. 90–88, 1990–2 C.B.7, for dispositions occurring during cal-endar year 1990; Rev. Rul. 91–67,1991–2 C.B. 13, for dispositions occur-ring during calendar year 1991; Rev.Rul. 92–101, 1992–2 C.B. 9, for dispo-sitions occurring during calendar year1992; Rev. Rul 93–83, 1993–2 C.B. 6,for dispositions occurring during calen-dar year 1993; Rev. Rul. 94–71, 1994–2C.B. 4, for dispositions occurring duringcalendar year 1994; Rev. Rul. 95–83,1995–2 C.B. 8, for dispositions occur-ring during calendar year 1995; Rev.Rul. 96–16, 1996–1 C.B. 3, for disposi-tions occurring during the period Janu-ary through March 1996; Rev. Rul.96–33, 1996–27 I.R.B. 4, for disposi-tions occurring during the period Aprilthrough June 1996; Rev. Rul. 96–45,1996–39 I.R.B. 5, for dispositions oc-curring during the period July throughSeptember 1996; and Rev. Rul. 96–59,1996–50 I.R.B. 4, for dispositions oc-curring during the period Octoberthrough December 1996.

DRAFTING INFORMATION

The principal author of this revenueruling is Jack Malgeri of the Office ofAssistant Chief Counsel (Passthroughsand Special Industries). For further in-formation regarding this revenue ruling,contact Mr. Malgeri at (202) 622–3040(not a toll-free call).

Section 338.—Certain StockPurchase Treated as AssetAcquisitions26 CFR 1.338–4: Asset and stock consistency.

T.D. 8710

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Part 1

Revisions of the Section 338Consistency Rules With Respect toTarget Affiliates That Are ControlledForeign Corporations

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document containsfinal regulations relating to the consis-

tency rules under section 338 of theInternal Revenue Code of 1986 that areapplicable to certain cases involvingcontrolled foreign corporations. The fi-nal regulations substantially revise andsimplify the stock and asset consistencyrules. The final regulations include theprovisions of the consistency rules ap-plicable to controlled foreign corpora-tions contained in recent proposed andtemporary regulations. The final regula-tions would affect taxpayers that owncontrolled foreign corporations.

EFFECTIVE DATE: These regulationsare effective January 20, 1997.

FOR FURTHER INFORMATION CON-TACT: Kenneth D. Allison at (202)622–3860 (not a toll-free number).

SUPPLEMENTARYINFORMATION:

Background

This document contains final IncomeTax Regulations (26 CFR part 1) undersection 338 of the Internal RevenueCode.On January 20, 1994, temporary regu-

lations (T.D. 8516) were published inthe Federal Register (59 FR 2956)under section 338 of the Internal Rev-

4

enue Code. See 1994–1 C.B. 119. Anotice of proposed rulemaking (INTL–0177–90) cross-referencing the tempo-rary regulations was published in theFederal Register for the same day (59FR 3045). See 1994–1 C.B. 818. Thetemporary regulations provided rules toreplace the asset and stock consistencyrules of §§ 1.338–4T and 1.338–5T.The temporary regulations included con-sistency rules applicable to certain casesinvolving controlled foreign corporations(CFCs).No written comments responding to

the notice were received. No publichearing was requested or held. Theproposed regulations under section 338are adopted as revised by this Treasurydecision, and the corresponding tempo-rary regulations are removed.

Explanation of Provisions

The preamble to the temporary andproposed regulations (1994–1 C.B. 119)contains a discussion of the provisions.Changes to the temporary and proposedregulations are noted below.Section 1.338–4T(h)(3) of the tempo-

rary regulations is clarified by statingthat the basis of the stock of a con-trolled foreign corporate target affiliateis not increased by section 1248 earn-ings attributable to the disposition of anasset in which a carryover basis is takenunder this section.Section 1.338–4T(h)(4) of the tempo-

rary regulations addresses a situation inwhich the income or gain from thedisposition of a controlled foreign cor-poration target affiliate (CFC T affiliate)asset is not subject to the consistencyrules of paragraph (h)(2). The regulationstates that if a CFC T affiliate pays adividend to a target (T) or a domestic Taffiliate wholly or partially out of theearnings generated by the disposition ofthat asset, and the dividend increases thebasis of the T stock under § 1.1502–32,then the basis of the stock of the CFC Taffiliate is reduced by the amount of thedividend that was paid from the earn-ings and profits resulting from the assetdisposition. This rule applies to anyactual dividend, amount treated as adividend under section 1248 (or thatwould have been so treated but forsection 1291) or amount included inincome under section 951(a)(1)(B).The final regulations retain this rule.

The final regulations also add a specialordering rule, in § 1.338–4(h)(4)(ii),clarifying that any such dividend is first

considered attributable to earnings andprofits resulting from the disposition ofthe asset.Section 1.338–4(h)(4)(ii) is clarified

to state that the basis of the stock of acontrolled foreign corporation may notbe reduced below zero under the car-ryover basis rules of § 1.338–4.Section 1.338–4(h)(2)(iv)(A) and

§ 1.338–4(h)(4)(iii)(A) are added to al-low the purchasing group in certaininstances to increase the basis of theCFC T stock by the amount of either thebasis increase denied under § 1.338–4(h)(2)(ii) or the basis reduction re-quired under § 1.338–4(h)(4)(ii). Therule applies when the purchasing groupdisposes of an asset acquired from CFCT that is subject to the consistency rulesto an unrelated party in a taxable trans-action and includes in U.S. gross in-come the greater of (i) the income orgain equal to the basis amount denied tothe asset under either § 1.338–4(h)(2)(i)or § 1.338–4(g) and § 1.338–4(h)(4)(i),respectively, or (ii) the gain recognizedon the asset.Similarly, § 1.338–4(h)(2)(iv)(B) and

§ 1.338–4(h)(4)(iii)(B) are added to al-low the purchasing group to increase thebasis of an asset acquired from CFC Tthat is subject to the consistency rulesby the basis amount denied to the assetunder either § 1.338–4(h)(2)(i) or§ 1.338–4(g) and § 1.338–4(h)(4)(i).The rule applies when the purchasinggroup disposes of the stock of CFC T toan unrelated party in a taxable transac-tion and includes in U.S. gross incomethe greater of (i) the gain equal to thebasis increase denied under § 1.338–4(h)(2)(ii) or the basis reduction re-quired under § 1.338–4(h)(4)(ii), respec-tively, or (ii) the gain recognized in thestock.

Special Analyses

It has been determined that this finalregulation is not a significant regulatoryaction as defined in EO 12866. There-fore, a regulatory assessment is notrequired. It also has been determinedthat section 553(b) of the AdministrativeProcedure Act (5 U.S.C. chapter 5) doesnot apply to these regulations, and be-cause the notice of proposed rulemakingpreceding the regulations was issuedprior to March 29, 1996 the RegulatoryFlexibility Act (5 U.S.C. chapter 6) doesnot apply. Therefore, a regulatory flex-ibility analysis is not required. Pursuantto section 7805(f) of the Internal Rev-enue Code, the notice of proposed

rulemaking preceding these regulationswas submitted to the Small BusinessAdministration for comment on its im-pact on small businesses.

Drafting Information

The principal author of these regula-tions is Kenneth D. Allison of the Officeof Associate Chief Counsel (Interna-tional), IRS. However, other personnelfrom the IRS and Treasury Departmentparticipated in their development.

* * * * *

Adoption of Amendments to the Regula-tions

Accordingly, 26 CFR part 1 isamended as follows: PART 1—IN-COME TAXESParagraph 1. The authority citation for

part 1 is amended by removing the entryfor Section 1.338–4T(h) to read as fol-lows:Authority: 26 U.S.C. 7805 * * *Par. 2. In § 1.338–0, the outline of

topics is amended by revising the entryfor § 1.338–4(h) and removing the entryfor § 1.338–4T to read as follows:

§ 1.338–0 Outline of topics.* * * * *

§ 1.338–4 Asset and stock consistency.* * * * *

(h) Consistency for target affiliatesthat are controlled foreign corporations.(1) In general.(2) Income or gain resulting from

asset dispositions.(i) General rule.(ii) Basis of controlled foreign corpo-

ration stock.(iii) Operating rule.(iv) Increase in asset or stock basis.(3) Stock issued by target affiliate

that is a controlled foreign corporation.(4) Certain distributions.(i) General rule.(ii) Basis of controlled foreign corpo-

ration stock.(iii) Increase in asset or stock basis.(5) Examples.

* * * * *Par. 3. Section 1.338–4 is amended as

follows:1. Paragraph (a)(5) is amended by

removing the language ‘‘Section 1.338–4T(h)’’ and adding ‘‘Paragraph (h) ofthis section’’ in its place.2. Paragraph (c)(4) is amended by

removing the language ‘‘§ 1.338–4T(h)(2)’’ and adding ‘‘paragraph (h)(2)of this section’’ in its place.

5

3. Paragraph (d)(2)(iii) is amended byremoving the language ‘‘§ 1.338–4T(h)(3)’’ and adding ‘‘paragraph (h)(3)of this section’’ in its place.4. Paragraph (g)(2) is amended by

removing the language ‘‘§ 1.338–4T(h)(4)’’ and adding ‘‘paragraph (h)(4)of this section’’ in its place.5. Paragraph (h) is revised.6. Paragraph (j)(3)9i)(A)(2) is

amended by removing the language‘‘§ 1.338–4T(h)’’ and adding ‘‘para-graph (h) of this section’’ in its place.The revision reads as follows:

§ 1.338–4 Asset and stock consistency.

* * * * *

(h) Consistency for target affiliatesthat are controlled foreign corpora-tions—(1) In general. This paragraph(h) applies only if target is a domesticcorporation. For additional rules thatmay apply with respect to controlledforeign corporations, see paragraph (g)of this section. The definitions and no-menclature of § 1.338–1(b) and (c) andparagraph (e) of this section apply forpurposes of this section.(2) Income or gain resulting from

asset dispositions—(i) General rule.In-come or gain of a target affiliate that isa controlled foreign corporation fromthe disposition of an asset is not re-flected in the basis of target stock underparagraph (c) of this section unless theincome or gain results in an inclusionunder section 951(a)(1)(A), 951(a)(1)-(C), 1291 or 1293.(ii) Basis of controlled foreign corpo-

ration stock. If, by reason of paragraph(h)(2)(i) of this section, the carryoverbasis rules of this section apply to anasset, no increase in basis in the stockof a controlled foreign corporation undersection 961(a) or 1293(d)(1), or underregulations issued pursuant to section1297(b)(5), is allowed to target or atarget affiliate to the extent the increaseis attributable to income or gain de-scribed in paragraph (h)(2)(i) of thissection. A similar rule applies to thebasis of any property by reason ofwhich the stock of the controlled foreigncorporation is considered owned undersection 958(a)(2) or 1297(a).(iii) Operating rule.For purposes of

this paragraph (h)(2)—(A) If there is an income inclusion

under section 951 (a)(1)(A) or (C), theshareholder’s income inclusion is firstattributed to the income or gain of thecontrolled foreign corporation from the

disposition of the asset to the extent ofthe shareholder’s pro rata share of suchincome or gain; and(B) Any income or gain under sec-

tion 1293 is first attributed to the in-come or gain from the disposition of theasset to the extent of the shareholder’spro rata share of the income or gain.(iv) Increase in asset or stock basis—

(A) If the carryover basis rules underparagraph (h)(2)(i) of this section applyto an asset, and the purchasing corpora-tion disposes of the asset to an unrelatedparty in a taxable transaction and recog-nizes and includes in its U.S. grossincome or the U.S. gross income of itsshareholders the greater of the incomeor gain from the disposition of the assetby the selling controlled foreign corpo-ration that was reflected in the basis ofthe target stock under paragraph (c) ofthis section, or the gain recognized onthe asset by the purchasing corporationon the disposition of the asset, then thepurchasing corporation or the target or atarget affiliate, as appropriate, shall in-crease the basis of the selling controlledforeign corporation stock subject toparagraph (h)(2)(ii) of this section, as ofthe date of the disposition of the assetby the purchasing corporation, by theamount of the basis increase that wasdenied under paragraph (h)(2)(ii) of thissection. The preceding sentence shallapply only to the extent that the con-trolled foreign corporation stock isowned (within the meaning of section958(a)) by a member of the purchasingcorporation’s affiliated group.(B) If the carryover basis rules under

paragraph (h)(2)(i) of this section applyto an asset, and the purchasing corpora-tion or the target or a target affiliate, asappropriate, disposes of the stock of theselling controlled foreign corporation toan unrelated party in a taxable transac-tion and recognizes and includes in itsU.S. gross income or the U.S. grossincome of its shareholders the greater ofthe gain equal to the basis increase thatwas denied under paragraph (h)(2)(ii) ofthis section, or the gain recognized inthe stock by the purchasing corporationor by the target or a target affiliate, asappropriate, on the disposition of thestock, then the purchasing corporationshall increase the basis of the asset, asof the date of the disposition of thestock of the selling controlled foreigncorporation by the purchasing corpora-tion or by the target or a target affiliate,as appropriate, by the amount of thebasis increase that was denied pursuantto paragraph (h)(2)(i) of this section.

The preceding sentence shall apply onlyto the extent that the asset is owned(within the meaning of section 958(a))by a member of the purchasing corpora-tion’s affiliated group.(3) Stock issued by target affiliate

that is a controlled foreign corporation.The exception to the carryover basisrules of this section provided in para-graph (d)(2)(iii) of this section does notapply to stock issued by a target affiliatethat is a controlled foreign corporation.After applying the carryover basis rulesof this section to the stock, the basis inthe stock is increased by the amounttreated as a dividend under section 1248on the disposition of the stock (or thatwould have been so treated but forsection 1291), except to the extent thebasis increase is attributable to the dis-position of an asset in which a carryoverbasis is taken under this section.(4) Certain distributions—(i) General

rule. In the case of a target affiliate thatis a controlled foreign corporation, para-graph (g) of this section applies withrespect to the target affiliate by treatingany reference to a dividend to whichsection 243(a)(3) applies as a referenceto any amount taken into account under§ 1.1502–32 in determining the basis oftarget stock that is—(A) A dividend;(B) An amount treated as a dividend

under section 1248 (or that would havebeen so treated but for section 1291); or(C) An amount included in income

under section 951(a)(1)(B).(ii) Basis of controlled foreign corpo-

ration stock.If the carryover basis rulesof this section apply to an asset, thebasis in the stock of the controlledforeign corporation (or any property byreason of which the stock is consideredowned under section 958(a)(2)) is re-duced (but not below zero) by the sumof any amounts that are treated, solelyby reason of the disposition of the asset,as a dividend, amount treated as adividend under section 1248 (or thatwould have been so treated but forsection 1291), or amount included inincome under section 951(a)(1)(B). Forthis purpose, any dividend, amounttreated as a dividend under section 1248(or that would have been so treated butfor section 1291), or amount included inincome under section 951(a)(1)(B) isconsidered attributable first to earningsand profits resulting from the dispositionof the asset.(iii) Increase in asset or stock ba-

sis—(A) If the carryover basis rulesunder paragraphs (g) and (h)(4)(i) of

6

this section apply to an asset, and thepurchasing corporation disposes of theasset to an unrelated party in a taxabletransaction and recognizes and includesin its U.S. gross income or the U.S.gross income of its shareholders thegreater of the gain equal to the basisincrease denied in the asset pursuant toparagraphs (g) and (h)(4)(i) of this sec-tion, or the gain recognized on the assetby the purchasing corporation on thedisposition of the asset, then the pur-chasing corporation or the target or atarget affiliate, as appropriate, shall in-crease the basis of the selling controlledforeign corporation stock subject toparagraph (h)(4)(ii) of this section, as ofthe date of the disposition of the assetby the purchasing corporation, by theamount of the basis reduction underparagraph (h)(4)(ii) of this section. Thepreceding sentence shall apply only tothe extent that the controlled foreigncorporation stock is owned (within themeaning of section 958(a)) by a memberof the purchasing corporation’s affiliatedgroup.(B) If the carryover basis rules under

paragraphs (g) and (h)(4)(i) of this sec-tion apply to an asset, and the purchas-ing corporation or the target or a targetaffiliate, as appropriate, disposes of thestock of the selling controlled foreigncorporation to an unrelated party in ataxable transaction and recognizes andincludes in its U.S. gross income or theU.S. gross income of its shareholdersthe greater of the amount of the basisreduction under paragraph (h)(4)(ii) ofthis section, or the gain recognized inthe stock by the purchasing corporationor by the target or a target affiliate, asappropriate, on the disposition of thestock, then the purchasing corporationshall increase the basis of the asset, asof the date of the disposition of thestock of the selling controlled foreigncorporation by the purchasing corpora-tion or by the target or a target affiliate,as appropriate, by the amount of thebasis increase that was denied pursuantto paragraphs (g) and (h)(4)(i) of thissection. The preceding sentence shallapply only to the extent that the asset isowned (within the meaning of section958(a)) by a member of the purchasingcorporation’s affiliated group.(5) Examples.This paragraph (h) may

be illustrated by the following examples:Example 1. Stock of target affiliate that is a

CFC. (a) The S group files a consolidated return;however, T2 is a controlled foreign corporation.On December 1 of Year 1, T1 sells the T2 stock toP and recognizes gain. On January 2 of Year 2, P

makes a qualified stock purchase of T from S. Nosection 338 election is made for T.(b) Under paragraph (b)(1) of this section,

paragraph (d) of this section applies to the T2stock. Under paragraph (h)(3) of this section,paragraph (d)(2)(iii) of this section does not applyto the T2 stock. Consequently, paragraph (d)(1) ofthis section applies to the T2 stock. However, afterapplying paragraph (d)(1) of this section, P’s basisin the T2 stock is increased by the amount of T1’sgain on the sale of the T2 stock that is treated as adividend under section 1248. Because P has acarryover basis in the T2 stock, the T2 stock is notconsidered purchased within the meaning of sec-tion 338(h)(3) and no section 338 election may bemade for T2.Example 2. Stock of target affiliate CFC; inclu-

sion under subpart F.(a) The S group files aconsolidated return; however, T2 is a controlledforeign corporation. On December 1 of Year 1, T2sells an asset to P and recognizes subpart Fincome that results in an inclusion in T1’s grossincome under section 951(a)(1)(A). On January 2of Year 2, P makes a qualified stock purchase of Tfrom S. No section 338 election is made for T.(b) Because gain from the disposition of the

asset results in an inclusion under section951(a)(1)(A), the gain is reflected in the basis ofthe T stock as of T’s acquisition date. Seeparagraph (h)(2)(i) of this section. Consequently,under paragraph (b)(1) of this section, paragraph(d)(1) of this section applies to the asset. Inaddition, under paragraph (h)(2)(ii) of this section,T1’s basis in the T2 stock is not increased undersection 961(a) by the amount of the inclusion thatis attributable to the sale of the asset.(c) If, in addition to making a qualified stock

purchase of T, P acquires the T2 stock from T1 onJanuary 1 of Year 2, the results are the same forthe asset sold by T2. In addition, under paragraph(h)(2)(ii) of this section, T1’s basis in the T2 stockis not increased by the amount of the inclusionthat is attributable to the gain on the sale of theasset. Further, under paragraph (h)(3) of thissection, paragraph (d)(1) of this section applies tothe T2 stock. However, after applying paragraph(d)(1) of this section, P’s basis in the T2 stock isincreased by the amount of T1’s gain on the saleof the T2 stock that is treated as a dividend undersection 1248. Finally, because P has a carryoverbasis in the T2 stock, the T2 stock is notconsidered purchased within the meaning of sec-tion 338(h)(3) and no section 338 election may bemade for T2.(d) If P makes a qualified stock purchase of T2

from T1, rather than of T from S, and T1’s gainon the sale of T2 is treated as a dividend undersection 1248, under paragraph (h)(1) of this sec-tion, paragraphs (h)(2) and (3) of this section donot apply because there is no target that is adomestic corporation. Consequently, the carryoverbasis rules of paragraph do not apply to the assetsold by T2 or the T2 stock.Example 3. Gain reflected by reason of section

1248 dividend; gain from non-subpart F asset.(a)The S group files a consolidated return; however,T2 is a controlled foreign corporation. In Years 1through 4, T2 does not pay any dividends to T1and no amount is included in T1’s income undersection 951(a)(1)(B). On December 1 of Year 4,T2 sells an asset with a basis of $400,000 to P for$900,000. T2’s gain of $500,000 is not subpart Fincome. On December 15 of Year 4, T1 sells T2,in which it has a basis of $600,000, to P for$1,600,000. Under section 1248, $800,000 of T1’sgain of $1,000,000 is treated as a dividend.However, in the absence of the sale of the asset byT2 to P, only $300,000 would have been treated as

a dividend under section 1248. On December 30of Year 4, P makes a qualified stock purchase ofT1 from T. No section 338 election is made forT1. (b) Under paragraph (h)(4) of this section,paragraph (g)(2) of this section applies by refer-ence to the amount treated as a dividend undersection 1248 on the disposition of the T2 stock.Because the amount treated as a dividend is takeninto account in determining T’s basis in the T1stock under § 1.1502–32, the sale of the T2 stockand the deemed dividend have the effect of atransaction described in paragraph (g)(1) of thissection. Consequently, paragraph (d)(1) of thissection applies to the asset sold by T2 to P and P’sbasis in the asset is $400,000 as of December 1 ofYear 4.(c) Under paragraph (h)(3) of this section, para-

graph (d)(1) of this section applies to the T2 stockand P’s basis in the T2 stock is $600,000 as ofDecember 15 of Year 4. Under paragraphs (h)(3)and (4)(ii) of this section, however, P’s basis inthe T2 stock is increased by $300,000 (the amountof T1’s gain treated as a dividend under section1248 ($800,000), other than the amount treated asa dividend solely as a result of the sale of theasset by T2 to P ($500,000)) to $900,000.

* * * * *

§ 1.338–4T [Removed]

Par. 4. Section 1.338–4T is removed.Par. 5. In § 1.338(i)–1, paragraphs (a)

and (b) are revised to read as follows:

§ 1.338(i)–1 Effective dates.

(a) In general. Sections 1.338–1through 1.338–5 (except § 1.338–4(h)),1.338(b)–1, and 1.338(h)(10)–1 gener-ally are applicable for targets with ac-quisition dates on or after January 20,1994. Section 1.338–4(h) is applicablefor targets with acquisition dates on orafter January 20, 1997. Section 1.338–4T(h) (as contained in 26 CFR part 1 asrevised April 1, 1996) is generally appli-cable for targets with acquisition dateson or after January 20, 1994, and beforeJanuary 20, 1997.

(b) Elective retroactive application.Atarget with an acquisition date on orafter January 14, 1992 and before Janu-ary 20, 1994 may apply §§ 1.338–1through 1.338–5, 1.338–4T(h) (as con-tained in 26 CFR part 1 as revised April1, 1996), 1.338(b)–1, and 1.338(h)-(10)–1 by including a statement with itsreturn (including a timely filed amendedreturn) for the period that includes theacquisition date to the effect that it isapplying all of these sections pursuantto this paragraph (b). A target with anacquisition date on or after January 14,1992, and before January 20, 1997, maychoose to apply § 1.338–4(h) for theperiod that includes the acquisition datepursuant to paragraph (b) of this section.

* * * * *

7

Margaret Milner Richardson,Commissioner of Internal Revenue.

Approved January 13, 1997.

Donald C. Lubick,Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register onJanuary 22, 1997, 8:45 a.m., and published in the

issue of the Federal Register for January 23, 1997,62 F.R. 3458)

8

Part III. Administrative, Procedural, and MiscellaneousTax on Certain ImportedSubstances; Notice ofDetermination

Notice 97–22

This notice announces a determina-tion, under Notice 89–61, 1989–1 C.B.717, that the list of taxable substances in§ 4672(a)(3) will be modified to includediglycidyl ether of bisphenol-A. Thismodification is effective April 1, 1992.

Background

Under § 4672(a), an importer or ex-porter of any substance may request thatthe Secretary determine whether thatsubstance should be listed as a taxablesubstance. The Secretary shall add thesubstance to the list of taxable sub-stances in § 4672(a)(3) if the Secretarydetermines that taxable chemicals con-stitute more than 50 percent of theweight, or more than 50 percent of thevalue, of the materials used to producethe substance. This determination is tobe made on the basis of the predominantmethod of production. Notice 89–61 setsforth the rules relating to the determina-tion process.

Determination

On February 24, 1997, the Secretarydetermined that diglycidyl ether ofbisphenol-A should be added to the listof taxable substances in § 4672(a)(3),effective April 1, 1992.The rate of tax prescribed for

diglycidyl ether of bisphenol-A, under§ 4671(b)(3), is $7.08 per ton. This isbased upon a conversion factor for ben-zene of 0.459, a conversion factor forpropylene of 0.494, a conversion factorfor chlorine of 0.833, and a conversionfactor for sodium hydroxide of 0.705.The petitioner is Dow Chemical Com-

pany, a manufacturer and exporter ofthis substance. No material commentswere received on this petition. The fol-lowing information is the basis for thedetermination.HTS number: 3907.3CAS number: 025085–99–8Diglycidyl ether of bisphenol-A

(DGEBA) is derived from the taxablechemicals benzene, propylene, chlorine,and sodium hydroxide and producedpredominantly from epichlorohydrin andbisphenol-A via a two-step reaction.The stoichiometric material consump-

tion formula for this substance is:

2 C6H6 (benzene) + 4 C3H6 (propylene) + 4 Cl2(chlorine) + 6 NaOH (sodium hydroxide) + 2 O22(oxygen) -----. (CH3)2C(C6H4OC3H50)2(DGEBA) + CH3COCH3 (acetone) + 2 HCl(hydrogen chloride) + 6 NaCl (sodium chloride) +5 H2O (water)Diglycidyl ether of bisphenol-A has

been determined to be a taxable sub-stance because a review of itsstoichiometric material consumption for-mula shows that, based on the predomi-nant method of production, taxablechemicals constitute 92.95 percent byweight of the materials used in itsproduction.The principal author of this notice is

Ruth Hoffman, Office of Assistant ChiefCounsel (Passthroughs and Special In-dustries). For further information regard-ing this notice contact Ruth Hoffman on(202) 622–3130 (not a toll-free number).

26 CFR 601.105 Examination of returns andclaims for refund, credits or abatement; determi-nation of correct tax liability.(Also Part I, Section 6001; 1.6001–1.)

Rev. Proc. 97–22

SECTION 1. PURPOSE

This revenue procedure providesguidance to taxpayers that maintainbooks and records by using an elec-tronic storage system that either imagestheir hardcopy (paper) books andrecords, or transfers their computerizedbooks and records, to an electronicstorage media, such as an optical disk.Records maintained in an electronicstorage system that complies with therequirements of this revenue procedurewill constitute records within the mean-ing of § 6001 of the Internal RevenueCode.

SECTION 2. BACKGROUND

.01 Section 6001 provides that everyperson liable for any tax imposed by theCode, or for the collection thereof, mustkeep such records, render such state-ments, make such returns, and complywith such rules and regulations as theSecretary may from time to time pre-scribe. Whenever necessary, the Secre-tary may require any person, by noticeserved upon that person or by regula-tions, to make such returns, render suchstatements, or keep such records, as theSecretary deems sufficient to showwhether or not that person is liable fortax..02 Section 1.6001–1(a) of the In-

come Tax Regulations provides that,

except for farmers and wage-earners,any person subject to income tax, or anyperson required to file a return of infor-mation with respect to income, mustkeep such books and records, includinginventories, as are sufficient to establishthe amount of gross income, deductions,credits, or other matters required to beshown by that person in any return ofsuch tax or information..03 Section 1.6001–1(e) provides that

the books or records required by § 6001must be kept available at all times forinspection by authorized internal rev-enue officers or employees, and must beretained so long as the contents thereofmay become material in the administra-tion of any internal revenue law.

SECTION 3. SCOPE

.01 This revenue procedure applies totaxpayers who maintain books andrecords using an ‘‘electronic storagesystem.’’ An electronic storage system isa system to prepare, record, transfer,index, store, preserve, retrieve, and re-produce books and records by either:

(1) electronically imaging hardcopydocuments to an electronic storage me-dia; or

(2) transferring computerizedbooks and records to an electronic stor-age media using a technique such as‘‘COLD’’ (computer output to laserdisk), which allows books and recordsto be viewed or reproduced without theuse of the original program..02 The requirements of this revenue

procedure pertain to all matters underthe jurisdiction of the Commissioner ofInternal Revenue including, but not lim-ited to, income, excise, employment,and estate and gift taxes, as well asemployee plans and exempt organiza-tions..03 A taxpayer’s use of a third party

(such as a service bureau or time-sharing service) to provide the taxpayerwith an electronic storage system for itsbooks and records does not relieve thetaxpayer of the responsibilities describedin this revenue procedure..04 Except as otherwise provided in

this revenue procedure, all requirementsof § 6001 that apply to hardcopy booksand records apply as well to books andrecords that are stored electronicallypursuant to this revenue procedure.

9

SECTION 4. ELECTRONICSTORAGE SYSTEMREQUIREMENTS

.01 General Requirements.(1) An electronic storage system

must ensure an accurate and completetransfer of the hardcopy or computerizedbooks and records to an electronic stor-age media. The electronic storage sys-tem must also index, store, preserve,retrieve, and reproduce the electronicallystored books and records.

(2) An electronic storage systemmust include:

(a) reasonable controls to ensurethe integrity, accuracy, and reliability ofthe electronic storage system;

(b) reasonable controls to pre-vent and detect the unauthorized cre-ation of, addition to, alteration of, dele-tion of, or deterioration of electronicallystored books and records;

(c) an inspection and quality as-surance program evidenced by regularevaluations of the electronic storage sys-tem including periodic checks of elec-tronically stored books and records;

(d) a retrieval system that in-cludes an indexing system (within themeaning of section 4.02 of this revenueprocedure); and

(e) the ability to reproduce leg-ible and readable hardcopies (within themeaning of section 4.01(3) of this rev-enue procedure) of electronically storedbooks and records.

(3) All books and records repro-duced by the electronic storage systemmust exhibit a high degree of legibilityand readability when displayed on avideo display terminal and when repro-duced in hardcopy. The term ‘‘legibil-ity’’ means the observer must be able toidentify all letters and numerals posi-tively and quickly to the exclusion of allother letters or numerals. The term‘‘readability’’ means that the observermust be able to recognize a group ofletters or numerals as words or completenumbers. The taxpayer must ensure thatthe reproduction process maintains thelegibility and readability of the elec-tronically stored document.

(4) The information maintained inan electronic storage system must pro-vide support for the taxpayer’s booksand records (including books andrecords in an automated data processingsystem). For example, the informationmaintained in an electronic storage sys-tem and the taxpayer’s books andrecords must be cross-referenced in a

manner that provides an audit trail be-tween the general ledger and the sourcedocument(s).

(5) For each electronic storage sys-tem used, the taxpayer must maintain,and make available to the Service uponrequest, complete descriptions of:

(a) the electronic storage system,including all procedures relating to itsuse; and

(b) the indexing system (see sec-tion 4.02 of this revenue procedure).

(6) At the time of an examination,or for the tests described in section 5 ofthis revenue procedure, the taxpayermust:

(a) retrieve and reproduce (in-cluding hardcopies if requested) elec-tronically stored books and records; and

(b) provide the Service with theresources (e.g., appropriate hardwareand software, personnel, documentation,etc.) necessary to locate, retrieve, read,and reproduce (including hardcopies)any electronically stored books andrecords.

(7) An electronic storage systemmust not be subject, in whole or in part,to any agreement (such as a contract orlicense) that would limit or restrict theService’s access to and use of theelectronic storage system on the taxpay-er’s premises (or any other place wherethe electronic storage system is main-tained), including personnel, hardware,software, files, indexes, and softwaredocumentation.

(8) The taxpayer must retain elec-tronically stored books and records solong as their contents may become ma-terial in the administration of the Inter-nal Revenue laws under § 1.6001–1(e).

(9) The taxpayer may use morethan one electronic storage system. Inthat event, each electronic storage sys-tem must meet the requirements of thisrevenue procedure. Electronically storedbooks and records that are contained inan electronic storage system with re-spect to which the taxpayer ceases tomaintain the hardware and the softwarenecessary to satisfy the conditions ofthis revenue procedure will be deemeddestroyed by the taxpayer, unless theelectronically stored books and recordsremain available to the Service in con-formity with this revenue procedure.

(10) Taxpayers may use reasonabledata compression or formatting tech-nologies as part of their electronic stor-age system so long as the requirementsof this revenue procedure are satisfied.

.02 Requirements of an Indexing Sys-tem.

(1) For purposes of this revenueprocedure, an ‘‘indexing system’’ is asystem that permits the identificationand retrieval for viewing or reproducingof relevant books and records main-tained in an electronic storage system.For example, an indexing system mightconsist of assigning each electronicallystored document a unique identificationnumber and maintaining a separate data-base that contains descriptions of allelectronically stored books and recordsalong with their identification numbers.In addition, any system used to main-tain, organize, or coordinate multipleelectronic storage systems is treated asan indexing system under this revenueprocedure. The requirement to maintainan indexing system will be satisfied ifthe indexing system is functionally com-parable to a reasonable hardcopy filingsystem. The requirement to maintain anindexing system does not require that aseparate electronically stored books andrecords description database be main-tained if comparable results can beachieved without a separate descriptiondatabase.

(2) Reasonable controls must beundertaken to protect the indexing sys-tem against the unauthorized creation of,addition to, alteration of, deletion of, ordeterioration of any entries..03 Recommended Practices.The

implementation of records managementpractices is a business decision that issolely within the discretion of the tax-payer. Records management practicesmay include the labeling of electroni-cally stored books and records, provid-ing a secure storage environment, creat-ing back-up copies, selecting an off-sitestorage location, retaining hardcopies ofbooks or records that are illegible orthat cannot be accurately or completelytransferred to an electronic storage sys-tem, and testing to confirm recordsintegrity.

SECTION 5. DISTRICT DIRECTORTESTING

.01 The District Director may peri-odically initiate tests of a taxpayer’selectronic storage system. These testsmay include an evaluation (by actualuse) of a taxpayer’s equipment andsoftware, as well as the procedures usedby a taxpayer to prepare, record, trans-fer, index, store, preserve, retrieve, andreproduce electronically stored docu-ments. In some instances, the District

10

Director may choose to review the inter-nal controls, security procedures, anddocumentation associated with the tax-payer’s electronic storage system..02 The tests described in section

5.01 of this revenue procedure are notan ‘‘examination,’’ ‘‘investigation,’’ or‘‘inspection’’ of the books and recordswithin the meaning of § 7605(b), or aprior audit for purposes of § 530 of theRevenue Act of 1978, 1978–3 (Vol.1)C.B. 119, as amended by § 1122 of theSmall Business Job Protection Act of1996, because these tests are not directlyrelated to the determination of the taxliability of a taxpayer for a particulartaxable period..03 The District Director must inform

the taxpayer of the results of any testsunder this section.

SECTION 6. COMPLIANCE

.01 A taxpayer’s electronic storagesystem that meets the requirements ofthis revenue procedure will be treated asbeing in compliance with therecordkeeping requirements of § 6001and the regulations thereunder..02 A taxpayer’s electronic storage

system that fails to meet the require-ments of this revenue procedure may betreated as not being in compliance withthe recordkeeping requirements of§ 6001 and the regulations thereunder.See section 9 of this revenue procedurefor applicable penalties. However, eventhough a taxpayer’s electronic storagesystem fails to meet the requirements ofthis revenue procedure, the penaltiesdescribed in section 9 of this revenueprocedure may not apply if the taxpayermaintains its original books and records,or maintains its books and records inmicrographic form in conformity withRev. Proc. 81–46, 1981–2 C.B. 621.

SECTION 7. DESTRUCTION ANDDELETION OF ORIGINAL BOOKSAND RECORDS

This revenue procedure permits thedestruction of the original hardcopybooks and records and the deletion ofthe original computerized records (otherthan ‘‘machine-sensible’’ records re-quired to be retained by Rev. Proc.91–59, 1991–2 C.B. 841), after thetaxpayer:

(1) has completed its own testingof the electronic storage system thatestablishes that hardcopy or computer-ized books and records are being repro-duced in compliance with all the provi-sions of this revenue procedure; and

(2) has instituted procedures thatensure its continued compliance with allthe provisions of this revenue procedure.

SECTION 8. IMPACT ONMACHINE-SENSIBLE RECORDS

The provisions of this revenue proce-dure regarding electronically storedbooks and records do not relieve taxpay-ers of the responsibility of retaining anyother books and records required to beretained under § 6001. Such otherbooks and records may include‘‘machine-sensible’’ records required tobe retained by Rev. Proc. 91–59 inconnection with the taxpayer’s use of anautomatic data processing (ADP) sys-tem.

SECTION 9. PENALTIES

The District Director may issue aNotice of Inadequate Records pursuantto § 1.6001–1(d) if the taxpayer’s booksand records are available only as elec-tronically stored books and records andthe taxpayer’s electronic storage systemfails to meet the requirements of thisrevenue procedure. Taxpayers whoseelectronic storage system fails to meetthe requirements of this revenue proce-dure may also be subject to applicablepenalties under subtitle F of the Code,including the § 6662(a) accuracy-relatedcivil penalty and the § 7203 willfulfailure criminal penalty.

SECTION 10. INTERNAL REVENUESERVICE OFFICE CONTACT

.01 Questions regarding this revenueprocedure should be directed to theOffice of the Assistant Commissioner(Examination). The telephone numberfor this office is (202) 622–5480 (not atoll-free number). Written questionsshould be addressed to: Assistant Com-missioner (Examination)

Attention: CP:EXInternal Revenue Service1111Constitution Ave., NWWashington, DC 20224

.02 Questions regarding the applica-tion of this revenue procedure to aspecific factual situation should be di-rected to the appropriate District Direc-tor.

SECTION 11. PAPERWORKREDUCTION ACT

The collections of information con-tained in this revenue procedure havebeen reviewed and approved by theOffice of Management and Budget inaccordance with the Paperwork Reduc-tion Act (44 U.S.C. 3507) under controlnumber 1545–1533.An agency may not conduct or spon-

sor, and a person is not required torespond to, a collection of informationunless the collection of information dis-plays a valid control number.The collections of information are in

sections 4 and 5 of this revenue proce-dure. This information is required toensure that records maintained in anelectronic storage system will constituterecords within the meaning of § 6001.The collections of information are man-datory for a taxpayer who chooses toelectronically store its books andrecords. The likely respondents are indi-viduals, state or local governments,farms, business or other for-profit insti-tutions, federal agencies or employees,nonprofit institutions, and small busi-nesses or organizations.The estimated total annual record-

keeping burden is 1,000,400 hours.The estimated annual burden per

recordkeeper will vary from 20 hours to22 hours, depending on individual cir-cumstances, with an estimated averageof 20 hours. The estimated number ofrecordkeepers is 50,000.Books or records relating to a collec-

tion of information must be retained aslong as their contents may become ma-terial in the administration of any inter-nal revenue law. Generally tax returnsand tax return information are confiden-tial, as required by 26 U.S.C. 6103.

11

Part IV. Items of General InterestNotice of Proposed Rulemakingand Notice of Public Hearing

Amortization of Intangible Property

REG–209709–94

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemak-ing and notice of public hearing.

SUMMARY: This document containsproposed regulations relating to the am-ortization of certain intangible property.The proposed regulations reflect changesto the law made by the Omnibus BudgetReconciliation Act of 1993 (OBRA ’93),and affect taxpayers who acquired intan-gible property after August 10, 1993, ormade a retroactive election to applyOBRA ’93 to intangibles acquired afterJuly 25, 1991. This document also pro-vides notice of a public hearing on theproposed regulations.

DATES: Comments must be receivedby April 16, 1997. Requests to appearand outlines of oral comments to bepresented at the public hearing sched-uled for May 15, 1997, must be re-ceived by April 24, 1997.

ADDRESSES: Send submissions to:CC:DOM:CORP:R (REG–209709–94),room 5228, Internal Revenue Service,POB 7604, Ben Franklin Station, Wash-ington, DC 20044. Submissions may behand delivered between the hours of 8a.m. and 5 p.m. to: CC:DOM:CORP:R(REG–209709–94), Courier’s Desk, In-ternal Revenue Service,1111 Constitu-tion Avenue NW, Washington, DC. Al-ternatively, taxpayers may submitcomments electronically via the Internetby selecting the ‘‘Tax Regs’’ option ofthe IRS Home Page, or by submittingcomments directly to the IRS Internetsite at http:\\www.irs.ustreas.gov\prod\tax_regs\comments.html. The publichearing will be held in the Commission-er’s Conference Room (Room 3313),Internal Revenue Building,1111Consti-tution Avenue NW, Washington, DC20224.

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,John Huffman at (202) 622–3110; con-cerning submissions and the hearing,Michael Slaughter at (202) 622–8452(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposedregulations under sections 167(f) and197. These provisions were added to theInternal Revenue Code of 1986 (theCode) by section 13261 of OBRA ’93,and apply to intangible property ac-quired after August 10, 1993 (or afterJuly 25, 1991, if a valid retroactiveelection to apply OBRA ’93 to intan-gibles has been made pursuant to§ 1.197–1T).

The proposed regulations providedefinitions and rules for amortization ofintangible property subject to sections197 and 167(f). On June 24, 1994, theIRS published Announcement 94–92(1994–28 I.R.B. 139) in theFederalRegister (59 FR 32670) inviting com-ments under section 197 relating to theamortization of goodwill and certainother intangibles that should be ad-dressed in proposed regulations. TheIRS has reviewed these comments andhas addressed certain issues raised in thecomments in the proposed regulations.However, because these comments werereceived in anticipation of the issuanceof these proposed regulations, and be-cause these regulations are subject tofurther comment and a public hearing,no attempt has been made to describeall of the principal comments that arenot reflected in these regulations or thereasons therefor.

Explanation of Provisions

1. General overview

Sections 167(f) and 197 provide com-prehensive rules for the depreciation andamortization of many intangible assets.Intangible assets subject to section 197are broadly defined to include mostintangible assets acquired in connectionwith the acquisition of a trade or busi-ness and certain other separately ac-quired intangible assets. The adjustedbasis of an amortizable section 197intangible must be amortized over a15-year period. Certain other intangibleassets are excluded from section 197 forvarious reasons. In some cases, such asstock and partnership interests, the assetis property of a character that is notsubject to an allowance for depreciationbecause it represents a permanent in-vestment that can only be recoveredthrough disposition of the asset (includ-

ing worthlessness). In other cases, suchas computer software, purchased mort-gage servicing rights, service and supplycontracts, and certain other contracts orrights with a fixed duration, other costrecovery methods were prescribed bythe OBRA ’93 amendments. In stillother cases, such as motion picturefilms, television series, books, andsound recordings, other cost recoverymethods that were in effect prior toOBRA ’93 are more appropriate underthe circumstances. Section 167(f) pro-vides alternative methods of deprecia-tion for certain of the intangibles ex-cluded from the application of section197.The proposed regulations provide

guidance for certain intangible propertysubject to sections 167(f) and 197. Thesection 167(f) proposed regulations pro-vide rules for intangible property subjectto the allowance for depreciation undersection 167 and specifically excludedfrom section 197. These intangible as-sets include certain computer software,rights to receive tangible property orservices, rights of fixed duration, pat-ents, copyrights, and mortgage servicingrights. These proposed regulations re-serve guidance on the method of depre-ciating the cost of separately acquiredrights to receive tangible property orservices where the amount of the prop-erty or services to be received is notspecified. The IRS invites comments onpossible methods of depreciation inthese cases.Because section 197 provides a

method of amortization and, except inthe case of certain covenants not tocompete, governmental licenses, permitsand other rights, and contracts for theuse of section 197 intangibles, does notalter the rules for determining the basisof an asset, section 197 generally doesnot apply to amounts that would other-wise be deductible. For example, section197 does not generally apply to thecosts of advertising because, in mostcases, these costs are deductible underother provisions of the Code. See Rev.Rul. 92–80 (1992–2 C.B. 57). In addi-tion, section 197 does not apply to coststhat would not, under general principlesof Federal income tax law, be includedin the basis of a section 197 intangible.For example, if a taxpayer borrowsmoney to purchase the assets of a tradeor business (including amortizable sec-tion 197 intangibles) and incurs fees inconnection with the loan, these costs are

12

generally amortized over the term of theloan rather than under the rules ofsections 167(f) and 197. As a furtherexample, if the amortizable section 197intangibles acquired in the transactioninclude a favorable supply contract, theamortizable basis in the contract doesnot include amounts required to be paidfor goods to be received pursuant to thecontract.In addition, section 197 does not

apply to any amount for which a deduc-tion would be disallowed under otherprovisions of the Code, such as section162(k) (relating to amounts paid orincurred by a corporation in connectionwith the acquisition of its stock or thestock of a related person).No inference should be drawn from

any provision in the proposed regula-tions concerning the classification ofany section 197 intangible as property,or whether any section 197 intangible istreated as tangible or intangible prop-erty, for other purposes of the Code.Furthermore, no inference should bedrawn from any provision in the pro-posed regulations regarding (a) whetherany section 197 intangible that is not anamortizable section 197 intangible maybe amortized or depreciated under anyprovision of the Code other than section197, or (b) the proper method for deter-mining any allowance therefor. Finally,no inference should be drawn from anyprovision in the proposed regulationsconcerning whether any section 197 in-tangible (or any interest therein) hasbeen purchased, leased, or licensed forFederal income tax purposes.

2. Section 197 intangibles

The proposed regulations define sec-tion 197 intangibles (subject to certainexceptions) as goodwill, going concernvalue, workforce in place, informationbase, know-how, customer- and supplier-based intangibles, governmental licensesand permits, covenants not to competeand other similar arrangements, fran-chises, trademarks, trade names, andcontracts for the use of the foregoingassets.

A. Covenants not to Compete

Some commentators in response toAnnouncement 94–92 suggested that acovenant not to compete relating to theredemption of stock or a partnershipinterest from a departing stockholder orpartner should be excluded from section197 because this situation does notinvolve the acquisition of a trade or

business. The legislative history pro-vides, however, that section 197 appliesto a covenant not to compete acquiredwith the assets of a trade or business,the stock in a corporation, or an interestin a partnership engaged in a trade orbusiness. Consequently, the proposedregulations do not provide for this ex-ception. In this regard, the proposedregulations provide that for purposes ofsection 197(f)(1)(B), the disposition orcancellation of redeemed stock of acorporation will not cause the covenantto be written off faster than over the15-year amortization period provided forunder section 197 (in the case of acovenant to which section 162(k) doesnot apply).

B. Contracts for the Use of Section 197Intangibles

Some commentators also requestedguidance on the extent to which con-tracts for the use of section 197 intan-gibles would be subject to section 197,in some cases suggesting that an intan-gible was not subject to section 197unless the taxpayer obtained ownershipof property for Federal income tax pur-poses. However, it is sometimes difficultto determine whether the terms of anagreement confer ownership, for Federalincome tax purposes, of property, andthe IRS and Treasury believe that thepurposes of section 197 could be cir-cumvented through the use of suchagreements. Accordingly, the proposedregulations provide that contracts for theuse of section 197 intangibles will alsobe treated as section 197 intangibles.Contracts that are so treated may, how-ever, be excluded under either section197(e)(4)(B) or (D) on the basis thatthey are contracts for the receipt ofproperty or services, contracts having afixed duration, or contracts having afixed amount and recovered on a unit-of-production method or other similarmethod.

3. Intangibles excluded from section197

A. Computer Software

Section 197 intangibles do not includecomputer software that is readily avail-able for purchase by the general public,is subject to a nonexclusive license, andhas not been substantially modified. Theproposed regulations provide a safe har-bor for purposes of determining whethercomputer software has been substan-tially modified. Under the safe harbor,

computer software has not been substan-tially modified if its capitalized costdoes not exceed the greater of $2,000 or125 percent of the price at which theunmodified version of the software isreadily available to the general public.The proposed regulations incorporate

some of the provisions of RevenueProcedure 69–21 (1969–2 C.B. 303),involving the treatment of costs of com-puter software, and modify other provi-sions to the extent necessary to conformto the amortization rules provided undersections 197 and 167(f). Consequently,if costs for developing computer soft-ware that the taxpayer has elected totreat as deferred expenses under section174(b) result in the development of aself-created intangible excluded undersection 197(c)(2) and subject to theallowance for depreciation under section167(a), deductions for the unrecoveredexpenditures are subject to section167(f)(1). Computer software costs in-cluded, without being separately stated,in the cost of the computer hardware(bundled software) continue to be capi-talized and depreciated as part of thecomputer hardware. The proposed regu-lations also continue to treat as currentlydeductible software costs properly andconsistently treated as deductible (notcapitalized) under § 1.162–11.

B. Certain Separately AcquiredIntangibles

Certain intangibles are excepted fromsection 197 if they are not acquired aspart of a purchase of a trade or business.The proposed regulations clarify that,for purposes of section 197, a group ofassets constitutes a trade or business iftheir use would constitute a trade orbusiness under section 1060; that is, ifgoodwill or going concern value couldunder any circumstances attach to theassets. Temporary and proposed regula-tions under section 1060, in turn, pro-vide that a group of assets constitutes atrade or business for purposes of section1060 if the use of such assets wouldconstitute an active trade or business forpurposes of section 355. However, inappropriate cases, even if the use of agroup of assets would not constitute anactive trade or business for purposesof section 355, such assets may never-theless constitute a trade or businessfor purposes of section 1060. See§ 1.1060–1T(b)(2).The IRS intends to provide additional

guidance as to the circumstances underwhich the acquisition of a group of

13

assets constitutes a trade or business forpurposes of section 1060 in regulationsunder that section. Accordingly, the pro-posed regulations do not provide sub-stantive guidance on this question, ex-cept to the extent that the considerationsare unique to the application of section197. The IRS invites comments on theextent to which additional rules undersection 197 may be necessary.

C. Certain Contracts and GovernmentalRights

While section 197 intangibles includelicenses, permits, and other rightsgranted by a governmental unit or anagency or instrumentality thereof (sec-tion 197(d)(1)(D)), certain rights grantedby these governmental entities are ex-cluded from section 197 pursuant tosection 197(e)(4)(B) and (D), subject tothe conditions and limitations therein.Because a particular right may be de-scribed in two or more of these provi-sions, the proposed regulations provideguidance regarding the potential conflictbetween, or overlap with, these provi-sions. Thus, a right that would besubject to section 197 pursuant to sec-tion 197(d)(1)(D) may nevertheless beexcluded if it is also described in sec-tion 197(e)(4) and meets all of therequirements for exclusion. Furthermore,a right that meets the requirements ofeither section 197(e)(4)(B) or section197(e)(4)(D) is excluded from section197 even if it fails to meet one of therequirements for the other exclusion. Inaddition, any license, permit, or otherright granted by a governmental unitthat otherwise meets the definition of afranchise under section 197(d)(1)(F),such as an FCC broadcast license orcable television franchise, is treated as afranchise under the regulations. Accord-ingly, these licenses do not qualify forany of the exceptions from section 197provided under section 197(e)(4).

4. Special rules of application

A. Loss Disallowance Provisions

The proposed regulations containrules for the loss disallowance provi-sions set forth in section 197(f)(1). Inparticular, the proposed regulations pro-vide that a taxpayer may not circumventthe loss disallowance rules, for example,by transferring some intangibles, whoseadjusted basis is greater than their fairmarket value, to a corporation in ex-change for stock in the corporation in atransaction described in section 351,

while retaining other intangibles ac-quired in the same or related transaction,and then selling the stock. Special rulesare also provided for the application ofthe loss disallowance provisions in caseswhere a taxpayer has disposed of all ofthe amortizable section 197 intangiblesacquired in a single transaction but istreated as having retained other amortiz-able section 197 intangibles solely byvirtue of the retention of amortizablesection 197 intangibles by a relatedperson.

B. Transactions Involving Partnerships

The proposed regulations providerules and examples relating to the treat-ment of section 197 intangibles acquiredor transferred in certain partnershiptransactions, including terminations un-der section 708(b)(1), and the applica-tion of section 197 to the special basisadjustments of partnership property forwhich a section 754 or section 732(d)election is in effect. Guidance is alsoprovided regarding the effect of curativeand remedial allocations and the appli-cation of the anti-churning rules to cer-tain partnership transactions.In the case of the termination of a

partnership under section 708(b)(1)(B)(relating to a sale or exchange of aninterest), the rules contained in the pro-posed regulations are based on recentlyproposed regulations under that section,pursuant to which the new partnership istreated as having directly acquired theassets of the old partnership in exchangefor the assumption of its liabilities andthe issuance of interests in the newpartnership. Accordingly, for purposes ofsection 197, the consequences of thetermination of a partnership under sec-tion 708(b)(1)(B) may not be the sameas the consequences of such a termina-tion under the rules in effect at the timesection 197 was enacted.

C. Treatment of Contingent Payments

The proposed regulations clarify that,except in the case of contingent pay-ments, amounts paid for section 197intangibles are treated as amountschargeable to capital account, and theentire principal amount is amortizedratably over the 15-year amortizationperiod beginning with the later of themonth in which the intangible is ac-quired or the date on which the activeconduct of a trade or business begins.Contingent payments for section 197intangibles paid or incurred after thetaxable year in which the intangible is

acquired are added to basis at such timeand generally amortized ratably over theremaining months in the 15-year periodas of the beginning of the month theamount is paid or incurred. However, inorder to reduce the administrative bur-den that may result from a requirementto maintain separate amortization sched-ules for each month during the 15-yearperiod, taxpayers are permitted to usecertain simplifying conventions. In addi-tion, any amount that is not properlyincluded in the basis of an amortizablesection 197 intangible until after theexpiration of the 15-year period is amor-tized in full immediately upon the inclu-sion of the amount in the basis of theintangible. The proposed regulations re-fer to § 1.461–1(a)(1) for rules govern-ing the time at which an amount may betaken into account by a taxpayer usingthe cash receipts and disbursementsmethod. They refer to § 1.461–1(a)(2)for rules governing the time at which aliability is incurred and generally takeninto account (for example, by treatingthe amount of the liability as a capitalexpenditure) by an accrual basis tax-payer.

5. Anti-churning Rules

To be eligible for amortization, sec-tion 197 intangibles must qualify asamortizable section 197 intangibles.Generally, amortizable section 197 in-tangibles are section 197 intangibles thatare acquired after August 10, 1993 (oracquired after July 25, 1991, and forwhich the taxpayer made a proper elec-tion under § 1.197–1T) and held inconnection with the conduct of a tradeor business or an activity described insection 212.The proposed regulations provide

anti-churning rules to prevent taxpayersfrom converting into amortizable section197 intangibles existing goodwill, goingconcern value, and any other section197 intangible for which amortizationwould not have been allowable prior toOBRA ’93 through the use of relatedpersons and certain other transactions.The proposed regulations define theterm related person for purposes ofthese rules.The proposed regulations also contain

provisions for the exception to the anti-churning rules in situations where theseller elects to recognize gain andagrees to pay a specified amount of tax.The regulations reserve guidance on themanner of making this election. The IRSintends to issue a revenue procedure in

14

order to provide interim guidance totaxpayers on the manner of making thiselection, and the final regulations willinclude the relevant provisions of thisrevenue procedure.The proposed regulations contain both

an anti-churning anti-abuse rule and ageneral anti-abuse rule that provide thatthe Commissioner may recast any trans-action if one of its principal purposes isto avoid the purposes of section 197.

6. Assumption Reinsurance Transactions

Section 197(f)(5) provides specialrules for section 197 intangibles result-ing from assumption reinsurance trans-actions. The proposed regulations re-serve guidance on certain aspects ofthese transactions. The IRS invites com-ments on the extent to which additionalguidance on the application of section197 to these transactions may be neces-sary.

7. Proposed Effective Dates

The regulations for sections 167(f)and 197 are proposed to be effective onthe date on which the final regulationsare published in theFederal Register.Regulations to implement section197(e)(4)(D) (separately acquired con-tracts of fixed duration or amount) areproposed to be effective August 11,1993, for property acquired after August10, 1993 (or July 26, 1991, if a validretroactive election has been made under§ 1.197–1T).

8. Accounting Method Changes

A change in the method of deprecia-tion or amortization of intangibles is achange in method of accounting thatrequires the consent of the Commis-sioner of Internal Revenue under section446(e). To obtain this consent, a Form3115, Application for Change in Ac-counting Method, generally must befiled within 180 days after the beginningof the taxable year in which the pro-posed change is to be made. Taxpayersthat have adopted a method of account-ing for certain intangibles may need tochange their method of accounting tocomply with the final regulations.

9. Basis Allocation Rules

In separate notices the IRS and Trea-sury are issuing temporary and proposedamendments to the temporary regula-tions under sections 1060 and 338(b).The existing temporary regulations es-tablish a four-class system for allocating

basis to individual assets in the case ofa direct acquisition of assets constitutinga trade or business or a deemed acquisi-tion of assets as the result of an electionunder section 338. Under this system,assets in the nature of goodwill andgoing concern value are included inClass IV, while other intangible assets,whether or not amortizable, are includedin Class III. Each successive class isallocated basis under a residual method,subject to a fair market value limitationfor all classes except Class IV. Afterbasis has been allocated to each class inthe aggregate, assets within each of thefirst three classes are allocated basis ona proportional method. This system isinconsistent with the policies of section197, which prescribes uniform treatmentfor all amortizable section 197 intan-gibles. Accordingly, appropriate modifi-cations are being proposed.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined in EO12866. Therefore, a regulatory assess-ment is not required. It also has beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to theseregulations, and, because the regulationsdo not impose a collection of informa-tion on small entities, the RegulatoryFlexibility Act (5 U.S.C. chapter 6) doesnot apply. Pursuant to section 7805(f) ofthe Internal Revenue Code, this noticeof proposed rulemaking will be submit-ted to the Chief Counsel for Advocacyof the Small Business Administration forcomment on its impact on small busi-ness.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, consider-ation will be given to any commentsthat are submitted (in the manner de-scribed in ADDRESSES) timely to theIRS. All comments will be available forpublic inspection and copying.A public hearing has been scheduled

for May 15, 1997, at 10 a.m. in theCommissioner’s Conference Room(Room 3313), Internal Revenue Build-ing, 1111 Constitution Avenue NW,Washington, DC 20224. Because of ac-cess restrictions, visitors will not beadmitted beyond the Internal RevenueBuilding lobby more than 15 minutesbefore the hearing starts.

The rules of 26 CFR 601.601(a)(3)apply to the hearing.Persons that wish to present oral

comments at the hearing must submitcomments and an outline of the topicsto be discussed and the time to bedevoted to each topic (in the mannerdescribed in ADDRESSES) by April 16,1997. A period of 10 minutes will beallotted to each person for making com-ments.An agenda showing the scheduling of

the speakers will be prepared after thedeadline for receiving outlines haspassed. Copies of the agenda will beavailable free of charge at the hearing.

Drafting Information

The principal author of these regula-tions is John Huffman, Office of Assis-tant Chief Counsel (Passthroughs andSpecial Industries), IRS. However, otherpersonnel from the IRS and TreasuryDepartment participated in their devel-opment.

* * * * *

Proposed Amendments to the Regula-tions

Accordingly, 26 CFR part 1 is pro-posed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citationfor part 1 is amended by adding anentry in numerical order to read asfollows:Authority: 26 U.S.C. 7805 * * *

Section 1.197–2 also issued under 26U.S.C. 197(g). * * *Par. 2. Section 1.167(a)–3 is amended

by adding a sentence at the end to readas follows:

§ 1.167(a)–3 Intangibles.

* * * See §§ 1.197–2 and 1.167(a)–14for amortization of goodwill and certainother intangibles acquired after August10, 1993, or after July 25, 1991, if avalid retroactive election under § 1.197–1T has been made.Par. 3. Section 1.167(a)–6 is amended

by adding two sentences at the end ofparagraph (a) to read as follows:

§ 1.167(a)–6 Depreciation in specialcases.

(a) * * * See § 1.167(a)–14(c)(4) fordepreciation of a separately acquiredinterest in a patent or copyright de-scribed in section 167(f)(2) acquiredafter the date on which the final regula-

15

tions are published in the Federal Regis-ter. See § 1.197–2 for amortization ofinterests in patents and copyrights thatconstitute amortizable section 197 intan-gibles.

* * * * *Par. 4. Section 1.167(a)–14 is added

to read as follows:

§ 1.167(a)–14 Treatment of certain in-tangible property excluded from section197.

(a) Overview. This section providesrules for the amortization of certainintangibles that are excluded from sec-tion 197 (relating to the amortization ofgoodwill and certain other intangibles).These excluded intangibles are specifi-cally described in § 1.197–2(c)(4), (6),(7), (11), and (13) and include certaincomputer software and certain otherseparately acquired rights, such as rightsto receive tangible property or services,patents and copyrights, rights of fixedduration or amount, and certain mort-gage servicing rights. Intangibles forwhich an amortization amount is deter-mined under section 167(f) and intan-gibles otherwise excluded from section197 (for example, self-created intan-gibles described in § 1.197–2(d)(2)) areamortizable only if they qualify as prop-erty subject to the allowance for depre-ciation under section 167(a).(b) Computer software—(1) In gen-

eral. The amount of the deduction forcomputer software described in section167(f)(1) and § 1.197–2(c)(4) is deter-mined by amortizing the adjusted basisof the computer software using thestraight line method described in§ 1.167(b)–1 (except that its salvagevalue is treated as zero) and an amorti-zation period of 36 months beginningwith the month that the computer soft-ware is placed in service. If costs fordeveloping computer software that thetaxpayer properly elects to defer undersection 174(b) result in the developmentof property subject to the allowance fordepreciation under section 167, the rulesof this paragraph (b) will apply to theunrecovered costs. In addition, this para-graph (b) applies to the cost of sepa-rately acquired computer software wherethese costs are separately stated and thecosts are required to be capitalized un-der section 263(a).(2) Exceptions. Paragraph (b)(1) of

this section does not apply to the cost ofcomputer software properly and consis-tently treated as currently deductible(that is, not capitalized) under § 1.162–

11. The cost of acquiring an interest incomputer software that is included,without being separately stated, in thecost of the hardware or other tangibleproperty is treated as part of the cost ofthe hardware or other tangible propertythat is capitalized and depreciated underother applicable sections of the InternalRevenue Code.(c) Certain interests or rights ac-

quired separately—(1) Certain rights toreceive tangible property or services.The amount of the deduction for aseparately acquired right to receive tan-gible property or services under a con-tract or from a governmental unit (speci-fied in section 167(f)(2) and § 1.197–2(c)(6)) is determined as follows:(i) Amortization of fixed amounts.

The cost of acquiring a right to receivea fixed amount of tangible property orservices is amortized for each taxableyear by multiplying the basis (as deter-mined under section 1011) of the rightby a fraction, the numerator of which isthe amount of tangible property or ser-vices received during the taxable yearand the denominator of which is thetotal amount of tangible property orservices received or to be received un-der the terms of the contract or govern-mental grant. For example, if a taxpayeracquires a favorable contract right toreceive a fixed amount of raw materialsduring an unspecified period, the tax-payer must amortize the cost of acquir-ing the contract right by multiplying thetotal cost by a fraction, the numerator ofwhich is the amount of raw materialsreceived under the contract during thetaxable year and the denominator ofwhich is the total amount of raw materi-als received or to be received under thecontract.(ii) Amortization of unspecified

amount over fixed period. The cost ofacquiring a right to receive an unspeci-fied amount of tangible property orservices over a fixed period is amortizedratably over the period of the right.(iii) Amortization in other cases. [Re-

served](2) Rights of fixed duration or

amount. The amount of the deductionfor a separately acquired right of fixedduration or amount received under acontract or granted by a governmentalunit (specified in section 167(f)(2) and§ 1.197–2(c)(13)) and not covered byparagraph (c)(1) of this section is deter-mined as follows:(i) Rights of a fixed amount. The cost

of acquiring a right of a fixed amount isamortized for each taxable year by mul-

tiplying the cost of the right by afraction, the numerator of which is theamount received or delivered during thetaxable year and the denominator ofwhich is the total amount to be receivedor delivered (including amounts receivedor delivered prior to the close of thetaxable year) under the terms of thecontract or governmental grant.(ii) Rights of unspecified amount and

fixed duration of less than 15 years. Thecost of acquiring a right of an unspeci-fied amount and a fixed duration of lessthan 15 years is amortized ratably overthe period of the right.(3) Application of renewals. (i) For

purposes of paragraphs (c)(1) and (2) ofthis section, the duration of a rightunder a contract (or granted by a gov-ernmental unit) includes any renewalperiod if, based on all of the facts andcircumstances in existence at any timeduring the taxable year in which theright is acquired, the facts clearly indi-cate a reasonable expectancy of renewal.(ii) The mere fact that a taxpayer will

have the opportunity to renew a contractright or other right on the same terms asare available to others, in a competitiveauction or similar process that is de-signed to reflect fair market value andin which the taxpayer is not contractu-ally advantaged, will generally not betaken into account in determining theduration of such right provided that thebidding produces a fair market valueprice comparable to the price that wouldbe obtained if the rights were purchasedimmediately after renewal from a person(other than the person granting the re-newal) in an arm’s-length transaction.(iii) The cost of a renewal not in-

cluded in the terms of the contract orgovernmental grant is treated as theacquisition of a separate intangible asset.(4) Patents and copyrights. The

amount of the deduction for a separatelyacquired interest in a patent or copyrightdescribed in section 167(f)(2) and§ 1.197–2(c)(7) is equal to the purchaseprice paid or incurred during the year ifthe purchase price is payable on at leastan annual basis as either a fixed amountper use or a fixed percentage of therevenue derived from the use of thepatent or copyright. Otherwise, the costor other basis of a separately acquiredpatent or copyright (or an interesttherein) is depreciated ratably over itsremaining useful life. If a patent orcopyright becomes valueless in any yearbefore its legal expiration, the adjustedbasis may be deducted in that year.

16

(5) Applicable rules and conventions.The period of amortization under para-graphs (c)(1) through (4) of this sectionbegins when the intangible is placed inservice. For other applicable rules, see§ 1.197–2(f).(d) Mortgage servicing rights. The

amount of the deduction for mortgageservicing rights described in section167(f)(3) and § 1.197–2(c)(11) is deter-mined by using the straight line methoddescribed in § 1.167(b)–1 (except thatthe salvage value is treated as zero) andan amortization period of 108 months.Mortgage servicing rights are not depre-ciable to the extent the rights arestripped coupons under section 1286. Anevent that renders mortgage servicingrights wholly worthless is considered adisposition of the rights. For purposes ofdetermining the deduction for mortgageservicing rights and any loss from thesale, exchange, or other disposition ofthe rights, rights to service a pool ofmortgages are treated as a single asset.Thus, if some (but not all) mortgages ina pool prepay and the taxpayer retainsrights to service the remaining mort-gages in the pool, no loss is recognizedby reason of the prepayment. The ad-justed basis of the mortgage servicingrights is not affected by the unrecog-nized loss.(e) Effective date. This section is ap-

plicable on the date final regulations arepublished in the Federal Registerexcept that § 1.167(a)–14(c)(2) (depre-ciation of the cost of certain separate-ly acquired rights) and so muchof § 1.167(a)–14(c)(3) as relates to§ 1.167(a)–14(c)(2) are applicable Au-gust 11, 1993 (or July 26, 1991, if avalid retroactive election has been madeunder § 1.197–1T).Par. 5. Section 1.197–0 is added to

read as follows:

§ 1.197–0 Table of contents.

This section lists the headings thatappear in § 1.197–2.

§ 1.197–2 Amortization of goodwill andcertain other intangibles.(a) Overview.(1) In general.(2) Section 167(f) property.(3) Amounts otherwise deductible.(4) Relationship to other Internal

Revenue Code provisions.(b) Section 197 intangibles; in gen-

eral.(1) Goodwill.(2) Going concern value.

(3) Workforce in place.(4) Information base.(5) Know-how, etc.(6) Customer-based intangibles.(7) Supplier-based intangibles.(8) Licenses, permits, and other

rights granted by governmental units.(9) Covenants not to compete and

other similar arrangements.(10) Franchises, trademarks, and

trade names.(11) Contracts for the use of, and

term interests in, other section 197 in-tangibles.

(12) Other similar items.(c) Section 197 intangibles; excep-

tions.(1) Interests in a corporation, part-

nership, trust, or estate.(2) Interests under certain financial

contracts.(3) Interests in land.(4) Certain computer software.(i) In general.(ii) Separately acquired software.(iii) Other exceptions.(iv) Computer software defined.(v) Readily available to the gen-

eral public.(5) Certain interests in films, sound

recordings, video tapes, books, or othersimilar property.

(6) Certain rights to receive tan-gible property or services.

(7) Certain interests in patents orcopyrights.

(8) Interests under leases of tan-gible property.

(i) Interest as a lessor.(ii) Interest as a lessee.

(9) Interests under indebtedness.(i) In general.(ii) Exceptions.

(10) Professional sports franchises.(11) Mortgage servicing rights.(12) Certain transaction costs.(13) Rights of fixed duration or

amount.(d) Amortizable section 197 intan-

gibles.(1) Definition.(2) Exception for self-created in-

tangibles.(i) In general.(ii) Created by the taxpayer.(A) Defined.(B) Contracts for the use of

intangibles.(C) Improvements and modifi-

cations.(iii) Exceptions.

(3) Exception for property subjectto anti-churning rules.(e) Purchase of a trade or business.

(1) Goodwill or going concernvalue.

(2) Customer-based intangibles.(3) Franchise, trademark, or trade

name.(i) In general.(ii) Exceptions.

(4) Acquisitions to be included.(5) Substantial portion.(6) Deemed asset purchases under

section 338.(f) Computation of amortization de-

duction.(1) In general.(2) Treatment of contingent

amounts.(i) Amounts added to basis dur-

ing 15-year period.(ii) Amounts becoming fixed af-

ter expiration of 15-year period.(iii) Time for including amounts

in basis.(3) Determination of amounts

chargeable to capital account in certaincases.

(i) Covenants not to compete,rights granted by governmental units,and contracts for the use of section 197intangibles.

(A) In general.(B) Time for taking amounts

into account.(ii) Franchises, trademarks, or

trade names and licenses, permits, andother rights granted by governmentalunits.

(iii) Certain reinsurance transac-tions.

(4) Transactions subject to section338 or 1060.(g) Special rules.(1) Treatment of certain disposi-

tions.(i) Loss disallowance rules.(A) In general.(B) Certain nonrecognition

transfers.(ii) Separately acquired property.(iii) Disposition of a covenant

not to compete.(iv) Taxpayers under common

control.(A) In general.(B) Treatment of disallowed

loss.(2) Treatment of certain nonrecog-

nition and exchange transactions.(i) In general.(A) Transfer disregarded.(B) Application of general

rule.(ii) Transactions covered.(iii) Certain exchanged-basis

property.

17

(iv) Transfers under section708(b)(1).

(A) In general.(B) Termination by sale or ex-

change of interest.(C) Other terminations.(D) Anti-churning rules.

(v) Distributions to which sec-tion 732(d) applies.

(vi) Curative and remedial allo-cations under section 704(c).

(3) Application of section 754 toacquisitions of an interest in an intan-gible held through a partnership.

(4) Treatment of certain reinsur-ance transactions.

(i) In general.(ii) Determination of adjusted

basis.(A) Acquisitions (other than

under section 338) of specified insur-ance contracts.

(B) Other acquisitions. [Re-served]

(5) Amounts paid or incurred for afranchise, trademark, or trade name.

(6) Amounts properly taken intoaccount in determining the cost of prop-erty that is not a section 197 intangible.

(7) Treatment of amortizable sec-tion 197 intangibles as depreciable prop-erty.

(i) In general.(ii) Exceptions and limitations.(A) Unstated interest and

original issue discount rules.(B) Treatment of other parties

to transaction.(h) Anti-churning rules.(1) Conversions of existing good-

will, going concern value, and certainother section 197 intangibles.

(2) Amounts deductible under sec-tion 1253(d).

(3) Transition period.(4) Exceptions.(5) Special partnership provisions.(i) Basis increases.(ii) Curative and remedial allo-

cations under section 704(c).(6) Related person.(i) In general.(ii) Time for testing relation-

ships.(iii) De minimis rule.(A) In general.(B) Determination of benefi-

cial ownership interest.(7) Special rules for entities that

owned or used property at any timeduring the transition period and that areno longer in existence.

(8) Special rules for section 338deemed acquisitions.

(9) Exception to anti-churningrules where gain is recognized.

(i) In general.(ii) Manner of making election.

[Reserved](iii) Determination of highest

marginal rate of tax.(A) Noncorporate taxpayers.(B) Corporations and tax-

exempt entities.(iv) Special rule for pass-through

entities.(v) Coordination with other pro-

visions.(A) In general.(B) Section 1374.(C) Procedural and adminis-

trative provisions.(D) Installment method.

(10) Transactions subject to bothanti-churning and nonrecognition rules.

(11) Anti-churning anti-abuse rule.(i) [Reserved].(j) General anti-abuse rule.(k) Examples.(l) Effective dates.

Par. 6. Section 1.197–2 is added toread as follows:

§ 1.197–2 Amortization of goodwill andcertain other intangibles.

(a) Overview—(1) In general. Section197 allows an amortization deductionfor the capitalized costs of anamortiz-able section 197 intangibleand prohibitsany other depreciation or amortizationwith respect to that property. Paragraphs(b), (c), and (e) of this section providerules and definitions for determiningwhether property is a section 197 intan-gible, and paragraphs (d) and (e) of thissection provide rules and definitions fordetermining whether asection 197 in-tangible is an amortizable section 197intangible. The amortization deductionunder section 197 is determined byamortizing adjusted basis ratably over a15-year period under the rules of para-graph (f) of this section. Section 197also includes various special rules per-taining to the disposition of amortizablesection 197 intangibles, nonrecognitiontransactions, anti-churning rules, andanti-abuse rules. Rules relating to theseprovisions are contained in paragraphs(g), (h), and (j) of this section. Ex-amples demonstrating the application ofthese provisions are contained in para-graph (k) of this section. The effectivedate of the rules in this section iscontained in paragraph (l) of this sec-tion.

(2) Section 167(f) property. Section167(f) prescribes rules for computingthe depreciation deduction for certainproperty to which section 197 does notapply. See § 1.167(a)–14 for rules undersection 167(f) and paragraphs (c)(4), (6),(7), (11), and (13) of this section for adescription of the property subject tosection 167(f).(3) Amounts otherwise deductible.

Except as otherwise provided in section197(f)(3) and paragraphs (b)(11) and(f)(3) of this section, section 197 doesnot apply to amounts that would becurrently deductible without regard tosection 197.(4) Relationship to other Internal

Revenue Code provisions. Section 197does not apply to any amount paid orincurred for a section 197 intangible if adeduction for the amount would bedisallowed under any provision of theInternal Revenue Code other than sec-tion 263. (See, for example, section162(k).)(b) Section 197 intangibles; in gen-

eral. Except as otherwise provided inparagraph (c) of this section, the termsection 197 intangiblemeans any prop-erty described in section 197(d)(1). Thefollowing rules and definitions provideguidance concerning property that is asection 197 intangible unless an excep-tion applies:(1) Goodwill. Section 197 intangibles

include goodwill. Goodwill is the valueof a trade or business attributable to theexpectancy of continued customer pa-tronage. This expectancy may be due tothe name or reputation of a trade orbusiness or any other factor.(2) Going concern value. Section 197

intangibles include going concern value.Going concern value is the additionalvalue that attaches to property by reasonof its existence as an integral part of anongoing business activity. Going con-cern value includes the value attribut-able to the ability of a trade or business(or a part of a trade or business) tocontinue functioning or generating in-come without interruption notwithstand-ing a change in ownership, but does notinclude any of the intangibles describedin any other provision of this paragraph(b). It also includes the value that isattributable to the immediate use oravailability of an acquired trade or busi-ness, such as, for example, the use ofthe revenues or net earnings that other-wise would not be received during anyperiod if the acquired trade or businesswere not available or operational.

18

(3) Workforce in place. Section 197intangibles include workforce in place.Workforce in place (sometimes referredto as agency force or assembledworkforce) includes the composition ofa workforce (for example, the experi-ence, education, or training of aworkforce), the terms and conditions ofemployment whether contractual or oth-erwise, and any other value placed onemployees or any of their attributes.Thus, the amount paid or incurred forworkforce in place includes, for ex-ample, any portion of the purchase priceof an acquired trade or business attribut-able to the existence of a highly-skilledworkforce, an existing employment con-tract (or contracts), or a relationshipwith employees or consultants (includ-ing, but not limited to, any key em-ployee contract or relationship).Workforce in place does not include anycovenant not to compete or other similararrangement described in paragraph(b)(9) of this section.(4) Information base. Section 197 in-

tangibles include business books andrecords, operating systems, and anyother information base, including lists orother information of current or prospec-tive customers (regardless of the methodof recording the information). Thus, theamount paid or incurred for these itemsincludes, for example, any portion of thepurchase price of an acquired trade orbusiness attributable to the intangiblevalue of technical manuals, trainingmanuals or programs, data files, andaccounting or inventory control systems.Other examples include the cost ofacquiring customer lists, subscriptionlists, insurance expirations, patient orclient files, or lists of newspaper, maga-zine, radio, or television advertisers.(5) Know-how, etc. Section 197 intan-gibles include any patent, copyright,formula, process, design, pattern, know-how, format, package design, computersoftware (as defined in paragraph (c)(4)of this section), or interest in a film,sound recording, video tape, book, orother similar property. (See, however,the exceptions in paragraph (c) of thissection.)(6) Customer-based intangibles. Sec-

tion 197 intangibles include anycustomer-based intangible. A customer-based intangible is any composition ofmarket, market share, or other valueresulting from the future provision ofgoods or services pursuant to contractualor other relationships in the ordinarycourse of business with customers.Thus, the amount paid or incurred for

customer-based intangibles includes, forexample, any portion of the purchaseprice of an acquired trade or businessattributable to the existence of a cus-tomer base, a circulation base, an unde-veloped market or market growth, insur-ance in force, the existence of aqualification to supply goods or servicesto a particular customer, a mortgageservicing contract (as defined in para-graph (c)(11) of this section), an invest-ment management contract, or other re-lationship with customers involving thefuture provision of goods or services.(See, however, the exceptions in para-graph (c) of this section.) In addition,customer-based intangibles include thedeposit base and any similar asset of afinancial institution. Thus, the amountpaid or incurred for customer-based in-tangibles also includes any portion ofthe purchase price of an acquired finan-cial institution attributable to the valuerepresented by existing checking ac-counts, savings accounts, escrow ac-counts, and other similar items of thefinancial institution. However, any por-tion of the purchase price of an acquiredtrade or business attributable to accountsreceivable or other similar rights toincome for goods or services providedto customers prior to the acquisition of atrade or business is not an amount paidor incurred for a customer-based intan-gible.(7) Supplier-based intangibles. Sec-

tion 197 intangibles include anysupplier-based intangible. A supplier-based intangible is the value resultingfrom the future acquisition, pursuant tocontractual or other relationships withsuppliers in the ordinary course of busi-ness, of goods or services that will besold or used by the taxpayer. Thus, theamount paid or incurred for supplier-based intangibles includes, for example,any portion of the purchase price of anacquired trade or business attributable tothe existence of a favorable relationshipwith persons providing distribution ser-vices (such as favorable shelf or displayspace at a retail outlet), the existence ofa favorable credit rating, or the exist-ence of favorable supply contracts. Theamount paid or incurred for supplier-based intangibles does not include anyamount required to be paid for thegoods or services themselves pursuant tothe terms of the agreement or otherrelationship. In addition, see the excep-tions in paragraph (c) of this section,including the exception in paragraph(c)(6) of this section for certain rights to

receive tangible property or servicesfrom another person.(8) Licenses, permits, and other

rights granted by governmental units.Section 197 intangibles include any li-cense, permit, or other right granted bya governmental unit (including, for pur-poses of section 197, an agency orinstrumentality thereof) even if the rightis granted for an indefinite period or isreasonably expected to be renewed foran indefinite period. These rights in-clude, for example, a liquor license, ataxi-cab medallion (or license), an air-port landing or takeoff right (sometimesreferred to as a slot), a regulated airlineroute, or a television or radio broadcast-ing license. The issuance or renewal ofa license, permit, or other right grantedby a governmental unit is considered anacquisition of the license, permit, orother right. (See, however, the excep-tions in paragraph (c) of this section,including the exceptions in paragraph(c)(3) of this section for an interest inland, in paragraph (c)(8) of this sectionfor an interest under a lease of tangibleproperty, and in paragraphs (c)(6) and(13) of this section for certain rightsgranted by a governmental unit. Seeparagraph (b)(10) of this section for thetreatment of franchises.)(9) Covenants not to compete and

other similar arrangements. Section 197intangibles include any covenant not tocompete, or agreement having substan-tially the same effect, entered into inconnection with the direct or indirectacquisition of an interest in a trade orbusiness or a substantial portion thereof.For purposes of this paragraph (b)(9), anacquisition may be made in the form ofan asset acquisition (including a quali-fied stock purchase that is treated as apurchase of assets under section 338), astock acquisition or redemption, and theacquisition or redemption of a partner-ship interest. An agreement requiring theperformance of services or the provisionof property or the use of property (otherthan property of the acquired trade orbusiness) does not have substantially thesame effect as a covenant not to com-pete to the extent that the amount paidunder the agreement represents reason-able compensation for the services actu-ally rendered or for the property or useof the property actually provided.(10) Franchises, trademarks, and

trade names. (i) Section 197 intangiblesinclude any franchise, trademark, ortrade name. The termfranchiseincludesany agreement that provides one of theparties to the agreement with the right

19

to distribute, sell, or provide goods,services, or facilities, within a specifiedarea. (See section 1253(b)(1).) The termincludes distributorships or other similarcontractual arrangements pursuant towhich the transferee is permitted orlicensed to operate or conduct a trade orbusiness within a specific area. The termtrademark includes any word, name,symbol, or device, or any combinationthereof, adopted and used by a manufac-turer or merchant to identify goods orservices and distinguish them from thosemanufactured or sold by others. Theterm trade name includes any nameused by a manufacturer or merchant toidentify or designate a particular tradeor business or the name or title used bya person or organization engaged in atrade or business. A license, permit, orother right granted by a governmentalunit is a franchise if it otherwise meetsthe definition of a franchise. A trade-mark or trade name includes any trade-mark or trade name arising under statuteor applicable common law, and anysimilar right granted by contract. Therenewal of a franchise, trademark, ortrade name is treated as an acquisitionof the franchise, trademark, or tradename.(ii) Notwithstanding the definitions

provided in paragraph (b)(10)(i) of thissection, any amount that is paid orincurred on account of a transfer, sale,or other disposition of a franchise, trade-mark, or trade name and that is subjectto section 1253(d)(1) is not included inthe basis of a section 197 intangible.(See paragraph (g)(5) of this section.)(11) Contracts for the use of, and

term interests in, other section 197intangibles. Section 197 intangibles in-clude any right under a license, contract,or other arrangement providing for theuse of property that would be a section197 intangible under any provision ofthis paragraph (b) (including this para-graph (b)(11)) after giving effect to allof the exceptions provided in paragraph(c) of this section. Section 197 intan-gibles also include any term interest(whether outright or in trust) in suchproperty.(12) Other similar items. Section 197

intangibles include any other intangibleproperty that is similar in all materialrespects to the property specifically de-scribed in section 197(d)(1)(C) andparagraphs (b)(3) through (7) of thissection. (See paragraph (g)(4) of thissection for special rules regarding cer-tain reinsurance transactions.)

(c) Section 197 intangibles; excep-tions. The term section 197 intangibledoes not include property described insection 197(e). The following rules anddefinitions provide guidance concerningproperty to which the exceptions apply:(1) Interests in a corporation, part-

nership, trust, or estate. Section 197intangibles do not include an interest ina corporation, partnership, trust, or es-tate. Thus, for example, amortizationunder section 197 is not available forthe cost of acquiring stock, partnershipinterests, or interests in a trust or estate,whether or not the interests are regularlytraded on an established market. (Seeparagraph (g)(3) of this section for spe-cial rules applicable to property of apartnership when a section 754 electionis in effect for the partnership.)(2) Interests under certain financial

contracts. Section 197 intangibles do notinclude an interest under an existingfutures contract, foreign currency con-tract, notional principal contract, interestrate swap, or other similar financialcontract, whether or not the interest isregularly traded on an established mar-ket. However, this exception does notapply to an interest under a mortgageservicing contract, credit card servicingcontract, or other contract to serviceanother person’s indebtedness, or aninterest under an assumption reinsurancecontract. (See paragraph (g)(4) of thissection for the treatment of assumptionreinsurance contracts. See paragraph(c)(11) of this section and § 1.167(a)–14(d) for the treatment of mortgageservicing rights.)(3) Interests in land. Section 197 in-

tangibles do not include any interest inland. For this purpose, an interest inland includes a fee interest, life estate,remainder, easement, mineral right, tim-ber right, grazing right, riparian right,air right, zoning variance, and any othersimilar right, such as a farm allotment,quota for farm commodities, or cropacreage base. An interest in land doesnot include an airport landing or takeoffright, a regulated airline route, or afranchise to provide cable televisionservice. The cost of acquiring a license,permit, or other land improvement right,such as a building construction or usepermit, is taken into account in the samemanner as the underlying improvement.(4) Certain computer software—(i) In

general. Section 197 intangibles do notinclude any interest in computer soft-ware that is (or has been) readily avail-able to the general public on similarterms, is subject to a nonexclusive li-

cense, and has not been substantiallymodified for the user. Computer soft-ware will not be considered to havebeen substantially modified if its costdoes not exceed the greater of 125percent of the price at which the un-modified version of the software isreadily available to the general public or$2,000. For the purpose of determiningwhether computer software has beensubstantially modified—(A) Integrated programs acquired in a

package from a single source are treatedas a single computer program; and(B) Any cost incurred to install the

computer software is not treated as acost of the software.(ii) Separately acquired software.

Section 197 intangibles do not includean interest in computer software that isnot acquired as part of a purchase of atrade or business within the meaning ofparagraph (e) of this section.(iii) Other exceptions. Neither section

197 nor section 167(f) apply in thefollowing cases:(A) Any amount of the cost of an

interest in computer software that isincluded, without being separatelystated, in the cost of the hardware orother tangible property will be treated aspart of the cost of the hardware or othertangible property.(B) Any amount of the cost of an

interest in computer software that wouldbe deductible under any provision otherthan section 167(f) or 197 may bededucted and is not required to becapitalized.(iv) Computer software defined. For

purposes of this section, computer soft-ware is any program or routine (that is,any sequence of machine-readable code)that is designed to cause a computer (asdefined in section 168(i)(2)(B)(ii)) toperform a desired function or set offunctions, and the documentation re-quired to describe and maintain thoseprograms. It includes all forms andmedia in which the software is con-tained, whether written, magnetic, orotherwise. Computer programs of allclasses, for example, operating systems,executive systems, monitors, compilersand translators, assembly routines, andutility programs as well as applicationprograms, are included. Computer soft-ware also includes any incidental andancillary rights that are necessary toeffect the acquisition of the title to, theownership of, or the right to use thecomputer software, and that are usedonly in connection with that specificcomputer software. Such incidental and

20

ancillary rights are not included in thedefinition of trademark or trade nameunder paragraph (b)(10)(i) of this sec-tion. For example, a trademark or tradename that is ancillary to the ownershipor use of a specific computer softwareprogram in the taxpayer’s trade or busi-ness and is not acquired for the purposeof marketing the computer software isincluded in the definition of computersoftware and is not included in thedefinition of trademark or trade name.Computer software does not include anydata or information base described inparagraph (b)(4) of this section unlessthe data base or item is in the publicdomain and is incidental to a computerprogram. For this purpose, a copyrightedor proprietary data or information baseis treated as in the public domain if itsavailability through the computer pro-gram does not contribute significantly tothe cost of the program. For example, ifa word-processing program includes adictionary feature used to spell-check adocument or any portion thereof, theentire program (including the dictionaryfeature) is computer software regardlessof the form in which the feature ismaintained or stored.(v) Readily available to the general

public. Computer software will betreated as readily available to the gen-eral public if the software may beobtained on substantially the same termsby a significant number of persons thatwould reasonably be expected to use thesoftware. The requirements of this para-graph (c)(4)(v) can be met even thoughthe software is not available through asystem of retail distribution.(5) Certain interests in films, sound

recordings, video tapes, books, or othersimilar property. Section 197 intangiblesdo not include any interest (including aninterest as a licensee) in a film, soundrecording, video tape, book, or othersimilar property (such as the right tobroadcast or transmit a live event) if theinterest is not acquired as part of apurchase of a trade or business. A film,sound recording, video tape, book, orother similar property includes any inci-dental and ancillary rights (such as atrademark or trade name) that are neces-sary to effect the acquisition of title to,the ownership of, or the right to use theproperty and are used only in connec-tion with that property. Such incidentaland ancillary rights are not included inthe definition of trademark or tradename under paragraph (b)(10)(i) of thissection. For purposes of this paragraph(c)(5), computer software (as defined in

paragraph (c)(4)(iv) of this section) isnot treated as other property similar to afilm, sound recording, video tape, orbook. (See section 167 for amortizationof excluded intangible property or inter-ests.)(6) Certain rights to receive tangible

property or services. Section 197 intan-gibles do not include any right to re-ceive tangible property or services undera contract or from a governmental unitif the right is not acquired as part of apurchase of a trade or business. Anyright that is described in the precedingsentence is not treated as a section 197intangible even though the right is alsodescribed in section 197(d)(1)(D) andparagraph (b)(8) of this section (relatingto certain governmental licenses, per-mits, and other rights) and even thoughthe right fails to meet one or more ofthe requirements of paragraph (c)(13) ofthis section (relating to certain rights offixed duration or amount). (See§ 1.167(a)–14(c)(1) and (3) for appli-cable rules.)(7) Certain interests in patents or

copyrights. Section 197 intangibles donot include any interest (including aninterest as a licensee) in a patent, patentapplication, or copyright that is notacquired as part of a purchase of a tradeor business. (See § 1.167(a)–14(c)(4)for applicable rules.)(8) Interests under leases of tangible

property—(i) Interest as a lessor. Sec-tion 197 intangibles do not include anyinterest as a lessor under an existinglease or sublease of tangible real orpersonal property. In addition, the costof acquiring an interest as a lessor inconnection with the acquisition of tan-gible property is taken into account aspart of the cost of the tangible property.For example, if a taxpayer acquires ashopping center that is leased to tenantsoperating retail stores, any portion of thepurchase price attributable to favorablelease terms is taken into account as partof the basis of the shopping center andin determining the depreciation deduc-tion allowed with respect to the shop-ping center. (See section 167(c)(2).)(ii) Interest as a lessee. Section 197

intangibles do not include any interestas a lessee under an existing lease oftangible real or personal property. Forthis purpose, an airline lease of anairport passenger or cargo gate is a leaseof tangible property. The cost of acquir-ing such an interest is taken into ac-count under section 178 and § 1.162–11(a). If an interest as a lessee under alease of tangible property is acquired in

a transaction with any other intangibleproperty, a portion of the total purchaseprice may be allocable to the interest asa lessee based on all of the relevantfacts and circumstances.(9) Interests under indebtedness—(i)

In general. Section 197 intangibles donot include any interest (whether as acreditor or debtor) under an indebted-ness in existence when the interest wasacquired. Thus, for example, the valueattributable to the assumption of anindebtedness with a below-market inter-est rate is not amortizable under section197. In addition, the premium paid foracquiring a debt instrument with anabove-market interest rate is not amor-tizable under section 197. See section171 for rules concerning the treatmentof amortizable bond premium.(ii) Exceptions. For purposes of this

paragraph (c)(9), an interest under anexisting indebtedness does not includethe deposit base (and other similaritems) of a financial institution. Aninterest under an existing indebtednessincludes mortgage servicing rights, how-ever, to the extent the rights are strippedcoupons under section 1286.(10) Professional sports franchises.

Section 197 intangibles do not includeany franchise to engage in professionalbaseball, basketball, football, or anyother professional sport, and any item(even though otherwise qualifying as asection 197 intangible) acquired in con-nection with such a franchise.(11) Mortgage servicing rights. Sec-

tion 197 intangibles do not include anyright described in section 197(e)(7)(concerning rights to service indebted-ness secured by residential real propertythat are not acquired as part of apurchase of a trade or business). (See§ 1.167(a)–14(d) for applicable rules.)(12) Certain transaction costs. Sec-

tion 197 intangibles do not include anyfees for professional services and anytransaction costs incurred by parties to atransaction in which all or any portionof the gain or loss is not recognizedunder part III of subchapter C of theInternal Revnue Code.(13) Rights of fixed duration or

amount. (i) Section 197 intangibles donot include any right under a contract orany license, permit, or other rightgranted by a governmental unit if theright—(A) Is acquired in the ordinary course

of business and not as part of a pur-chase of a trade or business;

21

(B) Is not described in sections197(d)(1)(A), (B), (C)(ii), (iv), or (vi),(E), or (F); and(C) Either—(1) Has a fixed duration of less than

15 years; or(2) Is fixed as to amount and the

adjusted basis thereof is properly recov-erable (without regard to this section)under a method similar to the unit-of-production method.(ii) See § 1.167(a)–14(c)(2) and (3)

for applicable rules.(d) Amortizable section 197 intan-

gibles—(1) Definition. Except as other-wise provided in this paragraph (d), theterm amortizable section 197 intangiblemeans any section 197 intangible ac-quired after August 10, 1993 (or afterJuly 25, 1991, if a valid retroactiveelection under § 1.197–1T has beenmade), and held in connection with theconduct of a trade or business or anactivity described in section 212.(2) Exception for self-created intan-

gibles—(i) In general. Except as pro-vided in paragraph (d)(2)(iii) of thissection, amortizable section 197 intan-gibles do not include any section 197intangible created by the taxpayer (aself-created intangible).(ii) Created by the taxpayer—(A) De-

fined. A section 197 intangible is createdby the taxpayer to the extent the tax-payer makes payments or otherwise in-curs costs for its creation, production,development, or improvement, whetherthe actual work is performed by thetaxpayer or by another person under acontract with the taxpayer entered intobefore the creation, production, develop-ment, or improvement occurs. For ex-ample, a technological process devel-oped specifically for a taxpayer underan arrangement with another person pur-suant to which the taxpayer retains allrights to the process is created by thetaxpayer.(B) Contracts for the use of intan-

gibles. A section 197 intangible is notcreated by the taxpayer to the extentthat it results from the entry into (orrenewal of) a contract for the use of anexisting section 197 intangible. Thus,for example, the exception for self-created intangibles does not apply tolegal and other professional fees in-curred by a licensee in connection withthe entry into (or renewal of) a contractfor the use of know-how or similarproperty.(C) Improvements and modifications.

If an existing section 197 intangible isimproved or otherwise modified by the

taxpayer or by another person under acontract with the taxpayer, the existingintangible and the improvements orother modifications are treated as sepa-rate section 197 intangibles for purposesof this paragraph (d).(iii) Exceptions. (A) The exception

for self-created intangibles does not ap-ply to any section 197 intangible de-scribed in section 197(d)(1)(D) (relatingto licenses, permits or other rightsgranted by a governmental unit),197(d)(1)(E) (relating to covenants notto compete), or 197(d)(1)(F) (relating tofranchises, trademarks, and tradenames). Thus, for example, capitalizedcosts incurred in the development, regis-tration, or defense of a trademark ortrade name do not qualify for the excep-tion and are amortized over 15 yearsunder section 197.(B) The exception for self-created in-

tangibles does not apply to any section197 intangible created in connectionwith the purchase of a trade or business(as defined in paragraph (e) of thissection).(C) If a taxpayer disposes of a self-

created intangible and subsequently re-acquires the intangible in an acquisitiondescribed in paragraph (h)(4)(ii) of thissection, the exception for self-createdintangibles does not apply to the reac-quired intangible.(3) Exception for property subject to

anti-churning rules. Amortizable section197 intangibles do not include any prop-erty to which the anti-churning rules ofsection 197(f)(9) and paragraph (h) ofthis section apply.(e) Purchase of a trade or business.

Several of the exceptions in section 197apply only to property that is not ac-quired in (or created in connection with)a transaction or series of related transac-tions involving the acquisition of assetsconstituting a trade or business or asubstantial portion thereof. Property ac-quired in (or created in connection with)such a transaction or series of relatedtransactions is referred to in this sectionas property acquired as part of (orcreated in connection with) a purchaseof a trade or business. For purposes ofsection 197 and this section, the applica-bility of the limitation is determinedunder the following rules:(1) Goodwill or going concern value.

A group of assets constitutes a trade orbusiness or a substantial portion thereofif their use would constitute a trade orbusiness under section 1060 (that is, ifgoodwill or going concern value couldunder any circumstances attach to the

assets). See § 1.1060–1T(b)(2). For thispurpose, all the facts and circumstances,including any employee relationshipsthat continue (or covenants not to com-pete that are entered into) as part of thetransfer of the assets, are taken intoaccount in determining whether good-will or going concern value could attachto the assets.(2) Customer-based intangibles.

Whether or not a group of assets isotherwise described in paragraph (e)(1)of this section, a group of assets consti-tutes a trade or business or a substantialportion thereof if the assets include anycustomer-based intangibles (as definedin paragraph (b)(6) of this section) orare acquired in a transaction or series ofrelated transactions that involve the cre-ation of any customer-based intangibles.(3) Franchise, trademark, or trade

name—(i) In general. The acquisition ofa franchise, trademark, or trade nameconstitutes the acquisition of a trade orbusiness or a substantial portion thereof.(ii) Exceptions. For purposes of this

paragraph (e)(3)—(A) A trademark or trade name is

disregarded if it is included in computersoftware under paragraph (c)(4) of thissection or in an interest in a film, soundrecording, video tape, book, or othersimilar property under paragraph (c)(5)of this section; and(B) A franchise, trademark, or trade

name is disregarded if its value isnominal or the taxpayer irrevocably dis-poses of it immediately after its acquisi-tion.(4) Acquisitions to be included. The

assets acquired in a transaction (or se-ries of related transactions) include onlyassets (including a beneficial or otherindirect interest in assets where theinterest is of a type described in para-graph (c)(1) of this section) acquired bythe taxpayer and persons related to thetaxpayer from another person and per-sons related to that other person. Forpurposes of this paragraph (e)(4), per-sons are related only if their relationshipis described in section 267(b) or 707(b)or they are engaged in trades or busi-nesses under common control within themeaning of section 41(f)(1).(5) Substantial portion. The determi-

nation of whether acquired assets consti-tute a substantial portion of a trade orbusiness is to be based on all of thefacts and circumstances, including thenature and the amount of the assetsacquired as well as the nature andamount of the assets retained by thetransferor. The value of the assets ac-

22

quired relative to the value of the assetsretained by the transferor is not determi-native of whether the acquired assetsconstitute a substantial portion of a tradeor business.(6) Deemed asset purchases under

section 338. A qualified stock purchasethat is treated as a purchase of assetsunder section 338 shall be treated as atransaction involving the acquisition ofassets constituting a trade or businessonly if the direct acquisition of theassets of the corporation would havebeen treated as the acquisition of assetsconstituting a trade or business.(f) Computation of amortization de-

duction—(1) In general. Except as pro-vided in paragraph (f)(2) of this section,the amortization deduction allowable un-der section 197(a) is computed as fol-lows:(i) The adjusted basis (for purposes

of determining gain) of an amortizablesection 197 intangible is amortized rat-ably over the 15-year period beginningon the later of—(A) The first day of the month in

which the property is acquired; or(B) In the case of property held in

connection with the conduct of a tradeor business, the first day of the month inwhich the active conduct of the trade orbusiness begins.(ii) Except as otherwise provided in

this section, adjusted basis is determinedunder section 1011 and salvage value isdisregarded.(iii) Property is not eligible for amor-

tization in the month of disposition.(iv) The amortization deduction for a

short taxable year is based on the num-ber of months in the short taxable year.(2) Treatment of contingent amounts

—(i) Amounts added to basis during15-year period. Any amount that isproperly included in the basis of anamortizable section 197 intangible afterthe first month of the 15-year perioddescribed in paragraph (f)(1)(i) of thissection and before the expiration of thisperiod is amortized ratably over theremainder of the 15-year period. For thispurpose, the remainder of the 15-yearperiod begins on the first day of themonth in which the basis increase oc-curs. Any reasonable convention may beused to determine the month in whichthe basis increase incurs, provided thatthe method selected is used consistentlyfor all amortizable section 197 intan-gibles acquired in the same transaction(or series of related transactions) andthat it does not result in any amountbeing added to basis earlier than the

midpoint of the period (for example,annual, semi-annual, or quarterly) se-lected.(ii) Amounts becoming fixed after ex-

piration of 15-year period. Any amountthat is not properly included in the basisof an amortizable section 197 intangibleuntil after the expiration of the 15-yearperiod described in paragraph (f)(1)(i) ofthis section is amortized in full immedi-ately upon the inclusion of the amountin the basis of the intangible.(iii) Time for including amounts in

basis. See § 1.461–1(a)(1) for rulesgoverning the time at which an amountmay be taken into account by a taxpayerusing the cash receipts and disburse-ments method, and § 1.461–1(a)(2) forrules governing the time at which aliability is incurred and generally takeninto account (for example, by treatingthe amount of the liability as a capitalexpenditure) by an accrual basis tax-payer.(3) Determination of amounts charge-

able to capital account in certaincases—(i) Covenants not to compete,rights granted by governmental units,and contracts for the use of section 197intangibles—(A) In general. In the caseof a covenant not to compete or othersimilar arrangement described in para-graph (b)(9) of this section, any license,permit, or other right granted by agovernmental unit or an agency or in-strumentality thereof described in para-graph (b)(8) of this section, or a contractfor the use of a section 197 intangibledescribed in paragraph (b)(11) of thissection, the amount chargeable to capitalaccount includes all amounts required tobe paid pursuant to the agreement orright, whether or not any amount wouldbe deductible under section 162 if theagreement or right were not a section197 intangible.(B) Time for taking amounts into ac-

count. For purposes of this paragraph(f)(3), in applying the provisions of§§ 1.461–1(a)(1) (in the case of a tax-payer using the cash receipts and dis-bursements method of accounting) and§ 1.461–1(a)(2) (in the case of a tax-payer using an accrual method of ac-counting), all amounts required to bepaid under an agreement described inparagraph (b)(9) or (11) of this sectionshall be treated as amounts payableunder the terms of a debt instrumentissued in exchange for property. Contin-gent payments made under an agreementdescribed in paragraph (b)(9) or (11) of

this section will be included in adjustedbasis under the rules of paragraph (f)(2)of this section.(ii) Franchises, trademarks, or trade

names and licenses, permits, and otherrights granted by governmental units.The costs paid or incurred for therenewal of a franchise, trademark, ortrade name or any license, permit, orother right granted by a governmentalunit or an agency or instrumentalitythereof are amortized over the 15-yearperiod that begins with the month ofrenewal. Any costs paid or incurred forthe issuance, or earlier renewal, continueto be taken into account over the re-maining portion of the amortization pe-riod that began at the time of theissuance, or earlier renewal. Any amountpaid or incurred for the protection, ex-pansion, or defense of a trademark ortrade name and chargeable to capitalaccount is treated as an amount paid orincurred for a renewal.(iii) Certain reinsurance transactions.

See paragraph (g)(4)(ii) of this sectionfor special rules regarding the adjustedbasis of an insurance contract acquiredthrough an assumption reinsurancetransaction.(4) Transactions subject to section

338 or 1060. In the case of a section197 intangible deemed to have beenacquired as the result of a qualifiedstock purchase within the meaning ofsection 338(d)(3), the basis shall bedetermined pursuant to section 338(b)(5)and the regulations thereunder. In thecase of a section 197 intangible acquiredin an applicable asset acquisition withinthe meaning of section 1060(c), thebasis shall be determined pursuant tosection 1060(a) and the regulationsthereunder.(g) Special rules—(1) Treatment of

certain dispositions—(i) Loss disallow-ance rules—(A) In general. No loss isrecognized on the disposition of anamortizable section 197 intangible ac-quired in a transaction or series ofrelated transactions in which the tax-payer acquired other amortizable section197 intangibles if, after the disposition,the taxpayer retains any of the otheramortizable section 197 intangibles, orthe right to use, or an interest in, any ofthe other amortizable section 197 intan-gibles (the retained intangibles). Exceptas otherwise provided in paragraph(g)(1)(iv)(B) of this section, the adjustedbasis of each of the retained intangiblesis increased by the product of the lossthat is not recognized solely by reasonof this rule and a fraction, the numerator

23

of which is the adjusted basis of theretained intangible on the date of thedisposition and the denominator ofwhich is the total adjusted bases of allthe retained intangibles on that date. Theabandonment of an amortizable section197 intangible, or any other event ren-dering an amortizable section 197 intan-gible worthless, is treated as a disposi-tion of the intangible for purposes ofthis paragraph (g)(1), and the abandonedor worthless intangible is disregarded(that is, it is not treated as a retainedintangible) for purposes of applying thisparagraph (g)(1) to the subsequent dis-position of any other amortizable section197 intangible.(B) Certain nonrecognition transfers.

The loss disallowance rule in paragraph(g)(1)(i)(A) of this section also applieswhen a taxpayer transfers an amortiz-able section 197 intangible from anacquired trade or business in a transac-tion in which the intangible istransferred-basis property and, after thetransfer, retains other amortizable sec-tion 197 intangibles from the trade orbusiness. Thus, for example, the transferof an amortizable section 197 intangibleto a corporation in exchange for stock inthe corporation in a transaction de-scribed in section 351, or to a partner-ship in exchange for an interest in thepartnership in a transaction described insection 721, when other amortizablesection 197 intangibles acquired in thesame transaction are retained, followedby a sale of the stock or partnershipinterest received, will not avoid theapplication of the loss disallowance pro-vision to the extent the adjusted basis ofthe transferred intangible at the time ofthe sale exceeds its fair market value atthat time.(ii) Separately acquired property.

Paragraph (g)(1)(i) of this section doesnot apply to an amortizable section 197intangible that is not acquired in atransaction or series of related transac-tions in which the taxpayer acquiresother amortizable section 197 intan-gibles (a separately acquired intangible).Consequently, a loss may be recognizedupon the disposition of a separatelyacquired section 197 intangible. How-ever, the termination or worthlessness ofonly a portion of an amortizable section197 intangible is not the disposition of aseparately acquired intangible. For ex-ample, neither the loss of several cus-tomers from an acquired customer list,the termination of several mortgages(not qualifying for the exception setforth in paragraph (c)(11) of this sec-

tion) from an acquired mortgage pool,nor the worthlessness of only someinformation from an acquired data baseconstitutes the disposition of a sepa-rately acquired intangible.(iii) Disposition of a covenant not to

compete. If a covenant not to competeor any other arrangement having sub-stantially the same effect is entered intoin connection with the direct or indirectacquisition of an interest in a trade orbusiness, the disposition or worthless-ness of the covenant or other arrange-ment will not be considered to occuruntil the disposition or worthlessness ofall interests in that trade or business. Forexample, a covenant not to competeentered into in connection with thepurchase of stock continues to be amor-tized on a 15-year straight-line basis(even after the covenant expires or be-comes worthless) unless all the trades orbusinesses in which an interest wasacquired through the stock purchase (orall the purchaser’s interests in thosetrades or businesses) also are disposedof or become worthless.(iv) Taxpayers under common con-

trol—(A) In general. Except as providedin paragraph (g)(1)(iv)(B) of this sec-tion, all persons that would be treated asa single taxpayer under section 41(f)(1)are treated as a single taxpayer underthis paragraph (g)(1). Thus, for example,a loss is not recognized on the disposi-tion of an amortizable section 197 intan-gible by a member of a controlled groupof corporations (as defined in section41(f)(5)) if, after the disposition, anothermember retains other amortizable sec-tion 197 intangibles acquired in thesame transaction as the amortizable sec-tion 197 intangible that has been dis-posed of.(B) Treatment of disallowed loss. If

retained intangibles are held by a personother than the person incurring the disal-lowed loss, only the adjusted basis ofintangibles retained by the person incur-ring the disallowed loss is increased,and only the adjusted basis of thoseintangibles is included in the denomina-tor of the fraction described in para-graph (g)(1)(i)(A) of this section. Ifnone of the retained intangibles are heldby the person incurring the disallowedloss, the loss is allowed ratably, as adeduction under section 197, over theremainder of the period during whichthe intangible giving rise to the losswould have been amortizable, exceptthat any remaining disallowed loss isallowed in full on the first date on

which all other retained intangibles havebeen disposed of or become worthless.(2) Treatment of certain nonrecogni-

tion and exchange transactions—(i) Ingeneral—(A) Transfer disregarded. Ex-cept as otherwise provided in paragraph(h) of this section, if a section 197intangible is transferred in a transactiondescribed in paragraph (g)(2)(ii) of thissection, the transfer is disregarded indetermining—(1) Whether, with respect to so much

of the intangible’s basis in the hands ofthe transferee as does not exceed itsbasis in the hands of the transferor, theintangible is an amortizable section 197intangible; and(2) The amount of the deduction un-

der section 197 with respect to suchbasis.(B) Application of general rule. If the

intangible described in paragraph(g)(2)(i)(A) of this section was an amor-tizable section 197 intangible in thehands of the transferor, the transfereewill continue to amortize its adjustedbasis, to the extent it does not exceedthe transferor’s adjusted basis, ratablyover the remainder of the transferor’s15-year amortization period. If the intan-gible was not an amortizable section197 intangible in the hands of thetransferor, the transferee’s adjusted ba-sis, to the extent it does not exceed thetransferor’s adjusted basis, cannot beamortized under section 197. In eitherevent, the intangible is treated, withrespect to so much of its adjusted basisin the hands of the transferee as exceedsits adjusted basis in the hands of thetransferor, in the same manner for pur-poses of section 197 as an intangibleacquired from the transferor in a trans-action that is not described in paragraph(g)(2)(ii) of this section. The rules ofthis paragraph (g)(2)(i) also apply to anysubsequent transfers of the intangible ina transaction described in paragraph(g)(2)(ii) of this section.(ii) Transactions covered. The trans-

actions described in this paragraph(g)(2)(ii) are—(A) Any transaction described in sec-

tion 332, 351, 361, 721, or 731; and(B) Any transaction between corpora-

tions that are members of the sameconsolidated group immediately after thetransaction.(iii) Certain exchanged-basis prop-

erty. This paragraph (g)(2)(iii) applies toproperty that is acquired in a transactionsubject to section 1031 or 1033 and ispermitted to be acquired without recog-nition of gain (replacement property).

24

Except as otherwise provided in para-graph (h) of this section, replacementproperty is treated as if it were theproperty by reference to which its basisis determined (the predecessor property)in determining whether, with respect toso much of its basis as does not exceedthe basis of the predecessor property, thereplacement property is an amortizablesection 197 intangible and the amortiza-tion period under section 197 with re-spect to such basis. Thus, if the prede-cessor property was an amortizablesection 197 intangible, the taxpayer willamortize the adjusted basis of the re-placement property, to the extent it doesnot exceed the adjusted basis of thepredecessor property, ratably over theremainder of the 15-year amortizationperiod for the predecessor property. Ifthe predecessor property was not anamortizable section 197 intangible, theadjusted basis of the replacement prop-erty, to the extent it does not exceed theadjusted basis of the predecessor prop-erty, may not be amortized under section197. In either event, the replacementproperty is treated, with respect to somuch of its adjusted basis as exceedsthe adjusted basis of the predecessorproperty, in the same manner for pur-poses of section 197 as property ac-quired from the transferee in a transac-tion that is not subject to section 1031or 1033. (See paragraph (h) of thissection for the application of the anti-churning rules.)(iv) Transfers under section 708(b)-

(1)—(A) In general. Paragraph (g)(2)(i)of this section applies to transfers ofsection 197 intangibles that occur or aredeemed to occur by reason of the termi-nation of a partnership under section708(b)(1).(B) Termination by sale or exchange

of interest. In applying paragraph(g)(2)(i) of this section to a partnershipthat is terminated pursuant to section708(b)(1)(B) (relating to a sale or ex-change of an interest), the terminatedpartnership is treated as the transferorand the new partnership is treated as thetransferee with respect to any section197 intangible held by the terminatedpartnership immediately preceding thetermination. (See paragraph (g)(3) ofthis section for the treatment of in-creases in the basis of property of theterminated partnership under section743(b).)(C) Other terminations. In applying

paragraph (g)(2)(i) of this section to apartnership that is terminated pursuantto section 708(b)(1)(A) (relating to ces-

sation of activities by a partnership), theterminated partnership is treated as thetransferor and the distributee partner istreated as the transferee with respect toany section 197 intangible held by theterminated partnership immediately pre-ceding the termination.(D) Anti-churning rules. See para-

graph (h) of this section for the applica-tion of the anti-churning rules.(v) Distributions to which section

732(d) applies. Paragraph (g)(2)(i) ofthis section applies to a distribution of asection 197 intangible to which section732(d) (relating to special partnershipbasis to transferee) applies. For purposesof section 197, any increase in the basisof the distributed intangible under sec-tion 732(d) is taken into account by apartner as if the increased portion wereattributable to the partner’s acquisitionof the underlying partnership propertyon the date of distribution from thetransferor of the partnership interest orthe deceased partner, as the case maybe. For purposes of the effective dateand anti-churning rules (paragraphs(d)(1) and (h) of this section), theintangible is treated as having beenacquired by the transferee partner at thetime of the transfer of the partnershipinterest described in section 732(d). Forpurposes of determining the amortiza-tion period under section 197 with re-spect to any increased basis, however,the intangible is treated as having beenacquired by the transferee partner at thetime of the distribution described insection 732(a). (See paragraph (h) ofthis section for the application of theanti-churning rules.)(vi) Curative and remedial alloca-

tions under section 704(c). For purposesof paragraph (g)(2)(i) of this section, ifa section 197 intangible is transferred toa partnership in a transaction describedin section 721, the basis of the intan-gible in the hands of the transferorincludes the amount of any curative orremedial allocations of amortization thatare made to a noncontributing partnerwith respect to the contributed intan-gible under the curative or remedialmethods for making allocations undersection 704(c). Thus, for example, if acontributed intangible is not an amortiz-able section 197 intangible in the handsof the transferor, any remedial alloca-tions of amortization made to a noncon-tributing partner with respect to theintangible are not amortizable undersection 197. See § 1.704–3(c) and (d)for a description of the curative andremedial methods.

(3) Application of section 754 to ac-quisitions of an interest in an intangibleheld through a partnership. Any in-crease in the basis of partnership prop-erty under section 734(b) (relating to theoptional adjustment to the basis of un-distributed partnership property) or sec-tion 743(b) (relating to the optionaladjustment to the basis of partnershipproperty) is taken into account undersection 197 by a partner as if theincreased portion of the basis wereattributable to the partner’s acquisitionof the underlying partnership propertyand as if the property were acquiredfrom the distributee partner on the dateof the distribution (in the case of a basisincrease under section 734(b)) or fromthe transferor of the partnership intereston the date of the transfer (in the caseof a basis increase under section743(b)). (See paragraph (h) of this sec-tion for the application of the anti-churning rules.)(4) Treatment of certain reinsurance

transactions—(i) In general. Section197 applies to any insurance contractacquired from another person through anassumption reinsurance transaction. Forpurposes of section 197, an assumptionreinsurance transaction is—(A) Any arrangement in which one

insurance company (the reinsurer) be-comes solely liable to policyholders oncontracts transferred by another insur-ance company (the ceding company);and(B) Any acquisition of an insurance

contract that is treated as occurring byreason of an election under section 338.(ii) Determination of adjusted basis—

(A) Acquisitions (other than under sec-tion 338) of specified insurance con-tracts. The amount taken into accountfor purposes of section 197 as theadjusted basis of specified insurancecontracts (as defined in section848(e)(1)) acquired in an assumptionreinsurance transaction that is not de-scribed in paragraph (g)(4)(i)(B) of thissection is equal to the excess of—(1) The amount paid or incurred (or

treated as having been paid or incurred)by the reinsurer for the purchase of thecontracts (as determined under § 1.817–4(d)(2)); over(2) The amount of the specified

policy acquisition expenses that are at-tributable to the reinsurer’s net positiveconsideration for the reinsurance agree-ment (as determined under § 1.848–2(f)(3)).(B) Other acquisitions. [Reserved]

25

(5) Amounts paid or incurred for afranchise, trademark, or trade name. Ifan amount to which section 1253(d)(relating to the transfer, sale, or otherdisposition of a franchise, trademark, ortrade name) applies is described in sec-tion 1253(d)(1)(B) (relating to contin-gent serial payments), the amount isdeductible under section 1253(d)(1) andis not included in the adjusted basis ofthe intangible for purposes of section197. Any other amount, whether fixedor contingent, to which section 1253(d)applies is chargeable to capital accountunder section 1253(d)(2) and is amortiz-able only under section 197.(6) Amounts properly taken into ac-

count in determining the cost of prop-erty that is not a section 197 intangible.Section 197 does not apply to anamount that is properly taken into ac-count in determining the cost of prop-erty that is not a section 197 intangible.The entire cost of acquiring the otherproperty is included in its basis andrecovered under other applicable Inter-nal Revenue Code provisions.(7) Treatment of amortizable section

197 intangibles as depreciable prop-erty—(i) In general. An amortizablesection 197 intangible is treated as prop-erty of a character subject to the allow-ance for depreciation under section 167.Thus, for example, an amortizable sec-tion 197 intangible is not a capital assetfor purposes of section 1221, but if heldfor more than one year, it generallyqualifies under section 1231 as propertyused in a trade or business. Also, anamortizable section 197 intangible issection 1245 property and section 1239applies to any gain recognized upon itssale or exchange between related per-sons (as defined in section 1239(b)).(ii) Exceptions and limitations—(A)

Unstated interest and original issue dis-count rules. In the case of the acquisi-tion of any amortizable section 197intangible in a transaction that wouldnot be treated as the sale or exchange ofproperty by the person from which theintangible was acquired, paragraph(g)(7)(i) of this section shall not apply(and the amortizable section 197 intan-gible shall not be treated as property)for purposes of—(1) Section 483(c) (relating to pay-

ments on account of the sale or ex-change of property); and(2) Section 1274(c) (relating to debt

instruments given in consideration forthe sale or exchange of property).(B) Treatment of other parties to

transaction. No person shall be treated

as having sold, exchanged, or otherwisedisposed of property in a transaction forpurposes of any provision of the InternalRevenue Code solely by reason of theapplication of paragraph (g)(7)(i) of thissection to any other party to the transac-tion.(h) Anti-churning rules—(1) Conver-

sions of existing goodwill, going con-cern value, and certain other section197 intangibles. Except as otherwiseprovided in this paragraph (h), goodwill,going concern value, or any other sec-tion 197 intangible for which a depre-ciation or amortization deduction wouldnot have been allowable prior to theenactment of section 197 may not beamortized as an amortizable section 197intangible if the section 197 intangibleis acquired by a taxpayer after August10, 1993 (or after July 25, 1991, if avalid retroactive election pursuant to§ 1.197–1T has been made) and ei-ther—(i) The taxpayer or a related person

held or used the intangible or an interesttherein at any time during the transitionperiod;(ii) The taxpayer acquired the intan-

gible from a person that held the intan-gible at any time during the transitionperiod and, as part of the transaction,the user of the intangible does notchange; or(iii) The taxpayer grants the right to

use the intangible to a person (or aperson related to that person) that heldor used the intangible at any time duringthe transition period.(2) Amounts deductible under section

1253(d). For purposes of paragraph(h)(1) of this section, deductions allow-able under section 1253(d)(2) or deduc-tions allowable pursuant to an electionunder section 1253(d)(3) (in either caseas in effect prior to the enactment ofsection 197) are treated as deductionsallowable for amortization.(3) Transition period. For purposes of

this paragraph (h), the transition periodbegins on July 25, 1991, and ends onAugust 10, 1993, except that for taxpay-ers that made a valid retroactive electionpursuant to § 1.197–1T, the transitionperiod is July 25, 1991.(4) Exceptions. The anti-churning

rules of this paragraph (h) do not applyto—(i) The acquisition of an intangible

by a taxpayer if the basis of the intan-gible is determined under section1014(a); or(ii) The acquisition of an intangible

by a taxpayer that is an amortizable

section 197 intangible in the hands ofthe seller (or transferor), but only if theacquisition by the taxpayer or sale bythe seller (or transfer by the transferor)was not part of a transaction or a seriesof related transactions in which theseller (or transferor) previously acquiredthe intangible or interest therein.(5) Special partnership provisions—

(i) Basis increases. In determiningwhether the anti-churning rules of thisparagraph (h) apply to any increase inthe basis of partnership property undersection 732, 734, or 743, the determina-tions are made at the partner level andeach partner is treated as having ownedand used the partner’s proportionateshare of the partnership property. Thus,for example, the anti-churning rules donot apply to an increase in the basis ofpartnership property under section743(b) that occurs upon the acquisitionof an interest in a partnership that hasmade a section 754 election if theperson acquiring the partnership interesteither is not related to the person trans-ferring the partnership interest or ac-quired the interest upon the death of theformer partner. Similarly, the anti-churning rules do not apply to a con-tinuing partner’s proportionate share ofan increase in the basis of partnershipproperty under section 734(b) that oc-curs upon the distribution of property ofa partnership that has made a section754 election if the continuing partner isnot related to the distributee partner.(ii) Curative and remedial allocations

under section 704(c). In determiningwhether the anti-churning rules of thisparagraph (h) apply, any curative orremedial allocation of amortizationmade to a noncontributing partner underthe curative or remedial methods formaking allocations under section 704(c)is treated in the same manner as anoncurative or nonremedial allocation ofamortization. Thus, for example, if theanti-churning rules would apply to anonremedial allocation of amortizationto a noncontributing partner, the anti-churning rules apply to any remedialallocation of amortization. See § 1.704–3(c) and (d) for a description of thecurative and remedial methods.(6) Related person—(i) In general.

Except as otherwise provided in para-graph (h)(6)(iii) of this section, a personis related to another person for purposesof this paragraph (h) if—(A) The person bears a relationship

to that person that would be specified insection 267(b) (determined without re-gard to section 267(e)) and, by substitu-

26

tion, section 267(f)(1), if those sectionswere amended by substituting 20 per-cent for 50 percent; or(B) The person bears a relationship to

that person that would be specified insection 707(b)(1) if that section wasamended by substituting 20 percent for50 percent; or(C) The persons are engaged in

trades or businesses under common con-trol (within the meaning of section41(f)(1)(A) and (B)).(ii) Time for testing relationships. For

purposes of this paragraph (h), a personis treated as related to another person ifthe relationship exists—(A) In the case of a single transac-

tion, immediately before or immediatelyafter the acquisition of the intangibleinvolved; or(B) In the case of a series of related

transactions, at any time during theperiod beginning immediately before theearliest acquisition and ending immedi-ately after the last acquisition of anyintangible acquired in the series oftransactions.(iii) De minimis rule—(A) In general.

Two corporations shall not be treated asrelated persons for purposes of thisparagraph (h)(6) if—(1) The corporations would (but for

the application of this paragraph(h)(6)(iii)) be treated as related personssolely by reason of substituting ‘‘morethan 20 percent’’ for ‘‘more than 50percent’’ in section 267(f)(1)(A); and(2) The beneficial ownership interest

of one corporation in the stock of theother corporation represents less than 10percent of the total combined votingpower of all classes of stock entitled tovote and less than 10 percent of thetotal value of the shares of all classes ofstock outstanding.(B) Determination of beneficial own-

ership interest. For purposes of thisparagraph (h)(6)(iii), the beneficial own-ership interest of one corporation in thestock of another corporation shall bedetermined under the principles of sec-tion 318(a), except that—(1) In applying section 318(a)(2)(C),

the 50 percent limitation containedtherein shall not be applied; and(2) Section 318(a)(3)(C) shall be ap-

plied by substituting ‘‘20 percent’’ for‘‘50 percent’’.(7) Special rules for entities that

owned or used property at any timeduring the transition period and that areno longer in existence. A corporation,partnership, or trust that owned or usedproperty at any time during the transi-

tion period and that is no longer inexistence is deemed to be in existencefor purposes of determining whether thetaxpayer that acquired the property isrelated to the corporation, partnership,or trust.(8) Special rules for section 338

deemed acquisitions. In the case of aqualified stock purchase that is treatedas a deemed sale and purchase of assetspursuant to section 338, the corporationthat is treated as selling its assets as aresult of an election thereunder (oldtarget) is not considered related to thecorporation that is treated as purchasingthe assets (new target) if stock of oldtarget meeting the requirements of sec-tion 1504(a)(2) is, or is deemed to havebeen, acquired by purchase after July25, 1991. See § 1.338–2(d). Thus, forexample, if a corporation (the purchas-ing corporation) makes a qualified stockpurchase of the stock of another corpo-ration (target) from unrelated third par-ties in July 1997, and a section 338election is made by the purchasing cor-poration, the deemed asset purchaseshall not be considered as an acquisitionbetween related persons solely by virtueof the fact that old target and new targetare treated as the same corporation forcertain other purposes of the Code orthat old target and new target are thesame corporation under the laws of thestate or other jurisdiction of its organi-zation. However, the anti-churning rulesof this paragraph (h) may neverthelessapply to a deemed asset purchase result-ing from a section 338 election becauseold target and new target are otherwisetreated as related parties within themeaning of paragraph (h)(6) of thissection.(9) Exception to anti-churning rules

where gain is recognized—(i) In gen-eral. If a taxpayer would not be subjectto paragraph (h) but for the substitutionof 20 percent for 50 percent underparagraph (h)(6)(i)(A) of this sectionand the person (whether or not subjectto Federal income tax) from which thetaxpayer acquires the intangible elects torecognize gain on the disposition of theintangible and, notwithstanding anyother provision of the Internal RevenueCode, agrees to pay an amount that,when added to any other Federal incometax, equals the gain on the dispositionmultiplied by the highest marginal rateof tax imposed by section 1 (for indi-viduals, estates, or trusts) or 11 (forcorporations), whichever is applicable,for the taxable year in which the gain isrealized by the person from which the

taxpayer acquires the intangible, thenthe anti-churning rules described in thisparagraph (h) only apply to the extentthe taxpayer’s adjusted basis in theintangible exceeds the gain recognized.(ii) Manner of making election. [Re-

served](iii) Determination of highest mar-

ginal rate of tax. For the purpose ofdetermining the highest marginal rate oftax applicable to the person from whichthe taxpayer acquires the intangible, thefollowing rules shall apply:(A) Noncorporate taxpayers. In the

case of an individual, estate, or trust, thehighest marginal rate of tax shall be thehighest marginal rate of tax in effectunder section 1, determined without re-gard to section 1(h).(B) Corporations and tax-exempt en-

tities. In the case of a corporation or anentity that is exempt from tax undersection 501(a), the highest marginal rateof tax shall be the highest marginal rateof tax in effect under section 11, deter-mined without regard to any rate that isadded to the otherwise applicable rate inorder to offset the effect of the gradu-ated rate schedule.(iv) Special rule for pass-through en-

tities. In the case of a partnership or Scorporation, the election under para-graph (h)(9)(i) of this section—(A) Shall be made by the entity

rather than by its owners or members;and(B) Shall constitute an election by

each of the owners or members of theentity (rather than the entity itself) topay a tax, determined as provided in thisparagraph (h)(9), on the portion of thegain properly allocable to each suchowner or member.(v) Coordination with other provi-

sions—(A) In general. For purposes ofapplying any provision of chapter 1 orchapter 6 of the Code other than section197(f)(9)(B), both the amount of gainsubject to the tax determined underparagraph (h)(9)(i) of this section andthe amount of the tax shall be disre-garded. Thus, for example, the amountof the gain shall not be reduced by anynet operating loss deduction under sec-tion 172(a), any capital loss under sec-tion 1212, or any other similar loss ordeduction. The amount of tax deter-mined under paragraph (h)(9)(i) of thissection shall not be reduced by anycredit of the taxpayer. In computing theamount of any net operating loss, capitalloss, or other similar loss or deduction,or any credit that may be carried to anytaxable year, any gain recognized, and

27

any tax paid, under paragraph (h)(9)(i)of this section shall not be taken intoaccount.(B) Section 1374. No provision of

paragraph (h)(9)(iv) of this section shallpreclude the application of section 1374(relating to a tax on certain built-ingains of S corporations) to any gainwith respect to which the election de-scribed in paragraph (h)(9)(i) of thissection is made. Neither paragraph(h)(9)(iv) nor paragraph (h)(9)(v)(A) ofthis section shall be treated as preclud-ing a taxpayer from applying the provi-sions of section 1366(f)(2) (relating totreatment of the tax imposed by section1374 as a loss sustained by the Scorporation) in determining the amountof tax payable under paragraph (h)(9)(i)of this section.(C) Procedural and administrative

provisions. For purposes of subtitle F,the amount determined under paragraph(h)(9)(i) of this section is treated as atax imposed by section 1 or 11, asappropriate.(D) Installment method. The gain

subject to the tax determined underparagraph (h)(9)(i) of this section maynot be reported under the method de-scribed in section 453(a). Any such gainthat would, but for the application ofthis paragraph (h)(9)(v)(D), be takeninto account under section 453(a) shallbe taken into account in the samemanner as if an election under section453(d) (relating to the election not toapply section 453(a)) had been made.(10) Transactions subject to both

anti-churning and nonrecognition rules.If a person acquires a section 197intangible in a transaction described inparagraph (g)(2) of this section from aperson in whose hands the intangiblewas an amortizable section 197 intan-gible, and as a result of the transaction,the person is or becomes related to anyperson described in paragraph (h)(1) ofthis section, the intangible ceases to bean amortizable section 197 intangible inthe hands of the transferee unless theexception provided in paragraph(h)(4)(ii) of this section applies. If aperson acquires a section 197 intangiblein anticipation of becoming related toany person described in paragraph (h)(1)of this section, the intangible is not anamortizable section 197 intangible in thehands of the transferee.(11) Anti-churning anti-abuse rule.

Section 197 does not apply to anyintangible acquired by a taxpayer if thetaxpayer acquires the intangible in atransaction one of the principal purposes

of which is to avoid any of the anti-churning rules for intangibles describedin paragraph (h)(1) of this section. Thus,for example, if section 197 intangiblesare acquired in a transaction (or seriesof related transactions) in which optionsto acquire stock are issued to a party tothe transaction, but the option is nottreated as having been exercised forpurposes of paragraph (h)(6) of thissection, this paragraph (h)(11) may ap-ply to the transaction.(i) [Reserved].(j) General anti-abuse rule. The rules

in this section shall be interpreted andapplied as necessary and appropriate toprevent avoidance of the purposes ofsection 197. If one of the principalpurposes of a transaction is to achieve atax result that is inconsistent with thepurposes of section 197, the Commis-sioner can recast the transaction forFederal tax purposes as appropriate toachieve tax results that are consistentwith the purposes of section 197, inlight of the applicable statutory andregulatory provisions and the pertinentfacts and circumstances.(k) Examples. The following ex-

amples illustrate the application of thissection:Example 1. Computer software. (i) X purchases

all of the assets of an existing trade or businessfrom Y. One of the assets acquired is all of Y’srights in certain computer software previouslyused by Y under the terms of a nonexclusivelicense from the software developer. The softwarewas developed for use by manufacturers to main-tain a comprehensive accounting system, includinggeneral and subsidiary ledgers, payroll, accountsreceivable and payable, cash receipts and disburse-ments, fixed asset accounting, and inventory costaccounting and controls. The software was notsubstantially modified for use by Y within themeaning of paragraph (c)(4)(i) of this section andwas acquired directly by Y from the developer.The developer does not maintain wholesale orretail outlets but markets the software directly toultimate users. Y’s license of the software islimited to an entity that is actively engaged inbusiness as a manufacturer.(ii) Notwithstanding these limitations, the soft-

ware is considered to be readily available to thegeneral public for purposes of paragraph (c)(4)(i)of this section. Accordingly, the software is not asection 197 intangible.Example 2. Governmental rights of fixed dura-

tion. (i) City M operates a municipal watersystem. In order to induce X to locate a newmanufacturing business in the city, M grants X theright to purchase water for 16 years at a specifiedprice. X incurs legal fees and other costs forprofessional services in the amount of $10x inconnection with its efforts to obtain these rights.(ii) The rights granted by M are described in

section 197(e)(4)(B) and paragraph (c)(6) of thissection and, thus, are not a section 197 intangible.This exclusion applies notwithstanding that therights may not qualify for exclusion under section197(e)(4)(D) and paragraph (c)(13) of this sectionor that they also may be described in section

197(d)(1)(D) and paragraph (b)(8) of this sectionand, as such, may not be treated as self-createdintangibles eligible for exclusion under section197(c)(2).Example 3. Advertising costs. (i) Q manufac-

tures and sells consumer products through a seriesof wholesalers and distributors. In order to in-crease sales of its product by encouraging con-sumer loyalty to its products and to enhance thevalue of the goodwill, trademarks, and tradenames of the business, Q advertises its products tothe consuming public. It regularly incurs costs todevelop radio, television, and print advertisements.These costs generally consist of employee costsand amounts paid to independent advertising agen-cies. Q also incurs costs to run these advertise-ments in the various media for which they weredeveloped. Except for the possible application ofsection 197, these costs would be ordinary andnecessary expenses deductible under section 162.(ii) The advertising costs are not subject to

amortization under section 197 pursuant to para-graph (a)(3) of this section because they areotherwise deductible.Example 4. Covenant not to compete acquired

in connection with stock redemption. (i) R, acorporation, redeems all of its stock owned by A,an individual. R and A have no business relation-ships with each other except for the corporate-shareholder relationship. In connection with thestock redemption, R and A enter into an agreementcontaining a covenant not to compete. Under thisagreement, A agrees that A will not compete withthe business of R within a prescribed geographicalterritory for a period of three years after the dateon which the stock redemption is completed. Inexchange for this agreement, R pays A consider-ation in addition to the amount paid for the stockredeemed by R.(ii) Because the agreement was entered into in

connection with the reacquisition by R of itsstock, section 162(k) provides that no deductionshall be allowed for any amount paid or incurredpursuant to the agreement. Accordingly, pursuantto paragraph (a)(4) of this section, section 197does not apply to these amounts.Example 5. Substantial portion of trade or

business. (i) S owns and operates 100 restaurantsin various locations. Each of these restaurants isoperated using a well-established trade name madeavailable to S under the terms of a franchiseagreement with F. S determined to cease operatingone of the franchised restaurants. Accordingly, Ssold to B all of the assets that it had usedexclusively in connection with the operation of itsrestaurant at that location. B agreed to extend anoffer of employment to all of the employees atthat location. B acquired no rights to the franchiseor to any of the trademarks or trade names thathad been used by S.(ii) The transaction between B and S is a

transaction involving the acquisition of assetsconstituting a trade or business or a substantialportion thereof within the meaning of paragraph(e) of this section, notwithstanding that B did notacquire a franchise from S or that the assets didnot represent a substantial portion of the assetsused by S in that trade or business.Example 6. Separate acquisition of franchise. (i)

S is a franchisor of retail outlets for specialtycoffees. On July 1, 1997, G enters into anagreement with S pursuant to which G is permit-ted to acquire and operate a store using the Strademark and trade name at the location specifiedin the agreement. G agrees to pay S $100,000upon execution of the agreement and also agreesto pay, on a monthly basis throughout the term ofthe franchise, a specified percentage of gross sales

28

from the store. The agreement contains detailedspecifications for the construction and operation ofthe business, but G is not required to purchasefrom S any of the materials necessary to constructthe improvements at the location specified in thefranchise agreement.

(ii) The franchise is a section 197 intangiblewithin the meaning of paragraph (b)(10) of thissection. The franchise does not qualify for theexclusion relating to self-created intangibles de-scribed in section 197(c)(2) and paragraph (d)(2)of this section because the franchise is describedin section 197(d)(1)(F). In addition, because theacquisition of the franchise constitutes the acquisi-tion of an interest in a trade or business or asubstantial portion thereof, the franchise may notbe excluded under section 197(e)(4). Thus, thefranchise is an amortizable section 197 intangible,the basis of which must be recovered over a15-year period. However, the amounts to be paidby G computed as a percentage of gross sales arenot subject to the provisions of section 197 byreason of section 197(f)(4)(C) and paragraph(b)(10)(ii) of this section.Example 7. Acquisition and amortization of

covenant not to compete. (i) As part of theacquisition of a trade or business from C, B and Center into an agreement containing a covenant notto compete. Under this agreement, C agrees that itwill not compete with the business acquired by Bwithin a prescribed geographical territory for aperiod of three years after the date on which thebusiness is sold to B. In exchange for thisagreement, B agrees to pay C $90,000 per year foreach year in the term of the agreement. Theagreement further provides that, in the event of abreach by C of his obligations under the agree-ment, B may terminate the agreement, ceasemaking any of the payments due thereafter, andpursue any other legal or equitable remediesavailable under applicable law. Assume that theamounts payable to C under the agreement repre-sent the value of C’s obligations to B pursuant tothe covenant and that the present fair market valueof B’s rights under the agreement is $225,000. Theaggregate consideration paid for all assets acquiredin the transaction other than the covenant exceedsthe sum of the amount of Class I assets and theaggregate fair market value of all Class II andClass III assets and all Class IV assets other thanthe covenant.(ii) Because the covenant is acquired in an

applicable asset acquisition (within the meaning ofsection 1060(c)), the basis of B in the covenantcannot exceed its fair market value. See § 1.1060–1T(e)(1). Under section 197(f)(3) and paragraphs(f)(3)(i) and (4) of this section, the adjusted basisof B in the agreement, determined as of the dateon which the agreement is entered into, is$225,000. B’s deduction for amortization withrespect to the amounts to be paid under theagreement is $1,250 per month, or $15,000 peryear, for each year in the 15-year period beginningon the date on which the agreement is enteredinto. The excess of the amounts payable pursuantto the agreement over the amount allocated to thecovenant under § 1.1060–1T(e)(1), or $45,000, isallocated to Class V assets.Example 8. Breach of covenant not to compete

subsequent to acquisition. (i) The facts are thesame as inExample 7, except that at the end ofthe second year of the agreement, C breaches theagreement by competing against B. B and C enterinto a settlement of all claims arising under theagreement and the subsequent breach by C byagreeing that B is not obligated to pay C the finalinstallment of $90,000.

(ii) Under paragraph (g)(1)(iii) of this section,the covenant is not treated as having been dis-posed of (or becoming worthless) because C hasnot disposed of all interests in the trade orbusiness acquired in the same transaction as thecovenant. The covenant is not a contingent incomeasset within the meaning of § 1.1060–1T(f)(4)(i).Accordingly, B must decrease the adjusted basis ofany asset acquired from C by $90,000 at thebeginning of the third year of the agreement in themanner provided by § 1.1060–1T(f)(3)(i). To theextent that any decrease is allocated to an amortiz-able section 197 intangible, B must reduce theamount of its deduction for amortization undersection 197 accordingly.Example 9. Loss disallowance rules involving

related persons. (i) Assume that X and Y aretreated as a single taxpayer for purposes ofparagraph (g)(1)(iv) of this section. In a singletransaction, X and Y acquired from Z all of theassets used by Z in a trade or business. Z hadoperated this business at two locations, and X andY each desired to acquire the assets used by Z atone of the locations. Three years after the acquisi-tion, X sold all of the assets, including amortizablesection 197 intangibles, to an unrelated purchaserat a loss of $120,000.(ii) Because X and Y are treated as a single

taxpayer for purposes of the loss disallowancerules of section 197(f)(1) and paragraph (g)(1) ofthis section, X may not recognize its loss on thesale of the amortizable section 197 intangibles.Under paragraph (g)(1)(iv) of this section, X mustamortize its disallowed loss under section 197, andY may not increase its adjusted basis in itsamortizable section 197 intangibles by the amountof the realized loss of X that is disallowed. Xmust amortize the disallowed loss over the remain-der of the amortization period for the amortizablesection 197 intangibles it sold. Accordingly, Xmust amortize the disallowed loss at the rate of$10,000 per year (or $833 per month) for each ofthe 12 years remaining in the 15-year period.Example 10. Disposition of retained intangibles

by related person. (i) The facts are the same as inExample 9, except that 10 years after the acquisi-tion of the assets by X and Y and seven yearsafter the sale of the assets by X, Y sells all of theassets acquired from Z, including amortizablesection 197 intangibles, to an unrelated purchaser.(ii) Upon the sale of assets by Y, X may

recognize a loss equal to the unamortized loss.Accordingly, pursuant to paragraph (g)(1)(iv) ofthis section, X may recognize a loss in the amountof $50,000, the amount obtained by reducing theloss on the sale of the assets at the end of thethird year ($120,000) by the amount of amortiza-tion allowed for the fourth through the tenth years($70,000).Example 11. Acquisition of an interest in part-

nership with no section 754 election. (i) A, B, andC each contribute $1,500 for equal shares ingeneral partnership P. On January 1, 1998, Pacquires as its sole asset an amortizable section197 intangible for $4,500. P still holds the intan-gible on January 1, 2003, at which time theintangible has an adjusted basis to P of $3,000,and A, B, and C each have an adjusted basis of$1,000 in their partnership interests. D (who is notrelated to A) acquires A’s interest in P for $1,600.No section 754 election is in effect for 2003.(ii) Pursuant to paragraph (h)(5)(i) of this sec-

tion, there is no change in the basis or amortiza-tion of the intangible and D merely steps into theshoes of A with respect to the intangible. D’sproportionate share of P’s adjusted basis in theintangible is $1,000, which continues to be amor-

tized over the 10 years remaining in the original15-year amortization period for the intangible.Example 12. Acquisition of an interest in part-

nership with a section 754 election. (i) The factsare the same as in Example 11, except that asection 754 election is in effect for 2003.(ii) Pursuant to section 197(f)(9)(E) and para-

graph (h)(5)(i) of this section, for purposes ofsection 197, D is treated as if P owns two assets.D’s proportionate share of P’s adjusted basis inone asset is $1,000, which continues to be amor-tized over the 10 years remaining in the original15-year amortization period. For the other asset,D’s proportionate share of P’s adjusted basis is$600 (the amount of the basis increase undersection 743 as a result of the section 754 election),which is amortized over a new 15-year periodbeginning January 2003. With respect to B and C,P’s remaining $2,000 adjusted basis in the intan-gible continues to be amortized over the 10 yearsremaining in the original 15-year amortizationperiod.Example 13. Payment to a retiring partner by

partnership with a section 754 election. (i) Thefacts are the same as inExample 11, except that asection 754 election is in effect for 2003 and,instead of D acquiring A’s interest in P, A retiresfrom P. A, B, and C are not related to each otherwithin the meaning of paragraph (h)(6) of thissection. A receives a payment under section 736from P of $1,600, all of which is in exchange forA’s interest in the intangible asset owned by P.(ii) Pursuant to paragraph (h)(5)(i) of this sec-

tion, because of the section 734 adjustment, P istreated as having two amortizable section 197intangibles, one with a basis of $3,000 and aremaining amortization period of 10 years and theother with a basis of $600 and a new amortizationperiod of 15 years.Example 14. Termination of partnership under

section 708(b)(1)(B). (i) A and B are partners withequal shares in the capital and profits of generalpartnership P. P’s only asset is an amortizablesection 197 intangible, which P had acquired onJanuary 1, 1994. On January 1, 1999, the assethad a fair market value of $100 and a basis to Pof $50. On that date, A sells his entire partnershipinterest in P to C, who is unrelated to A, for $50.At the time of the sale, the basis of each of A andB in their respective partnership interests is $25.(ii) The sale causes a termination of P under

section 708(b)(1)(B). Under section 708, the trans-action is treated as if P transfers its sole asset to anew partnership in exchange for the assumption ofits liabilities and the receipt of all of the interestsin the new partnership. Immediately thereafter, Pis treated as if it is liquidated, with B and C eachreceiving their proportionate share of the interestsin the new partnership. The contribution by P ofits asset to the new partnership is governed bysection 721, and the liquidating distributions by Pof the interests in the new partnership are gov-erned by section 731. However, C does not realizea special basis adjustment under section 743 withrespect to the amortizable section 197 intangibleunless P had a section 754 election in effect for itstaxable year in which the deemed transfer of theasset to the new partnership occurred.(iii) Under section 197, if P had a section 754

election in effect for its taxable year in which thedeemed transfer of the asset to the new partnershipoccurred, C is treated as if the new partnershiphad acquired two assets from P immediatelypreceding its termination. Even though the ad-justed basis of the new partnership in the twoassets is determined solely under section 723,because the transfer of assets is a transactiondescribed in section 721, the application of sec-

29

tions 743(b) and 754 to P immediately before itstermination causes P to be treated as if it held twoassets, for purposes of section 197, at this time.B’s and C’s proportionate share of the newpartnership’s adjusted basis is $25 each in oneasset, which continues to be amortized over the 10years remaining in the original 15-year amortiza-tion period. For the other asset, C’s proportionateshare of the new partnership’s adjusted basis is$25 (the amount of the basis increase resultingfrom the application of section 743 to the sale orexchange by A of the interest in P), which isamortized over a new 15-year period beginning inJanuary 1999.(iv) If P did not have a section 754 election in

effect for its taxable year in which the sale of thepartnership interest by A to C occurred, theadjusted basis of the new partnership in theamortizable section 197 intangible is determinedsolely under section 723, because the transfer is atransaction described in section 721, and P doesnot have a basis increase in its section 197intangible. Under section 197(f)(2) and paragraph(g)(2) of this section, the new partnership contin-ues to amortize the amortizable section 197 intan-gible over the 10 years remaining in the original15-year amortization period. No additional amorti-zation is allowable with respect to this asset undersection 197.Example 15. Disguised sale to partnership. (i)

Assume that E and F are individuals who areunrelated to each other within the meaning ofparagraph (h)(6) of this section. E has beenengaged in the active conduct of a trade orbusiness as a sole proprietor since 1990. E and Fform EF Partnership. E transfers all of the assetsof the business, having a fair market value of$100x, to EF, and F transfers $40x of cash to EF.E receives a 60 percent interest in EF and the$40x of cash contributed by F, and F receives a 40percent interest in EF, under circumstances inwhich the transfer by E is treated as a sale ofproperty to EF under § 1.707–3(b).(ii) Under § 1.707–3(a)(1), the transaction is

treated as if E had sold to EF a 40 percent interestin each asset for $40x and contributed the remain-ing 60 percent interest in each asset to EF inexchange solely for an interest in EF. Because Eand EF are related persons within the meaning ofparagraph (h)(6) of this section, no portion of anytransferred section 197 intangible that E heldduring the transition period (as defined in para-graph (h)(3) of this section) is an amortizablesection 197 intangible pursuant to paragraph (h)(1)of this section. Section 197(f)(9)(E) and paragraph(h)(5) of this section do not apply to any portionof the section 197 intangible in the hands of EFbecause the basis of EF in these assets was notincreased under any of sections 732, 734, or 743.Example 16. Acquisition by related person in

nonrecognition transaction. (i) A owns anonamortizable intangible that A acquired in 1990.In 1997, A sells a one-half interest in the intan-gible to B for cash. Immediately after the sale, Aand B, who are unrelated to each other, formpartnership P as equal partners. A and B eachcontribute their one-half interest in the intangibleto P.(ii) P has a transferred basis in the intangible

from A and B under section 723. The nonrecogni-tion transfer rule under paragraph (g)(2)(i) of thissection applies to A’s transfer of its one-halfinterest in the intangible to P, and consequently Psteps into A’s shoes with respect to A’snonamortizable transferred basis. The anti-churning rules of paragraph (h)(1)(i) of this sec-tion apply to B’s transfer of its one-half interest inthe intangible to P, because A, who is related to P

under paragraph (h)(6) of this section, held B’sone-half interest in the intangible during thetransition period. Pursuant to paragraph (h)(10) ofthis section, these rules apply to B’s transfer of itsone-half interest to P even though the nonrecogni-tion transfer rule under paragraph (g)(2)(i) of thissection would have permitted P to step into B’sshoes with respect to B’s otherwise amortizablebasis. Therefore, P’s entire basis in the intangibleis nonamortizable.Example 17. Acquisition of partnership interest

following formation of partnership. (i) The factsare the same as in Example 16 except that, in1996, A formed P with an affiliate and contributedthe intangible to the partnership and except thatthereafter, in an unrelated transaction, B purchasesa 50 percent interest in P. P has a section 754election in effect.(ii) For the reasons set forth inExample 14(iii),

B is treated as if P owns two assets. B’sproportionate share of P’s adjusted basis in oneasset is the same as A’s proportionate share of P’sadjusted basis in that asset, which is not amortiz-able under section 197. For the other asset, B’sproportionate share of the remaining adjusted basisof P is amortized over a new 15-year period.Example 18. Acquisition by related corporation

in nonrecognition transaction. (i) The facts are thesame asExample 16, except that P is a corpora-tion.(ii) P has a transferred basis in the intangible

from A and B under section 362. Pursuant toparagraph (h)(10) of this section, the applicationof the nonrecognition transfer rule under paragraph(g)(2)(i) and the anti-churning rules of paragraph(h)(1)(i) of this section to the facts of thisExample 18is the same as inExample 16. Thus,P’s entire basis in the intangible is nonamortizable.Example 19. Acquisition from corporation re-

lated to purchaser through remote indirect interest.(i) X, Y, and Z are each corporations that haveonly one class of issued and outstanding stock. Xowns 25 percent of the stock of Y and Y owns 25percent of the outstanding stock of Z. No othershareholder of any of these corporations is relatedto any other shareholder or to any of the corpora-tions. On June 30, 1997, X purchases from Zsection 197 intangibles that Z owned during thetransition period (as defined in paragraph (h)(3) ofthis section).(ii) Pursuant to paragraph (h)(6)(iii)(B) of this

section, the beneficial ownership interest of X in Zis 6.25 percent, determined by treating X as if itowned a proportionate (25 percent) interest in thestock of Z that is actually owned by Y. Thus, eventhough X is related to Y and Y is related to Z, Xand Z are not considered to be related forpurposes of the anti-churning rules of section 197.Example 20. Gain recognition election. (i) B

owns 25 percent of the stock of S, a corporationthat uses the calendar year as its taxable year. Noother shareholder of B or S is related to eachother. S is not a member of a controlled group ofcorporations within the meaning of section1563(a). S has section 197 intangibles that itowned during the transition period and was notpermitted to amortize or depreciate under anyother provision of the Code. S had a basis of$25,000 in the intangibles. In 1997, S sells theseintangibles to B for $75,000. S recognizes a gainof $50,000 on the sale and has no other items ofincome, deduction, gain, or loss for the year,except that S also has a net operating loss of$20,000 from prior years that it would otherwisebe entitled to use in 1997 pursuant to section172(b). As part of the transaction with B, S agreesto make the gain recognition election pursuant tosection 197(f)(9)(B).

(ii) If the gain recognition election had not beenmade, S would have taxable income of $30,000for 1997 and a tax liability of $4,500. As theresult of the election, S must pay a total taxliability for the year of $17,500 (35 percent of$50,000), consisting of the sum of its regular taxliability of $4,500 and the additional amount of$13,000 pursuant to section 197(f)(9)(B).(iii) Pursuant to paragraph (h)(9)(v)(A) of this

section, S determines the amount of its netoperating loss deduction in subsequent years with-out regard to the gain recognized on the sale ofthe section 197 intangible to B. Accordingly, theentire $20,000 net operating loss deduction thatwould have been available in 1997 but for thegain recognition election may be used in 1998,subject to the limitations of section 172.(iv) B has a basis of $75,000 in the section 197

intangibles acquired from S. As the result of thegain recognition election by S, B may amortize$50,000 of its basis under section 197. Theremaining basis may not be amortized by B.Example 21. Section 338 election. (i) P corpora-

tion makes a qualified stock purchase of the stockof T corporation from two shareholders in July1997, and a section 338 election is made by P.One of the selling shareholders is an individualwho owns 25 percent of the total value of thestock of each of the T and P corporation. No othershareholder of either T or P owns stock in both ofthese corporations, and no other shareholder isrelated to any other shareholder of either corpora-tion.(ii) Old target and new target (as these terms

are defined in § 1.338–1(c)(13)) are members of acontrolled group of corporations under section267(b)(3), as modified by section 197(f)(9)(C)(i),and any section 197 intangible held by old targetat any time during the transition period is not anamortizable section 197 intangible in the hands ofnew target. However, a gain recognition electionunder paragraph (h)(9)(i) of this section may bemade with respect to this transaction.

(l) Effective dates. This section isapplicable on the date final regulationsare published in the Federal Register,except that § 1.197–2(c)(13) (exceptionfrom section 197 for separately acquiredrights of fixed duration or amount) isapplicable August 11, 1993 (or July 26,1991, if a valid retroactive election hasbeen made under § 1.197–1T).

Margaret Milner Richardson,Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register onJanuary 9, 1997, 2:53 p.m., and published in theisue of the Federal Register for January 16, 1997,62 F.R. 2336)

Foundations Status of CertainOrganizations

Announcement 97–27The following organizations have

failed to establish or have been unableto maintain their status as public chari-ties or as operating foundations. Accord-ingly, grantors and contributors may not,after this date, rely on previous rulingsor designations in the Cumulative List

30

of Organizations (Publication 78), or onthe presumption arising from the filingof notices under section 508(b) of theCode. This listing doesnot indicate thatthe organizations have lost their statusas organizations described in section501(c)(3), eligible to receive deductiblecontributions.Former Public Charities. The follow-

ing organizations (which have beentreated as organizations that are notprivate foundations described in section509(a) of the Code) are now classifiedas private foundations:Action Arts, Inc., Pasadena, CAAlleluia, San Antonio, TXAmericans Back in Charge Foundation,Washington, DC

Bellaire Club Inc., Bellaire, TXBible Stories for the Children of theWorld, Inc., Longmont, CO

Biblical Studies Association Inc.,Mableton, GA

Black Police Officers SelectionCommittee, Inc., Houston, TX

Capitol Hill Artists Association, Inc.,Northglenn, CO

Car Clay Corporation, El Paso, TXCaring About People, Inc., Boulder, COCaring for Children Foundation ofTexas, Inc., Dallas, TX

Center for a New Direction Inc., AnnArbor, MI

Central Arizona Refugee EcumenicalServices, Phoenix, AZ

Central New Mexico Crimestoppers,Edgewood, NM

Change This World, Austin, TXCharlotte Edwards Center, Inc., LaPorte, TX

Childbirth Connection, Austin, TXChildren Benefit Foundation, Inc., Mesa,AZ

Dallas Repertoire Ballet, Dallas, TXDenvers First Step, Denver, COEarthwide Education Center, Inc.,Camden, NY

East Harlem Community Land Tr Ltd.,New York, NY

Elmore County Education Foundation,Inc., Wetumpka, AL

Four Winds Resource Conservation andDevelopment Area Inc., Quanah, TX

Funston Elementary Parent-TeachersOrganization, Wichita, KS

Hands United in Good Spirit Inc.,Miami, FL

Harmony Alliance Inc., Phoenix, AZHugs Inc., Oklahoma City, OKHumanitarian Air Transport Services,Inc., Sarasota, FL

Human Pursuits the Western HumanitiesConcern, Salt Lake City, UT

IAHA Foundation, Austin, TX

Imperial Homes Inc., Los Angeles, CAInterracial Family & Social Alliance OfDFW, Dallas, TX

Isleta Club of Albuquerque, Inc.,Albuquerque, NM

I X L Community ImprovementAssociation, Oklahoma City, OK

Jackson Area Quality Initiative Inc.,Jackson, MI

Keller Project Graduation Inc., Keller,TX

Keresztmama Foundation, Inc., NewYork, NY

Lallement Memorial Committee, Boston,MA

Latinas for Empowerment andEconomic Development, Inc., Albany,NY

Latvian Renaissance Association, Inc.,Darien, CT

Law School Foundation, Inc., Southport,CT

Leadership South, Davidson, NCMagi Foundation, Houston, TXMaine Masonic Foundation, Portland,ME

Major County Senior Citizens, Inc.,Fairview, OK

Maranatha Ministries, Birmingham, ALMargaret Bowers Scholarship Fund,Richmond, TX

Mark Travis Ministries, Inc., CorpusChristi, TX

Narrow Door Ministries Inc., Wichita,KS

National Church Residences ofLawrence Park, PA, Columbus, OH

North Fort Worth Community ArtsCenter Incorporated, Fort Worth, TX

Northside Plaza Inc., Houston, TXOakland Exploratory ChildrensMuseum, Richmond, CA

O B P C,Inc., Denver, COOceanic Foundation, Boulder, COOcoee Kids Incorporated, Ocoee, FLOil of Gladness Outreach Ministries,Inc., Rupert, WV

Oklahoma Dare Officers AssociationFoundation, Edmond, OK

Oklahoma Livestock IndustryFoundation, Inc., Stillwater, OK

Oklahoma State HemophiliaAssociation, Tulsa, OK

Old Sixth Ward NeighborhoodAssociation, Houston, TX

Old Town Music Hall Inc., El Segundo,CA

Olney Midget & Teen League Inc.,Philadelphia, PA

One Step Forward A Transitional Homefor Battered Women and Children,Los Angeles, CA

Open Circle, Inc., Santa Fe, NM

Open Door Food Pantry Inc., Mt.Jackson, VA

Opera Theater Corvallis Inc., Corvallis,OR

Opportunity Skyway Inc., College Park,MD

Pacific Communications Inc., Potomac,MD

Pack Productions, Inc., Brooklyn, NYPalo Duro Legal Aid, Lubbock, TXP A L S Inc., Stockton, CAPineywoods Animal Shelter Inc.,Crockett, TX

Positive I.D. Incorporated, Olney, MDPride Production Inc., Pine Bluff, ARReality, Inc., Kingman, KSReality Theatre, Columbus, OHSan Antonio Local OrganizingCommittee, San Antonio, TX

San Antonio Riders Foundation, SanAntonio, TX

San Benito Literacy Center Inc., SanBenito, TX

Sangre De Cristo Independent LivingCenter A Non-profit Corporation,Pueblo, CO

San Tan Historical Society, Inc., QueenCreek, AZ

School Childrens Assistance Fund,Canyon, TX

Sharon Affordable Housing, Inc.,Sharon, CT

Silver Street Assistance Program,Houston, TX

Smiles Against Cancer Corporation,Humble, TX

Songmakers Almanac, Boulder, COTexas Early Education Heritage Society,Houston, TX

Texas Enterprise for HousingDevelopment, Inc., Pharr, TX

Texas Foundation for EducationalOptions, Lewisville, TX

Texas Native American IndianAssociation, Fort Worth, TX

Texas Public Sculpture Fund, Denton,TX

Texas Table Tennis Association,Houston, TX

Texas Tissue Network, Inc., El Paso, TXUpshur County Crimestoppers, Inc.,Gilmer, TX

Valley Voice Youth Choir, Kent, WAVilla Encantada, Inc., Albuquerque, NMWilderness Covenant Incorporated,Tucson, AZ

Wilderness Heritage Society, Inc.,Georgetown, TX

Wildlife Museum, Inc., Fort Worth, TXWilliam Owens Ministry, Inc., Tulsa,OKIf an organization listed above sub-

mits information that warrants the re-newal of its classification as a public

31

charity or as a private operating founda-tion, the Internal Revenue Service willissue a ruling or determination letterwith the revised classification as tofoundation status. Grantors and con-tributors may thereafter rely upon suchruling or determination letter as pro-vided in section 1.509(a)–7 of theIncome Tax Regulations. It is notthe practice of the Service to announcesuch revised classification of foundationstatus in the Internal Revenue Bulletin.

Scenarios of Disciplinary ActionsFrom the Office of Director ofPracticeThe following scenarios are compos-

ites of matters that have come to theattention of the Office of Director ofPractice. The scenarios are intended toinform tax practitioners of the types ofactivity that may result in disciplinaryaction under Treasury Department Cir-cular No. 230, Regulations Governingthe Practice of Attorneys, Certified Pub-lic Accountants, Enrolled Agents, En-rolled Actuaries, and Appraisers Beforethe Internal Revenue Service (a republi-cation of 31 C.F.R. Part 10). Becausedisciplinary matters are resolved on thebasis of their particular facts and cir-cumstances, these scenarios do not con-stitute precedent in any matter beforethe Director.Comments concerning the scenarios

should be sent to: Office of Director ofPractice, C:AP:P, Internal Revenue Ser-vice, 1111Constitution Ave., NW, Wash-ington, DC 20224.False statements. The practitioner

was engaged by a physician to preparethe physician’s individual income taxreturn. When the physician delivered hisrecords, he commented to the practitio-ner that he hoped he could take asubstantial deduction for using his car inhis practice. The practitioner did not askfor further substantiation and, on the taxreturn submitted to the IRS, deductedvarious automobile expenses: deprecia-tion, insurance, maintenance, gas, andoil. When the tax return was audited,the physician explained to the IRS audi-tor that he considered his car to be usedin his practice because he drove itbetween his home and office.Thereafter, the Director called the

practitioner’s attention to possible viola-tions of Circular 230: lack of due dili-gence in preparing tax returns in viola-tion of section 10.22(a); and giving falseinformation to the Treasury Department

in violation of section 10.51(b). Thepractitioner asserted that he was entitledto place good faith reliance on hisclient’s information. However, the prac-titioner could not cite any authoritativeexception to the general rule that com-muting expenses are not deductible.Consequently, the Director consideredthe practitioner to be in violation ofsection 10.51(b).Contemptuous conduct. The practi-

tioner called an IRS revenue officer todiscuss his client’s case. The revenueofficer, after listening to the practition-er’s comments, stated that the clientcould still expect enforcement action.Whereupon, the practitioner said, ‘‘Howabout my coming down there and jerk-ing you around for a while?’’ He addedhe ‘‘would not mind kicking down thedoor.’’ The revenue officer terminatedthe call and notified IRS’ InspectionService. Later in the day, the practition-er called back to apologize.The Director contacted the practition-

er with regard to possible violations ofCircular 230: attempting to influence anIRS employee’s official action by use ofa threat, a violation of section 10.51(f);and contemptuous conduct consisting ofabusive language, a violation of section10.51(i). In response, the practitioneroffered little in the way of explanation,stating that he had simply lost histemper.The Director determined that the

practitioner’s statements constituted con-temptuous conduct in violation of sec-tion 10.51(i). Since this was the onlysuch instance involving the practitionerin many years of IRS practice, and inview of the quick apology, the Directordetermined that a reprimand, with awarning as to future conduct, was theappropriate sanction.Due Diligence.The practitioner’s em-

ployees completed clients’ tax returns,which the practitioner reviewed andsigned as the preparer. In completing aclient’s individual income tax return,one of the employees accepted the cli-ent’s characterization of several trips asbusiness trips. The employee made nofurther inquiry and did not request sub-stantiation. In fact, no business purposefor the trips could be substantiated. Thepractitioner reviewed and signed the taxreturn.The Director contacted the practition-

er, stating that the practitioner may haveviolated the regulations in Circular 230:lack of due diligence in preparing tax

returns in violation of section 10.22(a);and giving false information to the Trea-sury Department in violation of section10.51(b). The practitioner responded thatit would be unfair to hold him respon-sible for the actions of the employee,who had disregarded the office policy ofobtaining substantiation for businesstrips.In consideration of the practitioner’s

office policy, and in the absence of ahistory of inaccurate returns, the Direc-tor was satisfied that the practitioner hadnot knowingly submitted false informa-tion. Therefore, the Director resolved inthe practitioner’s favor any questionwith regard to a violation of section10.51(b). However, the practitioner, asthe person who signed the tax return,could not disclaim responsibility for thetax return’s accuracy. The Director con-sidered the practitioner to be in violationof section 10.22(a) for failing to exer-cise due diligence.Knowledge of client’s mistake. The

client completed the practitioner’s taxreturn preparation questionnaire, indicat-ing that he was separated from hisspouse. In reviewing the questionnaire,the practitioner asked the client whetherhe was ‘‘legally separated.’’ The clientreplied that he was. The practitionerprepared the client’s Form 1040, listingthe client’s filing status as single.Later, the practitioner learned that

although the client and the client’sspouse had come to terms on a separa-tion agreement, the agreement had notbeen incorporated into a decree of di-vorce or separate maintenance. Thepractitioner, knowing that the client haddeclined to file an amended tax return ina prior year, did not inform the client ofthe mistake.The Director informed the practitioner

that his conduct raised a question re-garding violation of section 10.21 ofCircular 230, which requires a practition-er who knows that his client has notcomplied with the Federal revenue lawsor has made an error in, or omissionfrom, a tax return or document to advisethe client of such noncompliance, error,or omission. The practitioner’s assump-tion that the client would not file anamended tax return did not relieve thepractitioner of his duty to advise theclient of errors. The practitioner’s con-duct violated section 10.21, the Directorfound.

32

Announcement of the Disbarment, Suspension, or Consent to VoluntarySuspension of Attorneys, Certified Public Accountants, Enrolled Agents andEnrolled Actuaries From Practice Before the Internal Revenue ServiceUnder 31 Code of Federal Regula-

tions, Part 10, an attorney, certified pub-lic accountant, enrolled agent or enrolledactuary, in order to avoid the institutionor conclusion of a proceeding for hisdisbarment or suspension from practicebefore the Internal Revenue Service,may offer his consent to suspensionfrom such practice. The Director ofPractice, in his discretion, may suspendan attorney, certified public accountant,enrolled agent or enrolled actuary inaccordance with the consent offered.Attorneys, certified public accoun-

tants, enrolled agents and enrolled actu-aries are prohibited in any Internal Rev-

enue Service matter from directly orindirectly employing, accepting assis-tance from, being employed by or shar-ing fees with, any practitioner disbarredor suspended from practice before theInternal Revenue Service.To enable attorneys, certified public

accountants, enrolled agents and en-rolled actuaries to identify practitionersunder consent suspension from practicebefore the Internal Revenue Service, theDirector of Practice will announce in theInternal Revenue Bulletin the names andaddresses of practitioners who havebeen suspended from such practice, theirdesignation as attorney, certified public

accountant, enrolled agent or enrolledactuary, and date or period of suspen-sion. This announcement will appear inthe weekly Bulletin at the earliest practi-cable date after such action and willcontinue to appear in the weekly Bulle-tins for five successive weeks or for asmany weeks as is practicable for eachattorney, certified public accountant, en-rolled agent or enrolled actuary so sus-pended and will be consolidated andpublished in the Cumulative Bulletin.The following individuals have been

placed under consent suspension frompractice before the Internal RevenueService:

Name Address Designation Date of Suspension

Vlymen, Neal Van San Diego, CA CPA Indefinite from November 1, 1996

Lombardi, Theresa Livonia, MI CPA November 1, 1996 to October 31, 1998

Orfall, Warren Hood River, OR CPA November 1, 1996 to June 30, 1997

Oberman, Joseph Highland Park, IL CPA December 1, 1996 to August 31, 1997

Gazzola, Frank N. Mankato, MN CPA December 1, 1996 to November 30, 1997

Tumminello, Anthony G. St. Louis, MO Attorney December 17, 1996 to June 16, 1997

Heffelfinger, Harry N. Buffalo Grove, IL CPA December 20, 1996 to June 19, 1998

Zintl Jr., Ernst J. Newport, MN CPA December 23, 1996 to December 22, 1997

Alms, William R. Lake Forest, CA CPA January 1, 1997 to March 31, 1997

Smith, Arthur L. Athens, GA CPA January 1, 1997 to December 31, 1997

DeGroote Sr., Kevin J. Mesa, AZ CPA January 1, 1997 to October 31, 1997

Oliveri, Robert Bensalem, PA CPA January 1, 1997 to December 31, 1997

Davies, Preston S. Deerfield, IL CPA January 15, 1997 to December 14, 1997

Elbert, David L. Franktown, CO CPA Indefinite from January 21, 1997

Smith Jr., Phillip M. Long Beach, CA Attorney February 1, 1997 to March 31, 1997

Pennington, Richard A. Vandergrift, PA CPA February 1, 1997 to January 31, 2000

Tameron, Joseph A. Chandler, AZ CPA February 1, 1997 to September 30, 1998

Kalb, Mary C. Kearny, NE CPA February 1, 1997 to March 31, 1997

Pritchard, John J. San Diego, CA Enrolled Agent February 1, 1997 to March 31, 1997

Garrett, Richard Torrance, GA Enrolled Agent March 1, 1997 to May 30, 1997

Englert, Larry R. Eaton, OH CPA April 1, 1997 to May 30, 1997

33

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as ‘‘rulings’’)that have an effect on previous rulingsuse the following defined terms to de-scribe the effect:Amplified describes a situation where

no change is being made in a priorpublished position, but the prior positionis being extended to apply to a variationof the fact situation set forth therein.Thus, if an earlier ruling held that aprinciple applied to A, and the newruling holds that the same principle alsoapplies to B, the earlier ruling is ampli-fied. (Compare withmodified, below).Clarified is used in those instances

where the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.Distinguished describes a situation

where a ruling mentions a previouslypublished ruling and points out an es-sential difference between them.Modified is used where the substance

of a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A but notto B, and the new ruling holds that itapplies to both A and B, the prior ruling

is modified because it corrects a pub-lished position. (Compare withamplifiedandclarified, above).Obsoleteddescribes a previously pub-

lished ruling that is not considered de-terminative with respect to future trans-actions. This term is most commonlyused in a ruling that lists previouslypublished rulings that are obsoleted be-cause of changes in law or regulations.A ruling may also be obsoleted becausethe substance has been included in regu-lations subsequently adopted.Revoked describes situations where

the position in the previously publishedruling is not correct and the correctposition is being stated in the newruling.Supersededdescribes a situation

where the new ruling does nothing morethan restate the substance and situationof a previously published ruling (orrulings). Thus, the term is used torepublish under the 1986 Code andregulations the same position publishedunder the 1939 Code and regulations.The term is also used when it is desiredto republish in a single ruling a series ofsituations, names, etc., that were previ-ously published over a period of time inseparate rulings. If the new ruling does

more than restate the substance of aprior ruling, a combination of terms isused. For example,modifiedand super-seded describes a situation where thesubstance of a previously published rul-ing is being changed in part and iscontinued without change in part and itis desired to restate the valid portion ofthe previously published ruling in a newruling that is self contained. In this casethe previously published ruling is firstmodified and then, as modified, is su-perseded.Supplementedis used in situations in

which a list, such as a list of the namesof countries, is published in a ruling andthat list is expanded by adding furthernames in subsequent rulings. After theoriginal ruling has been supplementedseveral times, a new ruling may bepublished that includes the list in theoriginal ruling and the additions, andsupersedes all prior rulings in the series.Suspendedis used in rare situations to

show that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current use andformerly used will appear in material published inthe Bulletin.

A—Individual.

Acq.—Acquiescence.

B—Individual.

BE—Beneficiary.

BK—Bank.

B.T.A.—Board of Tax Appeals.

C.—Individual.

C.B.—Cumulative Bulletin.

CFR—Code of Federal Regulations.

CI—City.

COOP—Cooperative.

Ct.D.—Court Decision.

CY—County.

D—Decedent.

DC—Dummy Corporation.

DE—Donee.

Del. Order—Delegation Order.

DISC—Domestic International Sales Corporation.

DR—Donor.

E—Estate.

EE—Employee.

E.O.—Executive Order.

ER—Employer.

ERISA—Employee Retirement Income Security Act.

EX—Executor.

F—Fiduciary.

FC—Foreign Country.

FICA—Federal Insurance Contribution Act.

FISC—Foreign International Sales Company.

FPH—Foreign Personal Holding Company.

F.R.—Federal Register.

FUTA—Federal Unemployment Tax Act.

FX—Foreign Corporation.

G.C.M.—Chief Counsel’s Memorandum.

GE—Grantee.

GP—General Partner.

GR—Grantor.

IC—Insurance Company.

I.R.B.—Internal Revenue Bulletin.

LE—Lessee.

LP—Limited Partner.

LR—Lessor.

M—Minor.

Nonacq.—Nonacquiescence.

O—Organization.

P—Parent Corporation.

PHC—Personal Holding Company.

PO—Possession of the U.S.

PR—Partner.

PRS—Partnership.

PTE—Prohibited Transaction Exemption.

Pub. L.—Public Law.

REIT—Real Estate Investment Trust.

Rev. Proc.—Revenue Procedure.

Rev. Rul.—Revenue Ruling.

S—Subsidiary.

S.P.R.—Statements of Procedural Rules.

Stat.—Statutes at Large.

T—Target Corporation.

T.C.—Tax Court.

T.D.—Treasury Decision.

TFE—Transferee.

TFR—Transferor.

T.I.R.—Technical Information Release.

TP—Taxpayer.

TR—Trust.

TT—Trustee.

U.S.C.—United States Code.

X—Corporation.

Y—Corporation.

Z—Corporation.

34

Numerical Finding List1

Bulletin 1997–1 through 1997–12Announcements:

97–1, 1997–2 I.R.B.6397–2, 1997–2 I.R.B.6397–3, 1997–2 I.R.B.6397–4, 1997–3 I.R.B.1497–5, 1997–3 I.R.B.1597–6, 1997–4 I.R.B.1197–7, 1997–4 I.R.B.1297–8, 1997–4 I.R.B.1297–9, 1997–5 I.R.B.2797–10, 1997–10 I.R.B.6497–11, 1997–6 I.R.B.1997–12, 1997–7 I.R.B.5597–13, 1997–8 I.R.B.3897–14, 1997–8 I.R.B.3897–15, 1997–9 I.R.B.2397–16, 1997–9 I.R.B.2397–17, 1997–9 I.R.B.2397–18, 1997–10 I.R.B.6797–19, 1997–10 I.R.B.6897–20, 1997–11 I.R.B.2297–21, 1997–11 I.R.B.2397–22, 1997–12 I.R.B.4797–23, 1997–11 I.R.B.2397–24, 1997–11 I.R.B.2497–25, 1997–12 I.R.B.4797–26, 1997–12 I.R.B.48

Notices:

97–1, 1997–2 I.R.B.2297–2, 1997–2 I.R.B.2297–3, 1997–1 I.R.B.897–4, 1997–2 I.R.B.2497–5, 1997–2 I.R.B.2597–6, 1997–2 I.R.B.2697–7, 1997–1 I.R.B.897–8, 1997–4 I.R.B.797–9, 1997–2 I.R.B.3597–10, 1997–2 I.R.B.4197–11, 1997–2 I.R.B.5097–12, 1997–3 I.R.B.1197–13, 1997–6 I.R.B.1397–14, 1997–8 I.R.B.2397–15, 1997–8 I.R.B.2397–16, 1997–9 I.R.B.1597–17, 1997–10 I.R.B.3497–18, 1997–10 I.R.B.3597–19, 1997–10 I.R.B.4097–20, 1997–10 I.R.B.5297–21, 1997–11 I.R.B.9

Proposed Regulations:

REG–209040–88, 1997–7 I.R.B.34REG–209121–89, 1997–11 I.R.B.15REG–208288–90, 1997–11 I.R.B.14REG–209494–90, 1997–8 I.R.B.24REG–208172–91, 1997–10 I.R.B.59REG–209672–93, 1997–6 I.R.B.15REG–209729–94, 1997–11 I.R.B.19REG–209762–95, 1997–3 I.R.B.12REG–209817–96, 1997–7 I.R.B.41REG–209824–96, 1997–11 I.R.B.19REG–209828–96, 1997–6 I.R.B.15REG–209834–96, 1997–4 I.R.B.9REG–209839–96, 1997–8 I.R.B.26

Proposed Regulations—Continued

REG–242996–96, 1997–9 I.R.B.18REG–246018–96, 1997–8 I.R.B.30REG–247678–96, 1997–6 I.R.B.17REG–247862–96, 1997–8 I.R.B.32REG–248770–96, 1997–8 I.R.B.33REG–249819–96, 1997–7 I.R.B.50REG–252231–96, 1997–7 I.R.B.52REG–252233–96, 1997–9 I.R.B.19REG–252665–96, 1997–12 I.R.B.46

Revenue Procedures:

97–1, 1997–1 I.R.B.1197–2, 1997–1 I.R.B.6497–3, 1997–1 I.R.B.8497–4, 1997–1 I.R.B.9697–5, 1997–1 I.R.B.13297–6, 1997–1 I.R.B.15397–7, 1997–1 I.R.B.18597–8, 1997–1 I.R.B.18797–9, 1997–2 I.R.B.5697–10, 1997–2 I.R.B.5997–11, 1997–6 I.R.B.1397–12, 1997–4 I.R.B.797–13, 1997–5 I.R.B.1897–14, 1997–5 I.R.B.2097–15, 1997–5 I.R.B.2197–16, 1997–5 I.R.B.2597–17, 1997–9 I.R.B.1597–18, 1997–10 I.R.B.5397–19, 1997–10 I.R.B.5597–20, 1997–11 I.R.B.1097–21, 1997–12 I.R.B.44

Revenue Rulings:

97–1, 1997–2 I.R.B.1097–2, 1997–2 I.R.B.797–3, 1997–2 I.R.B.597–4, 1997–3 I.R.B.697–5, 1997–4 I.R.B.597–6, 1997–4 I.R.B.497–7, 1997–5 I.R.B.1497–8, 1997–7 I.R.B.497–9, 1997–9 I.R.B.497–10, 1997–10 I.R.B.3197–11, 1997–10 I.R.B.597–12, 1997–11 I.R.B.597–14, 1997–11 I.R.B.597–15, 1997–12 I.R.B.42

Social Security Domestic Coverage Threshold

1997–9, I.R.B.17

Treasury Decisions:

8688, 1997–3 I.R.B.78689, 1997–3 I.R.B.98690, 1997–5 I.R.B.58691, 1997–5 I.R.B.168692, 1997–3 I.R.B.48693, 1997–6 I.R.B.98694, 1997–6 I.R.B.118695, 1997–4 I.R.B.58696, 1997–6 I.R.B.48697, 1997–2 I.R.B.118698, 1997–7 I.R.B.298699, 1997–6 I.R.B.48700, 1997–7 I.R.B.58701, 1997–7 I.R.B.238702, 1997–8 I.R.B.4

Treasury Decisions—Continued

8703, 1997–8 I.R.B.188704, 1997–8 I.R.B.128705, 1997–8 I.R.B.168706, 1997–9 I.R.B.118707, 1997–7 I.R.B.178708, 1997–10 I.R.B.148709, 1997–9 I.R.B.58711, 1997–12 I.R.B.358712, 1997–12 I.R.B.4

1A cumulative list of all Revenue Rulings,Revenue Procedures, Treasury Decisions, etc.,published in Internal Revenue Bulletins 1996–27through 1996–53 will be found in InternalRevenue Bulletin 1997–1, dated January 6, 1997.

35

Finding List of Current Action onPreviously Published Items1

Bulletin 1997–1 through 1997–12

*Denotes entry since last publication

Revenue Procedures:

66–3Modified by97–11, 1997–6 I.R.B.13

87–21Modified by97–11, 1997–6 I.R.B.13

92–20Modified by97–1, 1997–1 I.R.B.11

92–20Modified by97–10, 1997–2 I.R.B.59

92–90Superseded by97–1, 1997–1 I.R.B.11

94–52Revoked by97–11, 1997–6 I.R.B.13

96–1Superseded by97–1, 1997–1 I.R.B.11

96–2Superseded by97–2, 1997–1 I.R.B.64

96–3Superseded by97–3, 1997–1 I.R.B.84

96–4Superseded by97–4, 1997–1 I.R.B.96

96–5Superseded by97–5, 1997–1 I.R.B.132

96–6Superseded by97–6, 1997–1 I.R.B.153

96–7Superseded by97–7, 1997–1 I.R.B.185

96–8Superseded by97–8, 1997–1 I.R.B.187

97–2Amplified by97–21, 1997–12 I.R.B.44

Revenue Rulings:

70–480Revoked by97–6, 1997–4 I.R.B.4

72–527Obsoleted by8704, 1997–8 I.R.B.12

74–59Revoked by8708, 1997–10 I.R.B.14

Revenue Rulings—Continued

92–19Supplemented in part by97–2, 1997–2 I.R.B.7

96–12Superseded by97–3, 1997–1 I.R.B.84

96–13Modified by97–1, 1997–1 I.R.B.11

96–22Superseded by97–3, 1997–1 I.R.B.84

96–34Superseded by97–3, 1997–1 I.R.B.84

96–39Superseded by97–3, 1997–1 I.R.B.84

96–43Superseded by97–3, 1997–1 I.R.B.84

96–56Superseded by97–3, 1997–1 I.R.B.84

1A cumulative finding list for previously publisheditems mentioned in Internal Revenue Bulletins1996–27 through 1996–53 will be found in Inter-nal Revenue Bulletin 1997–1, dated January 6,1997.

36