Bulletin No.

2007-39
September 24, 2007

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

INCOME TAX and Notices 89–110 and 2002–45 modified. A public hearing
is scheduled for November 15, 2007.

Rev. Rul. 2007–56, page 668. REG–148393–06, page 714.

Interest rates; underpayments and overpayments. The Proposed regulations under section 402 of the Code clarify
rates of interest determined under section 6621 of the Code that a payment from a qualified plan for an accident or health
for the calendar quarter beginning October 1, 2007, will be insurance premium generally constitutes a distribution under
8 percent for overpayments (7 percent in the case of a cor- section 402(a) that is taxable to the distributee under sec-
poration), 8 percent for underpayments, and 10 percent for tion 72 in the taxable year in which the premium is paid. The
large corporate underpayments. The rate of interest paid on taxable amount generally would equal the amount of the pre-
the portion of a corporate overpayment exceeding $10,000 mium charged against the participant’s benefits under the plan.
will be 5.5 percent. These regulations would also provide that a distribution for the
payment of the premium by a qualified plan generally is not
T.D. 9349, page 668. excluded from gross income under section 104, 105 or 106,
This document removes temporary regulations under section but such distribution would constitute an amount paid for acci-
125 of the Code relating to benefits that may be offered to dent or health insurance under section 213. A public hearing
participants under a cafeteria plan. is scheduled for December 6, 2007.
Rev. Proc. 2007–60, page 679. Notice 2007–75, page 679.
This procedure corrects the inflation adjusted amounts set Weighted average interest rate update; corporate bond
forth in Rev. Proc. 2006–53, 2006–48 I.R.B. 996, that indices; 30-year Treasury securities. The weighted aver-
apply to taxpayers who elect to expense certain depreciable age interest rate for September 2007 and the resulting permis-
assets under section 179 of the Code. This correction reflects sible range of interest rates used to calculate current liability
statutory changes enacted subsequent to the publication of and to determine the required contribution are set forth.
Rev. Proc. 2006–53. Rev. Proc. 2006–53 modified.

EMPLOYEE PLANS

REG–142695–05, page 681.

Proposed regulations under section 125 of the Code pro-
vide guidance on cafeteria plans. EE–16–79, EE–130–86,
REG–243025–96, and REG–117162–99 withdrawn. Rev.
Ruls. 69–141, 2002–41, 2003–102, 2005–24, 2006–36,

(Continued on the next page)

Finding Lists begin on page ii.

Index for July through September begins on page v.
EXEMPT ORGANIZATIONS

Announcement 2007–86, page 719.

The IRS has revoked its determination that Museum of Amer-
ican Piano of Bangor, PA; Transitional Living Collaborative of
Moraga, CA; Ken-Ray, Incorporated, of Orem, UT; DreamHome
Foundation of Sherwood, OR; Creativity Innovation Productivity,
Incorporated, DBA Horizon Event Foundation of Highwood, MT;
Community Fellowship for Battered Women of Silicon Valley,
Inc., of San Jose, CA; Alta Crossing, Inc., of Nampa, ID; Home
Buyers Assistance Foundation, Inc., of Denver, CO; Interna-
tional Housing Solutions, Inc., of Sacramento, CA; and Filipino
American Community Development Council, Inc., of San Jose,
CA, qualify as organizations described in sections 501(c)(3)
and 170(c)(2) of the Code.

EMPLOYMENT TAX

T.D. 9356, page 675.

Final regulations under section 7701 of the Code explain
that certain disregarded entities (qualified subchapter S sub-
sidiaries and single-owner eligible entities) are to be treated
as entities separate from their owners for purposes of paying
and reporting federal employment and certain excise taxes.
Notice 99–6 obsoleted as of January 1, 2009.

EXCISE TAX

T.D. 9356, page 675.

Final regulations under section 7701 of the Code explain
that certain disregarded entities (qualified subchapter S sub-
sidiaries and single-owner eligible entities) are to be treated
as entities separate from their owners for purposes of paying
and reporting federal employment and certain excise taxes.
Notice 99–6 obsoleted as of January 1, 2009.

ADMINISTRATIVE

Announcement 2007–85, page 719.

This document provides notice of cancellation of a public
hearing on proposed regulations (REG–143797–06, 2007–26
I.R.B. 1495) providing guidance on employer comparable
contributions to Health Savings Accounts (HSAs).

September 24, 2007 2007–39 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping applying the tax law with integrity and fairness to all.
them understand and meet their tax responsibilities and by

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

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

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

2007–39 I.R.B. September 24, 2007

 Place missing child here.

September 24, 2007 2007–39 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 125.—Cafeteria Special Analyses Section 6621.—Determina-
Plans tion of Rate of Interest
It has been determined that this removal
26 CFR 1.125–2T: Cafeteria plan elections. of temporary regulations is not a signifi- 26 CFR 301.6621–1: Interest rate.
cant regulatory action as defined in Exec-
T.D. 9349 utive Order 12866. Therefore, a regula- Interest rates; underpayments and
tory assessment is not required. It also has overpayments. The rates of interest de-
DEPARTMENT OF been determined that section 553(b) of the termined under section 6621 of the Code
THE TREASURY Administrative Procedure Act (5 U.S.C. for the calendar quarter beginning Octo-
ber 1, 2007, will be 8 percent for overpay-
Internal Revenue Service chapter 5) does not apply to this removal
of temporary regulations. This removal ments (7 percent in the case of a corpo-
26 CFR Part 1 ration), 8 percent for underpayments, and
of temporary regulations does not impose
a collection of information on small en- 10 percent for large corporate underpay-
Employee Benefits — ments. The rate of interest paid on the por-
Cafeteria Plans tities, thus the Regulatory Flexibility Act
(5 U.S.C. chapter 6) does not apply. Pur- tion of a corporate overpayment exceeding
suant to section 7805(f) of the Code, the $10,000 will be 5.5 percent.
AGENCY: Internal Revenue Service
(IRS), Treasury. preceding temporary regulations were sub-
mitted to the Chief Counsel for Advocacy Rev. Rul. 2007–56
ACTION: Removal of temporary regula- of the Small Business Administration for Section 6621 of the Internal Revenue
tions. comment on its impact on small business. Code establishes the rates for interest
SUMMARY: This document removes the Drafting Information on tax overpayments and tax underpay-
temporary regulations pertaining to ben- ments. Under section 6621(a)(1), the
efits that may be offered to participants The principal author of this removal of overpayment rate is the sum of the federal
under a section 125 cafeteria plan. The temporary regulations is Mireille Khoury, short-term rate plus 3 percentage points
temporary regulations were published in Office of Division Counsel/Associate (2 percentage points in the case of a cor-
the Federal Register on February 4, 1986. Chief Counsel (Tax Exempt and Govern- poration), except the rate for the portion
Guidance issued by the IRS and the Trea- ment Entities). However, personnel from of a corporate overpayment of tax exceed-
sury Department under section 125 have Treasury participated in its development. ing $10,000 for a taxable period is the
made these temporary regulations obso- sum of the federal short-term rate plus
***** 0.5 of a percentage point. Under section
lete.
6621(a)(2), the underpayment rate is the
Amendments to the Regulations
DATES: Effective Dates: These regula- sum of the federal short-term rate plus 3
tions are effective August 1, 2007. Accordingly, 26 CFR part 1 is amended percentage points.
as follows: Section 6621(c) provides that for pur-
FOR FURTHER INFORMATION poses of interest payable under section
Paragraph 1. The authority citation for
CONTACT: Mireille Khoury at (202) 6601 on any large corporate underpay-
part 1 continues to read in part, as follows:
622–6080 (not a toll-free number). ment, the underpayment rate under section
Authority: 26 U.S.C. 7805 * * *
6621(a)(2) is determined by substituting
SUPPLEMENTARY INFORMATION:
§1.125–2T [Removed] “5 percentage points” for “3 percentage
Background points.” See section 6621(c) and section
Par. 2. Section 1.125–2T is removed. 301.6621–3 of the Regulations on Proce-
On February 4, 1986, the IRS and Trea- dure and Administration for the definition
sury Department published temporary reg- Kevin M. Brown, of a large corporate underpayment and
ulations on section 125. The temporary Deputy Commissioner for for the rules for determining the appli-
regulations were published in the Federal Services and Enforcement. cable date. Section 6621(c) and section
Register (T.D. 8073, 1986–1 C.B. 45 [51 301.6621–3 are generally effective for
Approved July 24, 2007.
FR 4318]) as section 1.125–2T. A notice of periods after December 31, 1990.
proposed rulemaking issued under section Eric Solomon, Section 6621(b)(1) provides that the
125 (REG–142695–05, this Bulletin) and Assistant Secretary of Secretary will determine the federal
other guidance issued by the IRS and the the Treasury (Tax Policy). short-term rate for the first month in each
Treasury Department under section 125 calendar quarter.
(Filed by the Office of the Federal Register on July 31, 2007,
have made these temporary regulations ob- 8:45 a.m., and published in the issue of the Federal Register
Section 6621(b)(2)(A) provides that the
solete. The temporary regulations are re- for August 1, 2007, 72 F.R. 41891) federal short-term rate determined under
moved. section 6621(b)(1) for any month applies

2007–39 I.R.B. 668 September 24, 2007

during the first calendar quarter beginning pursuant to section 6622, is subject to daily Interest factors for daily compound in-
after such month. compounding. terest for annual rates of 5.5 percent, 7 per-
Section 6621(b)(3) provides that the Rounded to the nearest full percent, the cent, 8 percent, and 10 percent are pub-
federal short-term rate for any month is federal short-term rate based on daily com- lished in Tables 16, 19, 21, and 25 of Rev.
the federal short-term rate determined pounding determined during the month of Proc. 95–17, 1995–1 C.B. 556, 570, 573,
during such month by the Secretary in July 2007 is 5 percent. Accordingly, an 575, and 579.
accordance with section 1274(d), rounded overpayment rate of 8 percent (7 percent Annual interest rates to be compounded
to the nearest full percent (or, if a multiple in the case of a corporation) and an under- daily pursuant to section 6622 that apply
of 1/2 of 1 percent, the rate is increased to payment rate of 8 percent are established for prior periods are set forth in the tables
the next highest full percent). for the calendar quarter beginning October accompanying this revenue ruling.
Notice 88–59, 1988–1 C.B. 546, an- 1, 2007. The overpayment rate for the por-
nounced that, in determining the quarterly tion of a corporate overpayment exceeding DRAFTING INFORMATION
interest rates to be used for overpayments $10,000 for the calendar quarter beginning
The principal author of this revenue
and underpayments of tax under section October 1, 2007, is 5.5 percent. The un-
ruling is Wendy Kribell of the Office of
6621, the Internal Revenue Service will derpayment rate for large corporate under-
Associate Chief Counsel (Procedure &
use the federal short-term rate based on payments for the calendar quarter begin-
Administration). For further informa-
daily compounding because that rate is ning October 1, 2007, is 10 percent. These
tion regarding this revenue ruling, contact
most consistent with section 6621 which, rates apply to amounts bearing interest dur-
Ms. Kribell at (202) 622–4570 (not a
ing that calendar quarter.
toll-free call).

TABLE OF INTEREST RATES

PERIODS BEFORE JUL. 1, 1975 — PERIODS ENDING DEC. 31, 1986
OVERPAYMENTS AND UNDERPAYMENTS
In 1995–1 C.B.
PERIOD RATE DAILY RATE TABLE
Before Jul. 1, 1975 6% Table 2, pg. 557
Jul. 1, 1975—Jan. 31, 1976 9% Table 4, pg. 559
Feb. 1, 1976—Jan. 31, 1978 7% Table 3, pg. 558
Feb. 1, 1978—Jan. 31, 1980 6% Table 2, pg. 557
Feb. 1, 1980—Jan. 31, 1982 12% Table 5, pg. 560
Feb. 1, 1982—Dec. 31, 1982 20% Table 6, pg. 560
Jan. 1, 1983—Jun. 30, 1983 16% Table 37, pg. 591
Jul. 1, 1983—Dec. 31, 1983 11% Table 27, pg. 581
Jan. 1, 1984—Jun. 30, 1984 11% Table 75, pg. 629
Jul. 1, 1984—Dec. 31, 1984 11% Table 75, pg. 629
Jan. 1, 1985—Jun. 30, 1985 13% Table 31, pg. 585
Jul. 1, 1985—Dec. 31, 1985 11% Table 27, pg. 581
Jan. 1, 1986—Jun. 30, 1986 10% Table 25, pg. 579
Jul. 1, 1986—Dec. 31, 1986 9% Table 23, pg. 577

TABLE OF INTEREST RATES

FROM JAN. 1, 1987 — DEC. 31, 1998
OVERPAYMENTS UNDERPAYMENTS
1995–1 C.B. 1995–1 C.B.
RATE TABLE PG RATE TABLE PG
Jan. 1, 1987—Mar. 31, 1987 8% 21 575 9% 23 577
Apr. 1, 1987—Jun. 30, 1987 8% 21 575 9% 23 577
Jul. 1, 1987—Sep. 30, 1987 8% 21 575 9% 23 577
Oct. 1, 1987—Dec. 31, 1987 9% 23 577 10% 25 579
Jan. 1, 1988—Mar. 31, 1988 10% 73 627 11% 75 629
Apr. 1, 1988—Jun. 30, 1988 9% 71 625 10% 73 627
Jul. 1, 1988—Sep. 30, 1988 9% 71 625 10% 73 627
Oct. 1, 1988—Dec. 31, 1988 10% 73 627 11% 75 629
Jan. 1, 1989—Mar. 31, 1989 10% 25 579 11% 27 581

September 24, 2007 669 2007–39 I.R.B.

 TABLE OF INTEREST RATES
FROM JAN. 1, 1987 — DEC. 31, 1998 – Continued
OVERPAYMENTS UNDERPAYMENTS
1995–1 C.B. 1995–1 C.B.
RATE TABLE PG RATE TABLE PG
Apr. 1, 1989—Jun. 30, 1989 11% 27 581 12% 29 583
Jul. 1, 1989—Sep. 30, 1989 11% 27 581 12% 29 583
Oct. 1, 1989—Dec. 31, 1989 10% 25 579 11% 27 581
Jan. 1, 1990—Mar. 31, 1990 10% 25 579 11% 27 581
Apr. 1, 1990—Jun. 30, 1990 10% 25 579 11% 27 581
Jul. 1, 1990—Sep. 30, 1990 10% 25 579 11% 27 581
Oct. 1, 1990—Dec. 31, 1990 10% 25 579 11% 27 581
Jan. 1, 1991—Mar. 31, 1991 10% 25 579 11% 27 581
Apr. 1, 1991—Jun. 30, 1991 9% 23 577 10% 25 579
Jul. 1, 1991—Sep. 30, 1991 9% 23 577 10% 25 579
Oct. 1, 1991—Dec. 31, 1991 9% 23 577 10% 25 579
Jan. 1, 1992—Mar. 31, 1992 8% 69 623 9% 71 625
Apr. 1, 1992—Jun. 30, 1992 7% 67 621 8% 69 623
Jul. 1, 1992—Sep. 30, 1992 7% 67 621 8% 69 623
Oct. 1, 1992—Dec. 31, 1992 6% 65 619 7% 67 621
Jan. 1, 1993—Mar. 31, 1993 6% 17 571 7% 19 573
Apr. 1, 1993—Jun. 30, 1993 6% 17 571 7% 19 573
Jul. 1, 1993—Sep. 30, 1993 6% 17 571 7% 19 573
Oct. 1, 1993—Dec. 31, 1993 6% 17 571 7% 19 573
Jan. 1, 1994—Mar. 31, 1994 6% 17 571 7% 19 573
Apr. 1, 1994—Jun. 30, 1994 6% 17 571 7% 19 573
Jul. 1, 1994—Sep. 30, 1994 7% 19 573 8% 21 575
Oct. 1, 1994—Dec. 31, 1994 8% 21 575 9% 23 577
Jan. 1, 1995—Mar. 31, 1995 8% 21 575 9% 23 577
Apr. 1, 1995—Jun. 30, 1995 9% 23 577 10% 25 579
Jul. 1, 1995—Sep. 30, 1995 8% 21 575 9% 23 577
Oct. 1, 1995—Dec. 31, 1995 8% 21 575 9% 23 577
Jan. 1, 1996—Mar. 31, 1996 8% 69 623 9% 71 625
Apr. 1, 1996—Jun. 30, 1996 7% 67 621 8% 69 623
Jul. 1, 1996—Sep. 30, 1996 8% 69 623 9% 71 625
Oct. 1, 1996—Dec. 31, 1996 8% 69 623 9% 71 625
Jan. 1, 1997—Mar. 31, 1997 8% 21 575 9% 23 577
Apr. 1, 1997—Jun. 30, 1997 8% 21 575 9% 23 577
Jul. 1, 1997—Sep. 30, 1997 8% 21 575 9% 23 577
Oct. 1, 1997—Dec. 31, 1997 8% 21 575 9% 23 577
Jan. 1, 1998—Mar. 31, 1998 8% 21 575 9% 23 577
Apr. 1, 1998—Jun. 30, 1998 7% 19 573 8% 21 575
Jul. 1, 1998—Sep. 30, 1998 7% 19 573 8% 21 575
Oct. 1, 1998—Dec. 31, 1998 7% 19 573 8% 21 575

TABLE OF INTEREST RATES

FROM JANUARY 1, 1999 — PRESENT
NONCORPORATE OVERPAYMENTS AND UNDERPAYMENTS
1995–1 C.B.
RATE TABLE PAGE
Jan. 1, 1999—Mar. 31, 1999 7% 19 573
Apr. 1, 1999—Jun. 30, 1999 8% 21 575
Jul. 1, 1999—Sep. 30, 1999 8% 21 575
Oct. 1, 1999—Dec. 31, 1999 8% 21 575
Jan. 1, 2000—Mar. 31, 2000 8% 69 623
Apr. 1, 2000—Jun. 30, 2000 9% 71 625
Jul. 1, 2000—Sep. 30, 2000 9% 71 625

2007–39 I.R.B. 670 September 24, 2007

 TABLE OF INTEREST RATES
FROM JANUARY 1, 1999 — PRESENT – Continued
NONCORPORATE OVERPAYMENTS AND UNDERPAYMENTS
1995–1 C.B.
RATE TABLE PAGE
Oct. 1, 2000—Dec. 31, 2000 9% 71 625
Jan. 1, 2001—Mar. 31, 2001 9% 23 577
Apr. 1, 2001—Jun. 30, 2001 8% 21 575
Jul. 1, 2001—Sep. 30, 2001 7% 19 573
Oct. 1, 2001—Dec. 31, 2001 7% 19 573
Jan. 1, 2002—Mar. 31, 2002 6% 17 571
Apr. 1, 2002—Jun. 30, 2002 6% 17 571
Jul. 1, 2002—Sep. 30, 2002 6% 17 571
Oct. 1, 2002—Dec. 31, 2002 6% 17 571
Jan. 1, 2003—Mar. 31, 2003 5% 15 569
Apr. 1, 2003—Jun. 30, 2003 5% 15 569
Jul. 1, 2003—Sep. 30, 2003 5% 15 569
Oct. 1, 2003—Dec. 31, 2003 4% 13 567
Jan. 1, 2004—Mar. 31, 2004 4% 61 615
Apr. 1, 2004—Jun. 30, 2004 5% 63 617
Jul. 1, 2004—Sep. 30, 2004 4% 61 615
Oct. 1, 2004—Dec. 31, 2004 5% 63 617
Jan. 1, 2005—Mar. 31, 2005 5% 15 569
Apr. 1, 2005—Jun. 30, 2005 6% 17 571
Jul. 1, 2005—Sep. 30, 2005 6% 17 571
Oct. 1, 2005—Dec. 31, 2005 7% 19 573
Jan. 1, 2006—Mar. 31, 2006 7% 19 573
Apr. 1, 2006—Jun. 30, 2006 7% 19 573
Jul. 1, 2006—Sep. 30, 2006 8% 21 575
Oct. 1, 2006—Dec. 31, 2006 8% 21 575
Jan. 1, 2007—Mar. 31, 2007 8% 21 575
Apr. 1, 2007—Jun. 30, 2007 8% 21 575
Jul. 1, 2007—Sep. 30, 2007 8% 21 575
Oct. 1, 2007—Dec. 31, 2007 8% 21 575

TABLE OF INTEREST RATES

FROM JANUARY 1, 1999 — PRESENT
CORPORATE OVERPAYMENTS AND UNDERPAYMENTS
OVERPAYMENTS UNDERPAYMENTS
1995–1 C.B. 1995–1 C.B.
RATE TABLE PG RATE TABLE PG
Jan. 1, 1999—Mar. 31, 1999 6% 17 571 7% 19 573
Apr. 1, 1999—Jun. 30, 1999 7% 19 573 8% 21 575
Jul. 1, 1999—Sep. 30, 1999 7% 19 573 8% 21 575
Oct. 1, 1999—Dec. 31, 1999 7% 19 573 8% 21 575
Jan. 1, 2000—Mar. 31, 2000 7% 67 621 8% 69 623
Apr. 1, 2000—Jun. 30, 2000 8% 69 623 9% 71 625
Jul. 1, 2000—Sep. 30, 2000 8% 69 623 9% 71 625
Oct. 1, 2000—Dec. 31, 2000 8% 69 623 9% 71 625
Jan. 1, 2001—Mar. 31, 2001 8% 21 575 9% 23 577
Apr. 1, 2001—Jun. 30, 2001 7% 19 573 8% 21 575
Jul. 1, 2001—Sep. 30, 2001 6% 17 571 7% 19 573
Oct. 1, 2001—Dec. 31, 2001 6% 17 571 7% 19 573
Jan. 1, 2002—Mar. 31, 2002 5% 15 569 6% 17 571
Apr. 1, 2002—Jun. 30, 2002 5% 15 569 6% 17 571
Jul. 1, 2002—Sep. 30, 2002 5% 15 569 6% 17 571

September 24, 2007 671 2007–39 I.R.B.

 TABLE OF INTEREST RATES
FROM JANUARY 1, 1999 — PRESENT – Continued
CORPORATE OVERPAYMENTS AND UNDERPAYMENTS
OVERPAYMENTS UNDERPAYMENTS
1995–1 C.B. 1995–1 C.B.
RATE TABLE PG RATE TABLE PG
Oct. 1, 2002—Dec. 31, 2002 5% 15 569 6% 17 571
Jan. 1, 2003—Mar. 31, 2003 4% 13 567 5% 15 569
Apr. 1, 2003—Jun. 30, 2003 4% 13 567 5% 15 569
Jul. 1, 2003—Sep. 30, 2003 4% 13 567 5% 15 569
Oct. 1, 2003—Dec. 31, 2003 3% 11 565 4% 13 567
Jan. 1, 2004—Mar. 31, 2004 3% 59 613 4% 61 615
Apr. 1, 2004—Jun. 30, 2004 4% 61 615 5% 63 617
Jul. 1, 2004—Sep. 30, 2004 3% 59 613 4% 61 615
Oct. 1, 2004—Dec. 31, 2004 4% 61 615 5% 63 617
Jan. 1, 2005—Mar. 31, 2005 4% 13 567 5% 15 569
Apr. 1, 2005—Jun. 30, 2005 5% 15 569 6% 17 571
Jul. 1, 2005—Sep. 30, 2005 5% 15 569 6% 17 571
Oct. 1, 2005—Dec. 31, 2005 6% 17 571 7% 19 573
Jan. 1, 2006—Mar. 31, 2006 6% 17 571 7% 19 573
Apr. 1, 2006—Jun. 30, 2006 6% 17 571 7% 19 573
Jul. 1, 2006—Sep. 30, 2006 7% 19 573 8% 21 575
Oct. 1, 2006—Dec. 31, 2006 7% 19 573 8% 21 575
Jan. 1, 2007—Mar. 31, 2007 7% 19 573 8% 21 575
Apr. 1, 2007—Jun. 30, 2007 7% 19 573 8% 21 575
Jul. 1, 2007—Sep. 30, 2007 7% 19 573 8% 21 575
Oct. 1, 2007—Dec. 31, 2007 7% 19 573 8% 21 575

TABLE OF INTEREST RATES FOR

LARGE CORPORATE UNDERPAYMENTS
FROM JANUARY 1, 1991 — PRESENT
1995–1 C.B.
RATE TABLE PG
Jan. 1, 1991—Mar. 31, 1991 13% 31 585
Apr. 1, 1991—Jun. 30, 1991 12% 29 583
Jul. 1, 1991—Sep. 30, 1991 12% 29 583
Oct. 1, 1991—Dec. 31, 1991 12% 29 583
Jan. 1, 1992—Mar. 31, 1992 11% 75 629
Apr. 1, 1992—Jun. 30, 1992 10% 73 627
Jul. 1, 1992—Sep. 30, 1992 10% 73 627
Oct. 1, 1992—Dec. 31, 1992 9% 71 625
Jan. 1, 1993—Mar. 31, 1993 9% 23 577
Apr. 1, 1993—Jun. 30, 1993 9% 23 577
Jul. 1, 1993—Sep. 30, 1993 9% 23 577
Oct. 1, 1993—Dec. 31, 1993 9% 23 577
Jan. 1, 1994—Mar. 31, 1994 9% 23 577
Apr. 1, 1994—Jun. 30, 1994 9% 23 577
Jul. 1, 1994—Sep. 30, 1994 10% 25 579
Oct. 1, 1994—Dec. 31, 1994 11% 27 581
Jan. 1, 1995—Mar. 31, 1995 11% 27 581
Apr. 1, 1995—Jun. 30, 1995 12% 29 583
Jul. 1, 1995—Sep. 30, 1995 11% 27 581
Oct. 1, 1995—Dec. 31, 1995 11% 27 581
Jan. 1, 1996—Mar. 31, 1996 11% 75 629
Apr. 1, 1996—Jun. 30, 1996 10% 73 627
Jul. 1, 1996—Sep. 30, 1996 11% 75 629
Oct. 1, 1996—Dec. 31, 1996 11% 75 629

2007–39 I.R.B. 672 September 24, 2007

 TABLE OF INTEREST RATES FOR
LARGE CORPORATE UNDERPAYMENTS
FROM JANUARY 1, 1991 — PRESENT – Continued
1995–1 C.B.
RATE TABLE PG
Jan. 1, 1997—Mar. 31, 1997 11% 27 581
Apr. 1, 1997—Jun. 30, 1997 11% 27 581
Jul. 1, 1997—Sep. 30, 1997 11% 27 581
Oct. 1, 1997—Dec. 31, 1997 11% 27 581
Jan. 1, 1998—Mar. 31, 1998 11% 27 581
Apr. 1, 1998—Jun. 30, 1998 10% 25 579
Jul. 1, 1998—Sep. 30, 1998 10% 25 579
Oct. 1, 1998—Dec. 31, 1998 10% 25 579
Jan. 1, 1999—Mar. 31, 1999 9% 23 577
Apr. 1, 1999—Jun. 30, 1999 10% 25 579
Jul. 1, 1999—Sep. 30, 1999 10% 25 579
Oct. 1, 1999—Dec. 31, 1999 10% 25 579
Jan. 1, 2000—Mar. 31, 2000 10% 73 627
Apr. 1, 2000—Jun. 30, 2000 11% 75 629
Jul. 1, 2000—Sep. 30, 2000 11% 75 629
Oct. 1, 2000—Dec. 31, 2000 11% 75 629
Jan. 1, 2001—Mar. 31, 2001 11% 27 581
Apr. 1, 2001—Jun. 30, 2001 10% 25 579
Jul. 1, 2001—Sep. 30, 2001 9% 23 577
Oct. 1, 2001—Dec. 31, 2001 9% 23 577
Jan. 1, 2002—Mar. 31, 2002 8% 21 575
Apr. 1, 2002—Jun. 30, 2002 8% 21 575
Jul. 1, 2002—Sep. 30, 2002 8% 21 575
Oct. 1, 2002—Dec. 31, 2002 8% 21 575
Jan. 1, 2003—Mar. 31, 2003 7% 19 573
Apr. 1, 2003—Jun. 30, 2003 7% 19 573
Jul. 1, 2003—Sep. 30, 2003 7% 19 573
Oct. 1, 2003—Dec. 31, 2003 6% 17 571
Jan. 1, 2004—Mar. 31, 2004 6% 65 619
Apr. 1, 2004—Jun. 30, 2004 7% 67 621
Jul. 1, 2004—Sep. 30, 2004 6% 65 619
Oct. 1, 2004—Dec. 31, 2004 7% 67 621
Jan. 1, 2005—Mar. 31, 2005 7% 19 573
Apr. 1, 2005—Jun. 30, 2005 8% 21 575
Jul. 1, 2005—Sep. 30, 2005 8% 21 575
Oct. 1, 2005—Dec. 31, 2005 9% 23 577
Jan. 1, 2006—Mar. 31, 2006 9% 23 577
Apr. 1, 2006—Jun. 30, 2006 9% 23 577
Jul. 1, 2006—Sep. 30, 2006 10% 25 579
Oct. 1, 2006—Dec. 31, 2006 10% 25 579
Jan. 1, 2007—Mar. 31, 2007 10% 25 579
Apr. 1, 2007—Jun. 30, 2007 10% 25 579
Jul. 1, 2007—Sep. 30, 2007 10% 25 579
Oct. 1, 2007—Dec. 31, 2007 10% 25 579

TABLE OF INTEREST RATES FOR CORPORATE

OVERPAYMENTS EXCEEDING $10,000
FROM JANUARY 1, 1995 — PRESENT

1995–1 C.B.
RATE TABLE PG
Jan. 1, 1995—Mar. 31, 1995 6.5% 18 572
Apr. 1, 1995—Jun. 30, 1995 7.5% 20 574

September 24, 2007 673 2007–39 I.R.B.

 TABLE OF INTEREST RATES FOR CORPORATE
OVERPAYMENTS EXCEEDING $10,000
FROM JANUARY 1, 1995 — PRESENT – Continued

1995–1 C.B.
RATE TABLE PG
Jul. 1, 1995—Sep. 30, 1995 6.5% 18 572
Oct. 1, 1995—Dec. 31, 1995 6.5% 18 572
Jan. 1, 1996—Mar. 31, 1996 6.5% 66 620
Apr. 1, 1996—Jun. 30, 1996 5.5% 64 618
Jul. 1, 1996—Sep. 30, 1996 6.5% 66 620
Oct. 1, 1996—Dec. 31, 1996 6.5% 66 620
Jan. 1, 1997—Mar. 31, 1997 6.5% 18 572
Apr. 1, 1997—Jun. 30, 1997 6.5% 18 572
Jul. 1, 1997—Sep. 30, 1997 6.5% 18 572
Oct. 1, 1997—Dec. 31, 1997 6.5% 18 572
Jan. 1, 1998—Mar. 31, 1998 6.5% 18 572
Apr. 1, 1998—Jun. 30, 1998 5.5% 16 570
Jul. 1, 1998—Sep. 30, 1998 5.5% 16 570
Oct. 1, 1998—Dec. 31, 1998 5.5% 16 570
Jan. 1, 1999—Mar. 31, 1999 4.5% 14 568
Apr. 1, 1999—Jun. 30, 1999 5.5% 16 570
Jul. 1, 1999—Sep. 30, 1999 5.5% 16 570
Oct. 1, 1999—Dec. 31, 1999 5.5% 16 570
Jan. 1, 2000—Mar. 31, 2000 5.5% 64 618
Apr. 1, 2000—Jun. 30, 2000 6.5% 66 620
Jul. 1, 2000—Sep. 30, 2000 6.5% 66 620
Oct. 1, 2000—Dec. 31, 2000 6.5% 66 620
Jan. 1, 2001—Mar. 31, 2001 6.5% 18 572
Apr. 1, 2001—Jun. 30, 2001 5.5% 16 570
Jul. 1, 2001—Sep. 30, 2001 4.5% 14 568
Oct. 1, 2001—Dec. 31, 2001 4.5% 14 568
Jan. 1, 2002—Mar. 31, 2002 3.5% 12 566
Apr. 1, 2002—Jun. 30, 2002 3.5% 12 566
Jul. 1, 2002—Sep. 30, 2002 3.5% 12 566
Oct. 1, 2002—Dec. 31, 2002 3.5% 12 566
Jan. 1, 2003—Mar. 31, 2003 2.5% 10 564
Apr. 1, 2003—Jun. 30, 2003 2.5% 10 564
Jul. 1, 2003—Sep. 30, 2003 2.5% 10 564
Oct. 1, 2003—Dec. 31, 2003 1.5% 8 562
Jan. 1, 2004—Mar. 31, 2004 1.5% 56 610
Apr. 1, 2004—Jun. 30, 2004 2.5% 58 612
Jul. 1, 2004—Sep. 30, 2004 1.5% 56 610
Oct. 1, 2004—Dec. 31, 2004 2.5% 58 612
Jan. 1, 2005—Mar. 31, 2005 2.5% 10 564
Apr. 1, 2005—Jun. 30, 2005 3.5% 12 566
Jul. 1, 2005—Sep. 30, 2005 3.5% 12 566
Oct. 1, 2005—Dec. 31, 2005 4.5% 14 568
Jan. 1, 2006—Mar. 31, 2006 4.5% 14 568
Apr. 1, 2006—Jun. 30, 2006 4.5% 14 568
Jul. 1, 2006—Sep. 30, 2006 5.5% 16 570
Oct. 1, 2006—Dec. 31, 2006 5.5% 16 570
Jan. 1, 2007—Mar. 31, 2007 5.5% 16 570
Apr. 1, 2007—Jun. 30, 2007 5.5% 16 570
Jul. 1, 2007—Sep. 30, 2007 5.5% 16 570
Oct. 1, 2007—Dec. 31, 2007 5.5% 16 570

2007–39 I.R.B. 674 September 24, 2007

Section 7701.—Definitions to wages paid on or after January 1, 2009. entity is treated as a corporation for pur-
With respect to excise taxes, these regula- poses of employment taxes and related re-
26 CFR 301.7701–2: Business entities; definitions. tions apply to liabilities imposed and ac- porting requirements. As provided in the
tions first required or permitted in periods proposed regulations, a disregarded entity
T.D. 9356 beginning on or after January 1, 2008. continues to be disregarded for other Fed-
eral tax purposes. The final regulations
DEPARTMENT OF FOR FURTHER INFORMATION clarify that an owner of a disregarded en-
THE TREASURY CONTACT: John Richards at (202) tity treated as a sole proprietorship is sub-
622–6040 (on the employment tax pro- ject to taxes under the Self-Employment
Internal Revenue Service
visions) or Susan Athy at (202) 622–3130 Contributions Act (SECA) (section 1401
26 CFR Parts 1 and 301 (on the excise tax provisions) (not toll-free et. seq.). Additionally, the final regula-
numbers). tions retain the example illustrating that an
Disregarded Entities; individual owner of a disregarded entity
Employment and Excise SUPPLEMENTARY INFORMATION: continues to be treated as self-employed
Taxes for purposes of SECA taxes, and not as an
Background employee of a disregarded entity for em-
AGENCY: Internal Revenue Service ployment tax purposes.
(IRS), Treasury. This document contains amendments Commentators suggested that the pro-
to 26 CFR parts 1 and 301. On October posed regulations not be finalized, and
ACTION: Final regulations. 18, 2005, a notice of proposed rulemak- that Notice 99–6, 1999–1 C.B. 321, be
ing (REG–114371–05, 2005–2 C.B. 930) retained. Notice 99–6 provides that em-
SUMMARY: This document contains fi- was published in the Federal Register ployment taxes and other employment tax
nal regulations under which qualified sub- (70 FR 60475) proposing to treat qual- obligations with respect to employees of
chapter S subsidiaries and single-owner ified subchapter S subsidiaries (QSubs) a disregarded entity may be satisfied in
eligible entities that currently are disre- (under section 1361(b)(3)(B) of the In- one of two ways: (1) calculation, report-
garded as entities separate from their own- ternal Revenue Code (Code)) and certain ing, and payment of all employment tax
ers for Federal tax purposes will be treated other single-owner eligible entities (un- obligations with respect to employees of
as separate entities for employment tax and der §§301.7701–1 through 301.7701–3 of the disregarded entity by its owner (as
related reporting requirement purposes. the Procedure and Administrative Regu- though the employees of the disregarded
This document also contains final regula- lations) that currently are disregarded as entity are employed directly by the owner)
tions that treat such disregarded entities entities separate from their owners (dis- and under the owner’s name and taxpayer
as separate entities for purposes of cer- regarded entities) as separate entities for identification number; or (2) separate cal-
tain excise taxes reported on Forms 720, purposes of employment tax and related culation, reporting, and payment of all
“Quarterly Federal Excise Tax Return;” reporting requirements and for purposes employment tax obligations by each state
730, “Monthly Tax Return for Wagers;” of certain excise taxes reported on Forms law entity with respect to its employees
2290, “Heavy Highway Vehicle Use Tax 720, 730, 2290, and 11–C; excise tax re- under its own name and taxpayer identifi-
Return;” and 11–C, “Occupational Tax funds or payments claimed on Form 8849; cation number.
and Registration Return for Wagering;” and excise tax registrations on Form 637. Commentators stated that the regula-
excise tax refunds or payments claimed on Comments addressing employment taxes tions would increase administrative bur-
Form 8849, “Claim for Refund of Excise were received from the public in response den for taxpayers that currently choose
Taxes;” and excise tax registrations on to the notice of proposed rulemaking. No to pay and report employment taxes at
Form 637, “Application for Registration comments were received regarding the the owner level as permitted by Notice
(For Certain Excise Tax Activities).” These excise tax provisions of the proposed reg- 99–6. Commentators also suggested that
regulations affect disregarded entities and ulations. No public hearing was requested if the regulations were finalized, compli-
the owners and employees of disregarded or held. After consideration of all the cations could arise for states where state
entities with respect to the payment and re- comments, the proposed regulations are employment tax filings are required at
porting of Federal employment taxes and adopted as revised by this Treasury deci- the owner level. No written comments
the reporting of wage payments. These sion. were received from any state. The IRS
regulations also affect disregarded entities and the Treasury Department continue
and their owners in the payment and re- Summary of Comments and Changes to believe that recognizing disregarded
porting of certain Federal excise taxes and Made entities as employers for Federal employ-
in registration and claims related to certain ment taxes will improve administration of
Federal excise taxes. As provided in the proposed regula- the Federal tax laws and simplify Federal
tions, the final regulations provide that a tax compliance with respect to reporting,
DATES: Effective Date: These regulations disregarded entity is treated as a separate payment, and collection of employment
are effective on August 16, 2007. entity for purposes of employment taxes taxes. In addition, because most states
Applicability Dates: With respect to and related reporting requirements. The recognize disregarded entities as employ-
employment taxes, these regulations apply final regulations clarify that the separate ers for reporting, payment, and collection

September 24, 2007 675 2007–39 I.R.B.

of state employment taxes, these regula- not subject to backup withholding under entity, with respect to the excise taxes af-
tions will more closely align Federal and section 3406. These regulations do not ap- fected by these regulations as having been
state reporting, payment and collection ply to reportable payments under section made or taken by the sole owner of that en-
of employment taxes. Accordingly, this 3406. Because the owner of a disregarded tity. Thus, for such periods, the owner of a
comment is not adopted. entity other than a QSub is required to disregarded entity will be treated as satis-
One commentator requested clari- file and furnish information returns with fying the owner’s obligations with respect
fication of the applicability of section respect to non-wage reportable payments to the excise taxes affected by these regu-
3306(c)(8) to services performed for a and that requirement is not affected by lations, provided that those obligations are
disregarded entity that is owned by an or- these regulations, the disregarded entity satisfied either (1) by the owner itself or
ganization described in section 501(c)(3). is not subject to the backup withholding (2) by the disregarded entity on behalf of
Section 3306(c)(8) provides that services requirements. Rather, the owner of the the owner.
performed for an organization described disregarded entity is responsible for any
in section 501(c)(3) are excepted from the backup withholding that is required with Effect on Other Documents
definition of employment for Federal Un- respect to reportable payments consid-
Disregarded entities, and the owners
employment Tax Act (FUTA) purposes. ered made by the owner. Under section
of such entities may continue to use the
Even though a disregarded entity owned 1361(b)(3)(E) disregarded entities that are
procedures permitted by Notice 99–6 for
by a section 501(c)(3) organization will QSubs are subject to information report-
wages paid prior to January 1, 2009. No-
be regarded for employment tax purposes, ing requirements on non-wage payments,
tice 99–6 provides that if the owner calcu-
the disregarded entity will continue to be unless the Secretary provides otherwise.
lates and pays all employment taxes and
considered an unincorporated branch or These regulations do not address the in-
satisfies all other employment tax obliga-
division of the section 501(c)(3) organi- formation reporting for QSubs.
tions with respect to employees of the dis-
zation for other Federal tax purposes. For
Availability of IRS Documents regarded entity under the owner’s name
example, the disregarded entity will be
and taxpayer identification number (as per-
considered an unincorporated branch or
The IRS notice and announcement cited mitted under method (1) of Notice 99–6)
division of the section 501(c)(3) organi-
in this preamble are published in the Inter- for a return period that begins on or af-
zation for purposes of the organization’s
nal Revenue Bulletin or Cumulative Bul- ter April 20, 1999, then the owner must
annual information reporting requirements
letin and are available at www.irs.gov. continue to use this method unless and un-
under section 6033. See Announcement
til otherwise permitted by the Commis-
99–102, 1999–2 C.B. 545. Because sec- Effective Date sioner. However, Notice 99–6 is modified
tion 3306(c)(8) looks to the employer’s
such that a taxpayer may switch to method
status for income tax purposes to establish The employment tax provisions of these
(2) of Notice 99–6 with respect to wages
the basis for exemption from FUTA, a regulations apply to wages paid on or af-
paid on or after August 16, 2007, and be-
disregarded entity owned solely by a sec- ter January 1, 2009. The notice of pro-
fore January 1, 2009, without seeking per-
tion 501(c)(3) organization is considered posed rulemaking provided that these reg-
mission of the Commissioner. Taxpayers
exempt from tax under section 501(c)(3) ulations would become effective with re-
who switch from method (1) to method (2)
for purposes of section 3306(c)(8). Thus, spect to wages paid on January 1 follow-
with respect to wages paid prior to January
a disregarded entity owned solely by a ing the year of publication of these fi-
1, 2009, may consider wages paid by the
section 501(c)(3) organization will not be nal regulations in the Federal Register,
owner to employees of the disregarded en-
subject to FUTA tax on wages it pays its which would have been January 1, 2008.
tity during the calendar year of the switch
employees. However, in order to ensure that taxpay-
as having been paid by the disregarded en-
One commentator requested clarifi- ers have sufficient time to make any nec-
tity for purposes of determining whether
cation of the applicability of the backup essary changes to their systems in response
wages paid to the disregarded entity’s em-
withholding provisions under section 3406 to these regulations, the IRS and the Trea-
ployees have reached the contribution and
to disregarded entities. Section 3406 re- sury Department have determined that it is
benefit base as determined under section
quires the payor of certain “reportable pay- appropriate to delay the effective date of
230 of the Social Security Act and for pur-
ments” to withhold from such payments a these regulations until January 1, 2009.
poses of the wage base under section 3306.
tax at the rate of 28 percent. For instance, The IRS and the Treasury Department
However, as provided in Notice 99–6, re-
if the payee where required to do so does believe that the considerations that support
gardless of whether the owner uses method
not provide a valid taxpayer identification a January 1, 2009, effective date for the
(1) or method (2), the owner is ultimately
number (TIN) to the payor, the payor must employment tax provisions do not apply
responsible for employment tax liabilities
backup withhold on reportable payments to the excise tax provisions. Thus, the ex-
and other employment tax responsibilities
to the payee. Reportable payments are cise tax provisions of these regulations ap-
with respect to all wages paid prior to Jan-
payments that must be reported to a payee ply to liabilities imposed and actions re-
uary 1, 2009, to employees of the disre-
on Form 1099, “U.S. Information Return quired or permitted in periods beginning
garded entity.
for Calendar Year 1971,” such as certain on or after January 1, 2008. For periods
Notice 99–6 is obsoleted as of January
payments for services made in the course beginning before that date, the IRS will
1, 2009.
of a trade or business. Wage payments are treat payments made by a disregarded en-
not reportable payments however, and are tity, or other actions taken by a disregarded

2007–39 I.R.B. 676 September 24, 2007

Special Analyses are, for purposes of section 34, treated as §1.1361–6 [Amended]
payable to the owner of that entity.
It has been determined that this Trea- Par. 5. Section 1.1361–6 is amended
sury decision is not a significant regula- §§1.34–2, 1.34–3, 1.34–4, 1.34–5, and by removing the language “Except
tory action as defined in Executive Order 1.34–6 [Removed] as provided in §§1.1361–4(a)(3)(iii),
12866. Therefore, a regulatory assessment 1.1361–4(a)(5)(i), and 1.1361–5(c)(2)”
is not required. It also has been deter- Par. 3. Sections 1.34–2, 1.34–3, and by adding the language “Except
mined that section 553(b) of the Admin- 1.34–4, 1.34–5, and 1.34–6 are removed. as provided in §§1.1361–4(a)(3)(iii),
istrative Procedure Act (5 U.S.C. chapter Par. 4. Section 1.1361–4 is amended as 1.1361–4(a)(5)(i), 1.1361–4(a)(6)(iii),
5) does not apply to these regulations, and follows: 1.1361–4(a)(7)(ii), 1.1361–4(a)(8)(ii), and
because the regulations do not impose a 1. In paragraph (a)(1) introductory text, 1.1361–5(c)(2)” in its place.
collection of information on small entities, the language “Except as otherwise pro-
the Regulatory Flexibility Act (5 U.S.C. vided in paragraphs (a)(3) and (a)(6)” is re- PART 301—PROCEDURE AND
chapter 6) does not apply. Pursuant to sec- moved, and the language “Except as other- ADMINISTRATION
tion 7805(f) of the Code, the proposed reg- wise provided in paragraphs (a)(3), (a)(6),
Par. 6. The authority citation for part
ulations preceding these regulations were (a)(7), and (a)(8)” is added in its place.
301 continues to read in part as follows:
submitted to the Chief Counsel for Advo- 2. Paragraphs (a)(7) and (a)(8) are
Authority: 26 U.S.C. 7805 * * *
cacy of the Small Business Administration added.
Par. 7. Section 301.7701–2 is amended
for comment on their impact on small busi- The additions read as follows:
as follows:
ness.
§1.1361–4 Effect of QSub election. 1. A sentence is added at the end of
Drafting Information paragraph (a).
(a) * * * 2. Paragraph (c)(2)(i) is revised.
The principal authors of these regula- (7) Treatment of QSubs for purposes 3. Paragraphs (c)(2)(iv), (c)(2)(v),
tions are Susan Athy, Office of Associate of employment taxes—(i) In general. A (e)(5), and (e)(6) are added.
Chief Counsel (Passthroughs and Special QSub is treated as a separate corporation The additions read as follows:
Industries), and John Richards, Office of for purposes of Subtitle C — Employ-
Associate Chief Counsel (Tax Exempt and §301.7701–2 Business entities;
ment Taxes and Collection of Income Tax
Government Entities). However, other definitions.
(Chapters 21, 22, 23, 23A, 24, and 25 of
personnel from the IRS and the Treasury the Internal Revenue Code). (a) * * * But see paragraphs (c)(2)(iv)
Department participated in their develop- (ii) Effective/applicability date. This and (v) of this section for special employ-
ment. paragraph (a)(7) applies with respect to ment and excise tax rules that apply to an
***** wages paid on or after January 1, 2009. eligible entity that is otherwise disregarded
(8) Treatment of QSubs for purposes of as an entity separate from its owner.
Adoption of Amendments to the certain excise taxes—(i) In general. A
QSub is treated as a separate corporation *****
Regulations
for purposes of— (c) * * *
Accordingly, 26 CFR parts 1 and 301 (A) Federal tax liabilities imposed by (2) Wholly owned entities—(i) In gen-
are amended as follows: Chapters 31, 32 (other than section 4181), eral. Except as otherwise provided in this
33, 34, 35, 36 (other than section 4461), paragraph (c), a business entity that has a
PART 1—INCOME TAXES and 38 of the Internal Revenue Code, or single owner and is not a corporation under
any floor stocks tax imposed on articles paragraph (b) of this section is disregarded
Paragraph 1. The authority citation for as an entity separate from its owner.
subject to any of these taxes;
part 1 continues to read in part as follows:
(B) Collection of tax imposed by Chap- *****
Authority: 26 U.S.C. 7805 * * *
ter 33 of the Internal Revenue Code; (iv) Special rule for employment tax
Par. 2. Section 1.34–1 is revised to read
(C) Registration under sections 4101, purposes—(A) In general. Paragraph
as follows:
4222, and 4412; and (c)(2)(i) of this section (relating to certain
§1.34–1 Special rule for owners of certain (D) Claims of a credit (other than a wholly owned entities) does not apply to
business entities. credit under section 34), refund, or pay- taxes imposed under Subtitle C — Em-
ment related to a tax described in para- ployment Taxes and Collection of Income
Amounts payable under sections 6420, graph (a)(8)(i)(A) of this section or under Tax (Chapters 21, 22, 23, 23A, 24, and 25
6421, and 6427 to a business entity that section 6426 or 6427. of the Internal Revenue Code). Paragraph
is treated as separate from its owner un- (ii) Effective/applicability date. This (c)(2)(i) of this section does apply to taxes
der §1.1361–4(a)(8) (relating to certain paragraph (a)(8) applies to liabilities im- imposed under Subtitle A, including Chap-
qualified subchapter S subsidiaries) or posed and actions first required or permit- ter 2 — Tax on Self-Employment Income.
§301.7701–2(c)(2)(v) of this chapter (re- ted in periods beginning on or after Jan- The owner of an entity that is treated in
lating to certain wholly-owned entities) uary 1, 2008. the same manner as a sole proprietorship

September 24, 2007 677 2007–39 I.R.B.

under paragraph (a) of this section will Internal Revenue Code. Thus, A is subject to tax un- section, LLCB is the producer of the coal and is liable
be subject to the tax on self-employment der section 1401 on A’s net earnings from self-em- for tax on its sale of such coal under chapter 32 of the
income. ployment with respect to LLCA’s activities. A is not Internal Revenue Code. LLCB must report and pay
an employee of LLCA for purposes of subtitle C of tax on Form 720, “Quarterly Federal Excise Tax Re-
(B) Treatment of entity. An entity that the Internal Revenue Code. Because LLCA is treated turn,” under its own name and taxpayer identification
is otherwise disregarded as an entity sep- as a sole proprietorship of A for income tax purposes, number.
arate from its owner but for paragraph A is entitled to deduct trade or business expenses (iii) LLCB uses undyed diesel fuel in an earth-
(c)(2)(iv)(A) of this section is treated as a paid or incurred with respect to activities carried on mover that is not registered or required to be reg-
corporation with respect to taxes imposed through LLCA, including the employer’s share of istered for highway use. Such use is an off-high-
employment taxes imposed under sections 3111 and way business use of the fuel. Under section 6427(l),
under Subtitle C — Employment Taxes 3301, on A’s Form 1040, Schedule C, “Profit or Loss the ultimate purchaser is allowed to claim an income
and Collection of Income Tax (Chapters From Business (Sole Proprietorship).” tax credit or payment related to the tax imposed on
21, 22, 23, 23A, 24, and 25 of the Internal (v) Special rule for certain excise tax diesel fuel used in an off-highway business use. Un-
Revenue Code). der paragraph (c)(2)(v) of this section, for purposes of
purposes—(A) In general. Paragraph
(C) Example. The following example the credit or payment allowed under section 6427(l),
(c)(2)(i) of this section (relating to certain LLCB is the person that could claim the amount on
illustrates the application of paragraph wholly owned entities) does not apply for its Form 720 or on a Form 8849, “Claim for Re-
(c)(2)(iv) of this section: purposes of— fund of Excise Taxes.” Alternatively, if LLCB did not
Example. (i) LLCA is an eligible entity owned claim a payment during the time prescribed in section
(1) Federal tax liabilities imposed by
by individual A and is generally disregarded as an 6427(i)(2) for making a claim under section 6427,
entity separate from its owner for Federal tax pur-
Chapters 31, 32 (other than section 4181),
§1.34–1 of this chapter provides that B, the owner of
poses. However, LLCA is treated as an entity sep- 33, 34, 35, 36 (other than section 4461), LLCB, could claim the income tax credit allowed un-
arate from its owner for purposes of subtitle C of the and 38 of the Internal Revenue Code, or der section 34 for the nontaxable use of diesel fuel by
Internal Revenue Code. LLCA has employees and any floor stocks tax imposed on articles LLCB.
pays wages as defined in sections 3121(a), 3306(b),
subject to any of these taxes; *****
and 3401(a).
(ii) LLCA is subject to the provisions of subtitle
(2) Collection of tax imposed by Chap- (e) * * *
C of the Internal Revenue Code and related pro- ter 33 of the Internal Revenue Code; (5) Paragraph (c)(2)(iv) of this section
visions under 26 CFR subchapter C, Employment (3) Registration under sections 4101, applies with respect to wages paid on or
Taxes and Collection of Income Tax at Source, parts 4222, and 4412; and
31 through 39. Accordingly, LLCA is required to
after January 1, 2009.
(4) Claims of a credit (other than a (6) Paragraph (c)(2)(v) of this section
perform such acts as are required of an employer
under those provisions of the Internal Revenue Code
credit under section 34), refund, or pay- applies to liabilities imposed and actions
and regulations thereunder that apply. All provisions ment related to a tax described in para- first required or permitted in periods be-
of law (including penalties) and the regulations pre- graph (c)(2)(v)(A)(1) of this section or un- ginning on or after January 1, 2008.
scribed in pursuance of law applicable to employers der section 6426 or 6427.
in respect of such acts are applicable to LLCA. Thus,
(B) Example. The following example Kevin M. Brown,
for example, LLCA is liable for income tax with-
holding, Federal Insurance Contributions Act (FICA)
illustrates the provisions of this paragraph Deputy Commissioner for
taxes, and Federal Unemployment Tax Act (FUTA) (c)(2)(v): Services and Enforcement.
taxes. See sections 3402 and 3403 (relating to in- Example. (i) LLCB is an eligible entity that has
come tax withholding); 3102(b) and 3111 (relating a single owner, B. LLCB is generally disregarded as Approved July 25, 2007.
to FICA taxes), and 3301 (relating to FUTA taxes). an entity separate from its owner. However, under
In addition, LLCA must file under its name and EIN paragraph (c)(2)(v) of this section, LLCB is treated as Eric Solomon,
the applicable forms in the 94X series, for example, an entity separate from its owner for certain purposes
Assistant Secretary of
Form 941, “Employer’s QUARTERLY Federal Tax relating to excise taxes.
(ii) LLCB mines coal from a coal mine located the Treasury (Tax Policy).
Return,” Form 940, “Employer’s Annual Federal
Unemployment(FUTA) Tax Return;” file with the So- in the United States. Section 4121 of chapter 32 of
(Filed by the Office of the Federal Register on August 15,
cial Security Administration and furnish to LLCA’s the Internal Revenue Code imposes a tax on the pro- 2007, 8:45 a.m., and published in the issue of the Federal
employees statements on Forms W–2, “Wage and ducer’s sale of such coal. Section 48.4121–1(a) of Register for August 16, 2007, 72 F.R. 45891)
Tax Statement;” and make timely employment this chapter defines a “producer” generally as the per-
tax deposits. See §§31.6011(a)–1, 31.6011(a)–3, son in whom is vested ownership of the coal under
31.6051–1, 31.6051–2, and 31.6302–1 of this chap- state law immediately after the coal is severed from
ter. the ground. LLCB is the person that owns the coal
(iii) A is self-employed for purposes of subtitle A, under state law immediately after it is severed from
chapter 2, Tax on Self-Employment Income, of the the ground. Under paragraph (c)(2)(v)(A)(1) of this

2007–39 I.R.B. 678 September 24, 2007

Part III. Administrative, Procedural, and Miscellaneous
Weighted Average Interest Funding Equity Act of 2004 and by the rate bond weighted average is based on the
Rates Update Pension Protection Act of 2006, provide monthly composite corporate bond rate de-
that the interest rates used to calculate cur- rived from designated corporate bond in-
Notice 2007–75 rent liability and to determine the required dices. The methodology for determining
contribution under § 412(l) for plan years the monthly composite corporate bond rate
This notice provides guidance as to the beginning in 2004 through 2007 must be as set forth in Notice 2004–34 continues to
corporate bond weighted average interest within a permissible range based on the apply in determining that rate. See Notice
rate and the permissible range of interest weighted average of the rates of interest on 2006–75, 2006–36 I.R.B. 366.
rates specified under § 412(b)(5)(B)(ii)(II) amounts invested conservatively in long The composite corporate bond rate for
of the Internal Revenue Code. In addi- term investment grade corporate bonds August 2007 is 6.33 percent. Pursuant
tion, it provides guidance as to the interest during the 4-year period ending on the last to Notice 2004–34, the Service has de-
rate on 30-year Treasury securities under day before the beginning of the plan year. termined this rate as the average of the
§ 417(e)(3)(A)(ii)(II). Notice 2004–34, 2004–1 C.B. 848, pro- monthly yields for the included corporate
vides guidelines for determining the cor- bond indices for that month.
CORPORATE BOND WEIGHTED porate bond weighted average interest rate The following corporate bond weighted
AVERAGE INTEREST RATE and the resulting permissible range of in- average interest rate was determined for
Sections 412(b)(5)(B)(ii) and terest rates used to calculate current liabil- plan years beginning in the month shown
412(l)(7)(C)(i), as amended by the Pension ity. That notice establishes that the corpo- below.

Corporate
For Plan Years Bond 90% to 100%
Beginning in: Weighted Permissible
Month Year Average Range
September 2007 5.86 5.27 to 5.86

30-YEAR TREASURY SECURITIES Drafting Information apply to taxpayers who elect to expense
INTEREST RATE certain depreciable assets under § 179 of
The principal authors of this notice are the Internal Revenue Code. This correc-
Section 417(e)(3)(A)(ii)(II) defines Paul Stern and Tony Montanaro of the Em- tion reflects statutory changes enacted sub-
the applicable interest rate, which must ployee Plans, Tax Exempt and Govern- sequent to the publication of Rev. Proc.
be used for purposes of determining the ment Entities Division. For further infor- 2006–53.
minimum present value of a participant’s mation regarding this notice, please con-
benefit under § 417(e)(1) and (2), as the tact the Employee Plans’ taxpayer assis- SECTION 2. BACKGROUND
annual rate of interest on 30-year Treasury tance telephone service at 877–829–5500
securities for the month before the date (a toll-free number), between the hours of Prior to the enactment of the Small
of distribution or such other time as the 8:30 a.m. and 4:30 p.m. Eastern time, Business and Work Opportunity Tax
Secretary may by regulations prescribe. Monday through Friday. Mr. Stern may be Act of 2007, Pub. L. No. 110–28, 121
Section 1.417(e)–1(d)(3) of the Income reached at 202–283–9703. Mr. Montanaro Stat. 190 (2007) (the Act), § 179(b)(1)
Tax Regulations provides that the applica- may be reached at 202–283–9714. The prescribed a $100,000 limitation (the
ble interest rate for a month is the annual telephone numbers in the preceding sen- $100,000 amount) on the aggregate cost
interest rate on 30-year Treasury securi- tences are not toll-free. of section 179 property that could be
ties as specified by the Commissioner for treated as an expense for any taxable
that month in revenue rulings, notices or year beginning after 2002 and before
other guidance published in the Internal 26 CFR 601.602: Tax forms and instructions.
2010. For those same taxable years, sec-
Revenue Bulletin. (Also: Part I, § 179.) tion 179(b)(2) provided that the $100,000
The rate of interest on 30-year Treasury amount is reduced by the amount by which
securities for August 2007 is 4.93 percent. Rev. Proc. 2007–60 the cost of section 179 property placed in
The Service has determined this rate as the service during the taxable year exceeds
average of the yield on the 30-year Trea- $400,000 (the $400,000 amount). Both
sury bond maturing in February 2037 de- SECTION 1. PURPOSE the $100,000 amount and the $400,000
termined each day through August 8, 2007, amount were adjusted for inflation annu-
and the yield on the 30-year Treasury bond This revenue procedure corrects the in- ally. For taxable years beginning in 2007,
maturing in May 2037 determined each flation adjusted amounts set forth in Rev. section 3.19 of Rev. Proc. 2006–53 pro-
day for the balance of the month. Proc. 2006–53, 2006–48 I.R.B. 996, that vides that the $100,000 amount and the

September 24, 2007 679 2007–39 I.R.B.

$400,000 amount, adjusted for inflation, ning in 2007, under § 179(b)(1) the aggre- SECTION 6. DRAFTING
are $112,000 and $450,000, respectively. gate cost of any § 179 property a taxpayer INFORMATION
Section 8212 of the Act changes may elect to treat as an expense cannot
the $100,000 amount and the $400,000 exceed $125,000. Under § 179(b)(2) the The principal author of this revenue
amount to $125,000 (the $125,000 $125,000 limitation is reduced (but not be- procedure is Winston H. Douglas of the
amount) and $500,000 (the $500,000 low zero) by the amount by which the cost Office of Associate Chief Counsel (In-
amount), respectively, for taxable years of § 179 property placed in service during come Tax & Accounting). For further
beginning in 2007 through 2010. Sec- the 2007 taxable year exceeds $500,000. information regarding this revenue proce-
tion 8212 of the Act also provides that For taxable years beginning after 2007 and dure, contact Winston H. Douglas at (202)
the $125,000 amount and the $500,000 before 2011, the $125,000 amount under 622–4930 (not a toll-free call).
amount will be adjusted for inflation for § 179(b)(1) and $500,000 amount under
taxable years beginning after 2007 and § 179(b)(2) will be adjusted for inflation.
before 2011.
SECTION 4. EFFECT ON OTHER
SECTION 3. MODIFICATION OF DOCUMENTS
SECTION 3.19 OF REV. PROC. 2006–53
Section 3.19 of Rev. Proc. 2006–53 is
To reflect the statutory changes made to modified and superseded.
section 179 by § 8212 of the Act, section
3.19 of Rev. Proc. 2006–53 is modified to SECTION 5. EFFECTIVE DATE
read as follows:
.19 Election to Expense Certain Depre- This revenue procedure is effective for
ciable Assets. For taxable years begin- taxable years beginning in 2007.

2007–39 I.R.B. 680 September 24, 2007

Part IV. Items of General Interest
Withdrawal of Prior Notices of FOR FURTHER INFORMATION stantiation of expenses), and §1.125–7
Proposed Rulemaking, Notice CONTACT: Concerning the proposed (cafeteria plan nondiscrimination rules).
of Proposed Rulemaking and regulations, Mireille T. Khoury at (202) This information is required to file em-
622–6080; concerning submissions of ployment tax returns and Forms W–2. The
Notice of Public Hearing comments, the hearing, and/or to be placed collection of information is voluntary to
on the building access list to attend the obtain a benefit. The likely respondents
Employee Benefits — hearing, Oluwafunmilayo Taylor of the are Federal, state or local governments,
Cafeteria Plans Publications and Regulations Branch at business or other for-profit institutions,
(202) 622–7180 (not toll-free numbers). nonprofit institutions, and small busi-
REG–142695–05 nesses or organizations.
SUPPLEMENTARY INFORMATION: Estimated total annual reporting bur-
AGENCY: Internal Revenue Service den: 34,000,000 hours.
(IRS), Treasury. Paperwork Reduction Act Estimated average annual burden per
respondent: 5 hours.
ACTION: Withdrawal of prior notices of The collections of information con-
Estimated annual frequency of re-
proposed rulemaking, notice of proposed tained in this notice of proposed rulemak-
sponses: once.
rulemaking and notice of public hearing. ing have been submitted to the Office of
An agency may not conduct or sponsor,
Management and Budget for review in
and a person is not required to respond to, a
SUMMARY: This document contains new accordance with the Paperwork Reduc-
collection of information unless it displays
proposed regulations providing guidance tion Act of 1995 (44 U.S.C. 3507(d)).
a valid control number assigned by the Of-
on cafeteria plans. This document also Comments on the collections of infor-
fice of Management and Budget.
withdraws the notices of proposed rule- mation should be sent to the Office of
Books or records relating to a collection
making relating to cafeteria plans under Management and Budget, Attn: Desk
of information must be retained as long
section 125 that were published on May 7, Officer for the Department of Treasury,
as their contents may become material in
1984, December 31, 1984, March 7, 1989, Office of Information and Regulatory
the administration of any internal revenue
November 7, 1997 and March 23, 2000. In Affairs, Washington, DC 20503, with
law. Generally, tax returns and tax return
general, these proposed regulations would copies to the Internal Revenue Service,
information are confidential, as required
affect employers that sponsor a cafeteria Attn: IRS Reports Clearance Officer,
by 26 U.S.C. 6103.
plan, employees that participate in a cafe- SE:W:CAR:MP:T:T:SP, Washington, DC
teria plan, and third-party cafeteria plan 20224. Comments on the collections of Background
administrators. information should be received by Octo-
ber 5, 2007. Comments are specifically This document contains proposed In-
DATES: Written or electronic comments requested concerning: come Tax Regulations (26 CFR Part 1)
must be received by November 5, 2007. Whether the proposed collections of in- under section 125 of the Internal Revenue
Outlines of topics to be discussed at the formation is necessary for the proper per- Code (Code). On May 7, 1984, Decem-
hearing scheduled for November 15, 2007, formance of the functions of the Internal ber 31, 1984, March 7, 1989, November
at 10 a.m., must be received by October 25, Revenue Service, including whether the 7, 1997, and March 23, 2000, the IRS
2007. information will have practical utility; and Treasury Department published pro-
The accuracy of the estimated burden posed amendments to 26 CFR Part 1
ADDRESSES: Send submissions to: associated with the proposed collection of under section 125 in the Federal Reg-
CC:PA:LPD:PR (REG–142695–05), information; ister (EE–16–79, 1984–1 C.B. 563 [49
room 5203, Internal Revenue Service, How the quality, utility, and clarity of FR 19321], EE–16–79, 1985–1 C.B. 603
P.O. Box 7604, Ben Franklin Sta- the information to be collected may be en- [49 FR 50733], EE–130–86, 1989–1 C.B.
tion, Washington, DC 20044. Submis- hanced; 944 [54 FR 9460], REG–243025–96,
sions may be hand delivered Monday How the burden of complying with the 1997–2 C.B. 626 [62 FR 60196] and
through Friday between the hours of proposed collections of information may REG–117162–99, 2000–1 C.B. 871 [65
8 a.m. and 4 p.m. to CC:PA:LPD:PR be minimized, including through the appli- FR 15587]). These 1984, 1989, 1997
(REG–142695–05), Courier’s Desk, In- cation of automatic collection techniques and 2000 proposed regulations are hereby
ternal Revenue Service, 1111 Constitution or other forms of information technology; withdrawn. Also, the temporary regula-
Avenue, NW, Washington, DC, or sent and tions under section 125 that were pub-
electronically via the Federal eRulemak- Estimates of the capital or start-up costs lished on February 4, 1986 in the Federal
ing Portal at www.regulations.gov (IRS and costs of operation, maintenance, and Register (T.D. 8073, 1986–1 C.B. 45
REG–142695–05). The public hearing purchase of service to provide information. [51 FR 4318]) are being withdrawn in a
will be held at the IRS Auditorium, Inter- The collection of information in this separate document. The new proposed
nal Revenue Building, 1111 Constitution proposed regulation is in §1.125–2 (cafete- regulations that are published in this doc-
Avenue, NW, Washington, DC. ria plan elections); §1.125–6(b)–(g) (sub- ument replace those proposed regulations.

September 24, 2007 681 2007–39 I.R.B.

Explanation of Provisions all medical expenses be substantiated by with the interim ERISA rules for cafeteria
a third party before reimbursement, the plans:
Overview requirement that expenses be incurred Under ... ERISA, an employer con-
during the period of coverage, and the tribution made before January 1, 1977,
The new proposed regulations are prohibition against deferral of compensa- to a cafeteria plan in existence on June
organized as follows: general rules on tion (including the use-or-lose rule). The 27, 1974, is required to be included in
qualified and nonqualified benefits in prior proposed regulations also provided an employees’ gross income only to the
cafeteria plans (new proposed §1.125–1), guidelines for dependent care FSAs, and extent that the employee actually elects
general rules on elections (new proposed the application of section 125 to paid va- taxable benefits. In the case of a plan
§1.125–2), general rules on flexible cation days offered under a cafeteria plan. not in existence on June 27, 1974, the
spending arrangements (new proposed These remain substantially unchanged in employer contribution is required to be
§1.125–5), general rules on substantia- the new proposed regulations, with certain included in an employee’s gross income
tion of expenses for qualified benefits clarifications. Finally, the prior proposed to the extent the employee could have
(new proposed §1.125–6) and nondiscrim- regulations included a number of Q & As elected taxable benefits.
ination rules (new proposed §1.125–7). addressing transitional issues relating to
The new proposed regulations, new Pro- the enactment of section 125, as well as S. Rep. No. 1263, 95th Cong., 2d
posed §§1.125–1, 1.125–2, 1.125–5, the application of the now-repealed sec- Sess. 74 (1978), reprinted in 1978
1.125–6 and §1.125–7, consolidate and tion 89 (special nondiscrimination rules U.S.C.C.A.N. 6837; H.R. Rep. No.
restate Proposed §1.125–1 (1984, 1997, with respect to certain employee benefit 1445, 95th Cong., 2d Sess. 63 (1978);
2000), §1.125–2 (1989, 1997, 2000) and plans). These provisions are omitted from H.R. Conf. Rep. No. 1800, 95th Cong.,
§1.125–2T (1986). Unless otherwise in- the new proposed regulations. 2d Sess. 206 (1978).
dicated, references to “new proposed reg-
ulations” or “these proposed regulations” I. New Proposed §1.125–1—Qualified and The legislative history also provides:
mean the proposed section 125 regulations nonqualified benefits in cafeteria plans [G]enerally, employer contributions
being published in this document. under a written cafeteria plan which
The new proposed regulations reflect Section 125 exclusive noninclusion rule permits employees to elect between tax-
changes in tax law since the prior reg- able and nontaxable benefits are ex-
ulations were proposed, including: the Section 125 provides that, except in the cluded from the gross income of an
change in the definition of dependent case of certain discriminatory benefits, no employee to the extent that nontaxable
(section 152) and the addition of the fol- amount shall be included in the gross in- benefits are elected.
lowing as qualified benefits: adoption come of a participant in a cafeteria plan
assistance (section 137), additional de- (as defined in section 125(d)) solely be- S. Rep. No. 1263, 95th Cong., 2d
ferred compensation benefits described cause, under the plan, the participant may Sess. 75 (1978), reprinted in 1978
in section 125(d)(1)(B), (C) and (D), choose among the benefits of the plan. The U.S.C.C.A.N. 6838; H.R. Rep. No.
Health Savings Accounts (HSAs) (sec- new proposed regulations clarify and am- 1445, 95th Cong., 2d Sess. 63 (1978).
tions 223, 125(d)(2)(D) and 4980G), and plify the general rule in the prior proposed See also H.R. Conf. Rep. No. 1800,
qualified HSA distributions from health regulations that section 125 is the exclu- 95th Cong., 2d Sess. 206 (1978).
FSAs (section 106(e)). Other changes sive means by which an employer can offer
include the prohibition against long-term employees a choice between taxable and The legislative history to the 1984
care insurance and long-term care services nontaxable benefits without the choice it- amendments to section 125 continues:
(section 125(f)) and the addition of the self resulting in inclusion in gross income The cafeteria plan rules of the Code
key employee concentration test in section by the employees. When employees may provide that a participant in a nondis-
125(b)(2). elect between taxable and nontaxable ben- criminatory cafeteria plan will not be
The prior proposed regulations, efits, this election results in gross income treated as having received a taxable
§§1.125–1 and 1.125–2, provide the basic to employees, unless a specific Internal benefit offered under the plan solely
framework and requirements for cafeteria Revenue Code (Code) section (such as sec- because the participant has the op-
plans and elections under cafeteria plans. tion 125) intervenes to prevent gross in- portunity, before the benefit becomes
The prior proposed regulations also out- come inclusion. Thus, except for an elec- available, to choose among the taxable
lined the most significant rules for benefits tion made through a cafeteria plan that sat- and nontaxable benefits under the plan.
under a health flexible spending arrange- isfies section 125 or another specific Code
ment (health FSA) offered by a cafeteria section (such as section 132(f)(4)), any op- H.R. Conf. Rep. No. 861, 98th Cong.,
plan — the requirement that the maxi- portunity to elect among taxable and non- 2d Sess. 1173 (1984), reprinted in
mum reimbursement be available at all taxable benefits results in inclusion of the 1984 U.S.C.C.A.N. 1861. See also
times during the coverage period (the uni- taxable benefit regardless of what benefit H.R. Conf. Rep. No. 736, 104th
form coverage rule), the requirement of a is elected and when the election is made. Cong., 2d Sess. 295, reprinted in 1996
12-month period of coverage, the require- This interpretation of section 125 is con- U.S.C.C.A.N. 2108.
ment that the health FSA only reimburse sistent with the legislative history of sec- The new proposed regulations provide
medical expenses, the requirement that tion 125. The legislative history begins that unless a plan satisfies the requirements

2007–39 I.R.B. 682 September 24, 2007

of section 125 and the regulations, the plan in §1.125–4), and state how employer con- vide rules for dual status individuals and
is not a cafeteria plan. Reasons that a tributions may be made under the plan (for individuals moving between employee and
plan would fail to satisfy the section 125 example, salary reduction or nonelective non-employee status. A self-employed in-
requirements include: offering nonquali- employer contributions), the maximum dividual may, however, sponsor a cafeteria
fied benefits; not offering an election be- amount of elective contributions, and the plan for his or her employees.
tween at least one permitted taxable bene- plan year. If the plan includes a flexible
fit and at least one qualified benefit; defer- spending arrangement (FSA), the written Election between taxable and nontaxable
ring compensation; failing to comply with plan must include provisions comply- benefits
the uniform coverage rule or use-or-lose ing with the uniform coverage rule and
The new proposed regulations require
rule; allowing employees to revoke elec- the use-or-lose rule. Because section
that a cafeteria plan offer employees
tions or make new elections during a plan 125(d)(1)(A) states that a cafeteria plan
an election among only permitted tax-
year, except as provided in §1.125–4; fail- is a written plan under which “all partic-
able benefits (including cash) and qual-
ing to comply with substantiation require- ipants are employees,” the new proposed
ified nontaxable benefits. See section
ments; paying or reimbursing expenses in- regulations require that the written cafete-
125(d)(1)(B). For purposes of section 125,
curred for qualified benefits before the ef- ria plan specify that only employees may
cash means cash from current compensa-
fective date of the cafeteria plan or before participate in the cafeteria plan. The new
tion (including salary reduction), payment
a period of coverage; allocating experience proposed regulations also require that all
for annual leave, sick leave, or other paid
gains (forfeitures) other than as expressly provisions of the written plan apply uni-
time off, severance pay, property, and
allowed in the new proposed regulations; formly to all participants.
certain after-tax employee contributions.
and failing to comply with grace period
Distributions from qualified retirement
rules. Individuals who may participate in a
plans are not cash or taxable benefits for
cafeteria plan
Definition of a cafeteria plan purposes of section 125. See Rev. Rul.
2003–62, 2003–1 C.B. 1034 (distributions
All participants in a cafeteria plan must
The new proposed regulations provide to former employees from a qualified
be employees. See section 125(d)(1)(A).
that a cafeteria plan is a separate written employees’ trust, applied to pay health
These proposed regulations provide that
plan that complies with the requirements insurance premiums, are includible in
employees include common law employ-
of section 125 and the regulations, that is former employees’ gross income under
ees, leased employees described in section
maintained by an employer for employees section 402), see §601.601(d)(2)(ii)(b).
414(n), and full-time life insurance sales-
and that is operated in compliance with the
men (as defined in section 7701(a)(20)). Qualified benefits
requirements of section 125 and the reg-
These proposed regulations further pro-
ulations. Participants in a cafeteria plan
vide that former employees (including In general, in order for a benefit to be
must be permitted to choose among at least
laid-off employees and retired employees) a qualified benefit for purposes of sec-
one permitted taxable benefit (for exam-
may participate in a plan, but a plan may tion 125, the benefit must be excludible
ple, cash, including salary reduction) and
not be maintained predominantly for for- from employees’ gross income under a
at least one qualified benefit. A plan offer-
mer employees. See Rev. Rul. 82–196, specific provision of the Code and must
ing only elections among nontaxable ben-
1982–2 C.B. 53; Rev. Rul. 85–121, not defer compensation, except as specif-
efits is not a cafeteria plan. Also, a plan
1985–2 C.B. 57, see §601.601(d)(2)(ii)(b). ically allowed in section 125(d)(2)(B),
offering only elections among taxable ben-
All employees who are treated as em- (C) or (D). Examples of qualified ben-
efits is not a cafeteria plan. See Rev. Rul.
ployed by a single employer under section efits include the following: group-term
2002–27, 2002–1 C.B. 925, Situation 2,
414(b), (c) or (m) are treated as employed life insurance on the life of an employee
see §601.601(d)(2)(ii)(b). Finally, a cafe-
by a single employer for purposes of (section 79); employer-provided acci-
teria plan must not provide for deferral of
section 125. See section 125(g)(4). A dent and health plans, including health
compensation, except as specifically per-
participant’s spouse or dependents may flexible spending arrangements, and acci-
mitted in section 125(d)(2)(B), (C), or (D).
receive benefits through a cafeteria plan dental death and dismemberment policies
Written plan although they cannot participate in the (sections 106 and 105(b)); a dependent
cafeteria plan. care assistance program (section 129);
Section 125(d)(1) requires that a cafe- Self-employed individuals are not an adoption assistance program (section
teria plan be in writing. The cafeteria treated as employees for purposes of 137); contributions to a section 401(k)
plan must be operated in accordance with section 125. Accordingly, the new pro- plan; contributions to certain plans main-
the written plan terms. The new pro- posed regulations make clear that sole tained by educational organizations, and
posed regulations require that the written proprietors, partners, and directors of cor- contributions to HSAs. Section 125(f),
plan specifically describe all benefits, set porations are not employees and may not (d)(2)(B), (C), (D). See Notice 97–9,
forth the rules for eligibility to participate participate in a cafeteria plan. In addition, 1997–1 C.B. 365 (adoption assistance),
and the procedure for making elections, the new proposed regulations clarify that see §601.601(d)(2)(ii)(b); Notice 2004–2,
provide that all elections are irrevocable 2-percent shareholders of an S corporation 2004–1 C.B. 269, Q & A–33 (HSAs), see
(except to the extend that the plan in- are not employees for purposes of section §601.601(d)(2)(ii)(b). A cafeteria plan
cludes the optional change in status rules 125. The new proposed regulations pro- may also offer long-term and short-term

September 24, 2007 683 2007–39 I.R.B.

disability coverage as a qualified benefit the employee includes in gross income Dependent care assistance programs and
(see section 106). However, see paragraph the Table I cost of the excess coverage adoption assistance programs
(q) in §1.125–1 for nonqualified benefits. (minus all after-tax contributions by the
employee for group-term life insurance If the requirements of section 129 are
Group-term life insurance coverage) and that the entire amount of satisfied, up to $5,000 of employer-pro-
salary reduction and employer flex-credits vided assistance for amounts paid or in-
An employer may provide group-term for group-term life insurance coverage on curred by employees for dependent care
life insurance through a combination of the life of the employee is excludible from is excludible from employees’ gross in-
methods. Generally, under section 79(a), the employee’s gross income. As noted come. The new proposed regulations out-
the cost of $50,000 or less of group-term in this preamble, taxpayers may rely on line the general requirements for providing
life insurance on the life of an employee the new proposed regulations for guidance dependent care assistance programs and
provided under a policy (or policies) car- pending the issuance of final regulations. adoption assistance programs under sec-
ried directly or indirectly by an employer tion 137 through a cafeteria plan. See No-
is excludible from the employee’s gross Employer-provided accident and health tice 97–9, 1997–1 C.B. 365, section II, see
income. (Special rules apply to key em- plan §601.601(d)(2)(ii)(b).
ployees if the group-term life insurance
plan does not satisfy the nondiscrimina- Coverage under an employer-provided Cafeteria plan year
tion rules in section 79(d)). However, if accident and health plan that satisfies the
requirements of section 105(b) may be The new proposed regulations require
the group-term life insurance provided to
provided as a qualified benefit through that a cafeteria plan year must be 12 con-
an employee by an employer or employ-
a cafeteria plan and is excludible from secutive months and must be set out in
ers exceeds $50,000 (taking into account
employees’ gross income. Section 106; the written cafeteria plan. A short plan
all coverage provided both through a cafe-
§1.106–1. The nondiscrimination rules year (or a change in plan year resulting in
teria plan and outside a cafeteria plan),
under section 105(h) apply to self-insured a short plan year) is permitted only for a
the cost of coverage exceeding coverage
medical reimbursement arrangements (in- valid business purpose. A change in plan
of $50,000 is includible in the employee’s
cluding health FSAs). year resulting in a short plan year, for other
gross income. For this purpose, the cost
The new proposed regulations specif- than a valid business purpose, is disre-
of group-term life insurance is shown in
ically permit a cafeteria plan (but not a garded. If a principal purpose of a change
§1.79–3(d)(2), Table I (Table I). The Ta-
health FSA) to pay or reimburse substan- in plan year is to circumvent the rules of
ble I cost of the excess group-term life in-
tiated individual accident and health insur- section 125, the change in plan year is in-
surance (minus all after-tax contributions
ance premiums. See Rev. Rul. 61–146, effective.
by the employee for group-term life insur-
ance coverage) is includible in each cov- 1961–2 C.B. 25, see §601.601(d)(2)(ii)(b).
No deferral of compensation
ered employee’s gross income. The new In addition, a cafeteria plan may provide
proposed regulations provide that the cost for payment of COBRA premiums for an Qualified benefits must be current ben-
of group-term life insurance on the life of employee. efits. In general, a cafeteria plan may not
an employee, that either is less than or For employer-provided accident and offer benefits that defer compensation or
equal to the amount excludible from gross health plans and medical reimbursement operate to defer compensation. Section
income under section 79(a) or provides plans, the definition of dependents is the 125(d)(2)(A). In general, benefits may not
coverage in excess of that amount, but not definition in section 105(b) as amended be carried over to a later plan year or used
combined with any permanent benefit, is a by the Working Families Tax Relief Act in one plan year to purchase benefits to
qualified benefit that may be offered in a of 2004 (WFTRA), Public Law 108–311, be provided in a later plan year. For ex-
cafeteria plan. The new proposed regula- section 207(9) (118 Stat. 1166) (that ample, life insurance with a cash value
tions also provide that the entire amount of is, a dependent as defined in section build-up or group-term life insurance with
salary reduction and employer flex-credits 152, determined without regard to sec- a permanent benefit (within the meaning of
for group-term life insurance coverage on tion 152(b)(1), (b)(2), or (d)(1)(B)). See §1.79–0) defers the receipt of compensa-
the life of an employee is excludible from Notice 2004–79, 2004–2 C.B. 898, see tion and thus is not a qualified benefit.
an employee’s gross income. §601.601(d)(2)(ii)(b). For purposes of the The new proposed regulations clarify
The rule in the new proposed regula- exclusion from employees’ gross income whether certain benefits and plan adminis-
tions differs from Notice 89–110, 1989–2 for accident and health plans and for med- tration practices defer compensation. For
C.B. 447, see §601.601(d)(2)(ii)(b). No- ical reimbursement under sections 105(b) example, the regulations permit an acci-
tice 89–110 provides that an employee and 106, the spouse or dependent of a dent and health insurance policy to pro-
includes in gross income the greater of former employee (including a retired em- vide certain benefit features that apply for
the Table I cost of group-term life in- ployee or a laid-off employee) or of a de- more than one plan year, such as reason-
surance coverage exceeding $50,000 or ceased employee is treated as a spouse or able lifetime limits on benefits, level pre-
the employee’s salary reduction and em- dependent. See Rev. Rul. 82–196, 1982–2 miums, premium waiver during disabil-
ployer flex-credits for excess group-term C.B. 53; Rev. Rul. 85–121, 1985–2 C.B. ity, guaranteed renewability of coverage,
life insurance coverage. The new pro- 57, see §601.601(d)(2)(ii)(b). coverage for specified accidental injury or
posed regulations provide instead that specific diseases, and the payment of a

2007–39 I.R.B. 684 September 24, 2007

fixed amount per day for hospitalization. same qualified benefit. The amount of un- See section 125(f). Long-term care ser-
But these insurance policies must not pro- used benefits and contributions available vices are nonqualified benefits, H.R. Conf.
vide an investment fund or cash value to during the grace period may be limited Rep. No. 736, 104th Cong., 2d Sess. 296,
pay premiums, and no part of the premium by the employer. A grace period may reprinted in 1996 U.S.C.C.A.N. 2109. (An
may be held in a separate account for any extend to the fifteenth day of the third HSA funded through a cafeteria plan may,
beneficiary. The new proposed regulations month after the end of the plan year (but however, be used to pay premiums for
also provide that the following benefits may be for a shorter period). Benefits or long-term care insurance or for long-term
and practices do not defer compensation: contributions not used as of the end of care services.) The new proposed regula-
a long-term disability policy paying bene- the grace period are forfeited under the tions clarify that contributions to Archer
fits over more than one plan year; reason- use-or-lose rule. The grace period ap- Medical Savings Accounts (sections 220,
able premium rebates or policy dividends; plies to all employees who are participants 106(b)), group term life insurance for an
certain two-year lock-in vision and den- (including through COBRA), as of the employee’s spouse, child or dependent,
tal policies; certain advance payments for last day of the plan year. Grace period and elective deferrals to section 403(b)
orthodontia; salary reduction contributions rules must apply uniformly to all partic- plans are also nonqualified benefits. A
in the last month of a plan year used to pay ipants. The grace period rules in these plan offering any nonqualified benefit is
accident and health insurance premiums proposed regulations are based on Notice not a cafeteria plan. A cafeteria plan may
for the first month of the following plan 2005–42, 2005–1 C.B. 1204, modified not offer a health FSA that provides for
year; reimbursement of section 213(d) ex- in Notice 2007–22, 2007–10 I.R.B. 670, the carryover of unused benefits. See
penses for durable medical equipment; and see §601.601(d)(2)(ii)(b), amplified in Notice 2002–45, 2002–2 C.B. 93, Part I;
allocation of experience gains (forfeitures) Notice 2005–86, 2005–2 C.B. 1075, am- Rev. Rul. 2002–41, 2002–2 C.B. 75, see
among participants. plified in Notice 2007–22, 2007–10 I.R.B. §601.601(d)(2)(ii)(b).
670, see §601.601(d)(2)(ii)(b). For eli-
Paid time off gibility to contribute to a Health Savings After-tax employee contributions
Account (HSA) during a grace period,
Under the prior proposed regulations, The new proposed regulations allow a
see Notice 2005–86, 2005–2 C.B. 1075,
permitted taxable benefits included vari- cafeteria plan to offer after-tax employee
see §601.601(d)(2)(ii)(b). For Form W–2
ous forms of paid leave. Since the prior contributions for qualified benefits or paid
reporting for unused dependent care assis-
proposed regulations were issued, many time off. A cafeteria plan may only offer
tance used for expenses incurred during a
employers have recharacterized and com- the taxable benefits specifically permitted
grace period, see Notice 2005–61, 2005–2
bined vacation days, sick leave and per- in the new proposed regulations. Nonqual-
C.B. 607, see §601.601(d)(2)(ii)(b).
sonal days into a single category of “paid ified benefits may not be offered through a
time off.” The new proposed regulations Contributions to section 401(k) plans cafeteria plan, even if paid with after-tax
use the term “paid time off” to refer to va- through a cafeteria plan employee contributions.
cation days and other types of paid leave.
The new proposed regulations contain the A cafeteria plan may include contri- Employer contributions through salary
same ordering rule for elective and non- butions to a section 401(k) plan. Section reduction
elective paid time off as set forth in Prop. 125(d)(2)(B). The new proposed regu-
Employees electing a qualified bene-
§1.125–1, Q & A–7 (1984). A plan offer- lations clarify the interactions between
fit through salary reduction are electing to
ing an election solely between paid time section 125 and section 401(k). Contribu-
forego salary and instead to receive a ben-
off and taxable benefits is not a cafeteria tions to a section 401(k) plan expressed
efit which is excludible from gross income
plan. as a percentage of compensation are per-
because it is provided by employer contri-
mitted. Pursuant to §1.401(k)–1(a)(3)(ii),
Grace period butions. Section 125 provides that the em-
elective contributions to a section 401(k)
ployee is treated as receiving the qualified
plan may be made through automatic
The new proposed regulations allow benefit from the employer in lieu of the
enrollment (that is, when the employee
a written cafeteria plan to provide an op- taxable benefit. A cafeteria plan may also
does not affirmatively elect cash, the em-
tional grace period immediately following impose reasonable fees to administer the
ployee’s compensation is reduced by a
the end of each plan year, extending the cafeteria plan which may be paid through
fixed percentage, which is contributed to
period for incurring expenses for quali- salary reduction. A cafeteria plan is not re-
a section 401(k) plan).
fied benefits. A grace period may apply quired to allow employees to pay for any
to one or more qualified benefits (for Nonqualified benefits qualified benefit with after-tax employee
example, health FSA or dependent care contributions.
assistance program) but in no event does A cafeteria plan must not offer any
it apply to paid time off or contributions of the following benefits: scholarships
to section 401(k) plans. Unused benefits (section 117); employer-provided meals
or contributions for one qualified benefit and lodging (section 119); educational
may only be used to reimburse expenses assistance (section 127); fringe benefits
incurred during the grace period for that (section 132); long-term care insurance.

September 24, 2007 685 2007–39 I.R.B.

II. New Prop. §1.125–2—Elections in minating employment (or who returns to quirement of section 125, all benefits and
cafeteria plans employment following an unpaid leave of contributions must be used by the end of
absence of less than 30 days). the plan year (or grace period, if applica-
Making, revoking and changing elections New elections and revocations or ble), or are forfeited. The new proposed
changes in elections can be made elec- regulations continue the use-or-lose rule.
Generally, a cafeteria plan must require
tronically. The safe harbor for electronic
employees to elect annually between tax- Period of coverage
elections in §1.401(a)–21 is available.
able benefits and qualified benefits. Elec-
Only an employee can make an election
tions must be made before the earlier of The required period of coverage for all
or revoke or change his or her election.
the first day of the period of coverage FSAs continues to be twelve months, with
An employee’s spouse or dependent may
or when benefits are first currently avail- an exception for short plan years that sat-
not make an election under a cafeteria
able. The determination of whether a tax- isfy the conditions in the new proposed
plan and may not revoke or change an
able benefit is currently available does not regulations. The period of coverage and
employee’s election.
depend on whether it has been construc- the plan year need not be the same. The
tively received by the employee for pur- III. New Prop. §1.125–5—Flexible beginning and end of a period of cover-
poses of section 451. Annual elections spending arrangements age is clarified. The new proposed regu-
generally must be irrevocable and may not lations also clarify that FSAs for different
be changed during the plan year. However, Overview qualified benefits need not have the same
§1.125–4 permits a cafeteria plan to pro- coverage period. See also “Grace period”,
vide for changes in elections based on cer- In general, a flexible spending arrange- discussed in this preamble. The new pro-
tain changes in status. An employer that ment (FSA) is a benefit designed to re- posed regulations also continue to provide
wishes to permit such changes in elections imburse employees for expenses incurred that expenses are incurred when services
must incorporate the rules in §1.125–4 in for certain qualified benefits, up to a max- are provided. Expenses incurred before or
its written cafeteria plan. These proposed imum amount not substantially in excess after the period of coverage may not be re-
regulations omit the rule in Q & A–6(b) of the salary reduction and employer flex- imbursed.
in Prop. §1.125–2 (1989) (cessation of re- credits allocated for the benefit. The max-
quired contributions), because the change imum amount of reimbursement reason- Health FSA
in status rules in §1.125–4 superseded this ably available must be less than five times
provision of the 1989 proposed regula- the value of the coverage. Employer flex- A health FSA may only reimburse
tions. credits are non-elective employer contri- certain substantiated section 213(d) med-
If HSA contributions are made through butions that an employer makes available ical care expenses incurred by the em-
salary reduction under a cafeteria plan, em- for every employee eligible to participate ployee, or by the employee’s spouse
ployees may prospectively elect, revoke or in the cafeteria plan, to be used at the or dependents. A health FSA may be
change salary reduction elections for HSA employee’s election only for one or more limited to a subset of permitted section
contributions at any time during the plan qualified benefits (but not as cash or other 213(d) medical expenses (for example,
year with respect to salary that has not be- taxable benefits). The three types of FSAs a health FSA is permitted to exclude re-
come currently available at the time of the are dependent care assistance, adoption as- imbursement of over-the-counter drugs
election. sistance and medical care reimbursements described in Rev. Rul. 2003–102, 2003–2
A cafeteria plan is permitted to in- (health FSA). C.B. 559, see §601.601(d)(2)(ii)(b)).
clude an automatic election for new Similarly, a health FSA may be an
employees or current employees. Rev. Uniform coverage rule HSA-compatible limited-purpose health
Rul. 2002–27, 2002–1 C.B. 925, see FSA or post-deductible health FSA. Rev.
The new proposed regulations retain
§601.601(d)(2)(ii)(b). A new rule also Rul. 2004–45, 2004–1 C.B. 971, see
the rule that the maximum amount of re-
permits a cafeteria plan to provide an §601.601(d)(2)(ii)(b), amplified, Notice
imbursement from a health FSA must be
optional election for new employees be- 2005–86, 2005–2 C.B. 1075. A health
available at all times during the period
tween cash and qualified benefits. New FSA may not reimburse premiums for ac-
of coverage (properly reduced as of any
employees avoid gross income inclusion cident and health insurance or long-term
particular time for prior reimbursements).
if they make an election within 30 days care insurance. See section 125(f).
The uniform coverage rule does not apply
after the date of hire even if benefits pro- A health FSA must satisfy all require-
to FSAs for dependent care assistance or
vided pursuant to the election relate back ments of section 105(b), §§1.105–1 and
adoption assistance.
to the date of hire. However, salary re- 1.105–2. The section 105(h) nondiscrim-
duction amounts used to pay for such an Use-or-lose rule ination rules apply to health FSAs. All
election must be from compensation not medical expenses must be substantiated
yet currently available on the date of the An FSA must satisfy all the require- before expenses are reimbursed. See In-
election. Also, this special election rule ments of section 125, including the prohi- curring and reimbursing expenses for
for new employees does not apply to any bition against deferring compensation. In qualified benefits, discussed in this pre-
employee who terminates employment general, as discussed under “No deferral of amble. The new proposed regulations
and is rehired within 30 days after ter- compensation”, in order to satisfy this re- also clarify when medical expenses are

2007–39 I.R.B. 686 September 24, 2007

incurred.1 A cafeteria plan may limit lects, including ratably over the plan year Debit cards
enrollment in a health FSA to those em- based on the employer’s payroll periods or
ployees who participate in the employer’s in equal installments at other regular inter- The new proposed regulations incor-
accident and health plan. vals (for example, quarterly installments). porate previously issued guidance on
These rules must apply uniformly to all substantiating, paying and reimbursing
Qualified HSA distributions participants. expenses for section 213(d) medical care
incurred at a medical care provider when
Section 106(e), enacted in section IV. New Prop. §1.125–6—Substantiation payment is made with a debit card. Rev.
302 of the Health Opportunity Patient of expenses for all cafeteria plans Rul. 2003–43, 2003–1 C.B. 935, am-
Empowerment Act of 2006, Public Law plified, Notice 2006–69, 2006–31 I.R.B.
109–432 (120 Stat. 2922 (2006)) allows Incurring and reimbursing expenses for 107, Notice 2007–2, 2007–2 I.R.B. 254;
“qualified HSA distributions” from health qualified benefits Rev. Proc. 98–25, 1998–1 C.B. 689,
FSAs to HSAs. Section 106(e) applies see §601.601(d)(2)(ii)(b). Among the
The new proposed regulations provide
to distributions between December 20, permissible substantiation methods are
that only expenses for qualified benefits
2006 and December 31, 2011. The pro- copayment matches, recurring expenses,
incurred after the later of the effective date
posed regulations incorporate the rules on and real-time substantiation. The new pro-
or the adoption date of the cafeteria plan
qualified HSA distributions set forth in posed regulations also allow point-of-sale
are permitted to be reimbursed under the
Notice 2007–22, 2007–10 I.R.B. 670. See substantiation through matching inventory
cafeteria plan. Similarly, if a plan amend-
§601.601(d)(2)(ii)(b). information with a list of section 213(d)
ment adds a new qualified benefit, only ex-
medical expenses. The employer is re-
Dependent care assistance after penses incurred after the later of the effec-
sponsible for ensuring that the inventory
termination tive date or the adoption date are eligible
information approval system complies
for reimbursement.2 This rule applies to
with the new regulations and with the
A new optional rule permits an em- all qualified benefits. Similarly, a cafeteria
recordkeeping requirements in section
ployer to reimburse a terminated em- plan may pay or reimburse only expenses
6001. Rev. Rul. 2003–43, 2003–1 C.B.
ployee’s qualified dependent care ex- for qualified benefits incurred during a par-
935, amplified, Notice 2006–69, 2006–31
penses incurred after termination through ticipant’s period of coverage.
I.R.B. 107, Notice 2007–2, 2007–2 I.R.B.
a dependent care FSA, if all section 129 254; Rev. Proc. 98–25, 1998–1 C.B. 689,
requirements are otherwise satisfied. Substantiation and reimbursement of
expenses for qualified benefits see §601.601(d)(2)(ii)(b). The new pro-
posed regulations also provide rules under
Experience gains
The new proposed regulations provide, which an FSA may pay or reimburse de-
If an employee fails to use all contri- after an employee incurs an expense for a pendent care expenses using debit cards.
butions and benefits for a plan year be- qualified benefit during the coverage pe- Pursuant to prior guidance (in Notice
fore the end of the plan year (and the grace riod, the expense must first be substanti- 2006–69, 2006–31 I.R.B. 107, amplified,
period, if applicable), those unused con- ated before the expense may be paid or re- Notice 2007–2, 2007–2 I.R.B. 254), for
tributions and benefits are forfeited un- imbursed. All expenses must be substanti- plan years beginning after December 31,
der the use-or-lose rule. Unused amounts ated (substantiating only a limited number 2006, the recordkeeping requirements de-
are also known as experience gains. The of total claims, or not substantiating claims scribed in paragraph (f) in §1.125–6 apply
new proposed regulations retain the for- below a certain dollar amount does not sat- (that is, responsibility of employers rely-
feiture allocation rules in the 1989 pro- isfy the requirements in the new proposed ing on the inventory information approval
posed regulations, and clarify that the em- regulations). See §1.105–2; Rev. Rul. system for health FSA debit cards to en-
ployer sponsoring the cafeteria plan may 2003–80; Rev. Rul. 2003–43, 2003–1 sure that the system complies with the new
retain forfeitures, use forfeitures to defray C.B. 935, see §601.601(d)(2)(ii)(b); No- proposed recordkeeping requirements, in-
expenses of administering the plan or al- tice 2006–69, 2006–31 I.R.B. 107, Notice cluding Rev. Proc. 98–25, 1998–1 C.B.
locate forfeitures among employees con- 2007–2, 2007–2 I.R.B. 254. FSAs for de- 689, Notice 2006–69, 2006–31 I.R.B. 107,
tributing through salary reduction on a rea- pendent care assistance and adoption assis- amplified, Notice 2007–2, 2007–2 I.R.B.
sonable and uniform basis. tance must follow the substantiation proce- 254. For health FSA debit card transac-
dures applicable to health FSAs. tions occurring on or before December
FSA Administrative rules 31, 2007, all supermarkets, grocery stores,
discount stores and wholesale clubs that do
Salary reduction contributions may be not have a medical care merchant category
made at whatever interval the employer se- code (as described in Rev. Rul. 2003–43,

1See Rev. Rul. 2005–55, 2005–2 C.B. 284, and Rev. Rul. 2005–24, 2005–1 C.B. 892, see §601.601(d)(2)(ii)(b) (section 105(b) exclusion only applicable to reimbursements for medical
expenses incurred by employee, or by the employee’s spouse or dependents); Rev. Rul. 2002–3, 2002–1 C.B. 316 (purported reimbursements to employees of health insurance premiums not
paid by employees and therefore impermissible); Rev. Rul. 2002–80, 2002–2 C.B. 925, see §601.601(d)(2)(ii)(b) (so-called advance reimbursements and purported loans are impermissible);
Rev. Rul. 2003–43, 2003–1 C.B. 935, see §601.601(d)(2)(ii)(b); Notice 2006–69, 2006–31 I.R.B. 107 (substantiation requirements for debit cards), amplified in Notice 2007–2, 2007–2 I.R.B.
254, see §601.601(d)(2)(ii)(b).
2 See American Family Mut. Ins. Co. v. United States, 815 F. Supp. 1206 (W.D. Wis. 1992); Wollenberg v. United States, 75 F. Supp.2d 1032 (D. Neb. 1999); Rev. Rul. 2002–58, 2002–2
C.B. 541, see §601.601(d)(2)(ii)(b); Notice 97–9, section II (adoption assistance).

September 24, 2007 687 2007–39 I.R.B.

2003–1 C.B. 935, are nevertheless deemed ployee), officer, five percent shareholder, pending the issuance of final regulations.
to be an “other medical provider” as de- key employee and compensation. The new Prior published guidance on qualified ben-
scribed in Rev. Rul. 2003–43. (For a proposed regulations also provide guid- efits under sections 79, 105, 106, 129, 137
list of merchant category codes, see Rev. ance on the nondiscrimination as to eligi- and 223 that is affected by these proposed
Proc. 2004–43, 2004–2 C.B. 124.) During bility requirement by incorporating some regulations remains applicable through the
this time period, mail-order vendors and of the rules under section 410(b) (specif- effective date of the final regulations (ex-
web-based vendors that sell prescription ically the rules under §1.410(b)–4(b) and cept as modified in “Effect on other docu-
drugs are also deemed to be an “other (c) dealing with reasonable classification, ments” section of this preamble).
medical provider” as described in Rev. the safe harbor percentage test and the
Rul. 2003–43. After December 31, 2008, unsafe harbor percentage component of Effect on Other Documents
health FSA debit cards may not be used the facts and circumstances test).
Notice 89–110, 1989–2 C.B. 447,
at stores with the Drug Stores and Phar- The new proposed regulations also pro-
see §601.601(d)(2)(ii)(b), states that
macies merchant category code unless vide additional guidance on the contribu-
where group-term life insurance pro-
(1) the store participates in the inventory tions and benefits test and, unlike the prior
vided to an employee by an employer
information approval system described in proposed regulations, the new proposed
exceeds $50,000, the employee includes
Notice 2006–69, or (2) on a store loca- regulations provide an objective test to de-
in gross income the greater of the cost
tion by store location basis, 90 percent of termine when the actual election of bene-
of group-term life insurance shown in
the store’s gross receipts during the prior fits is discriminatory. Specifically, the new
§1.79–3(d)(2), Table I (Table I ) on the
taxable year consisted of items which proposed regulations provide that a cafete-
excess coverage or the employee’s salary
qualify as expenses for medical care under ria plan must give each similarly situated
reduction and employer flex-credits for
section 213(d) (including nonprescrip- participant a uniform opportunity to elect
excess coverage. Notice 89–110 is modi-
tion medications described in Rev. Rul. qualified benefits, and that highly compen-
fied, effective as of the date the proposed
2003–102, 2003–2 C.B. 559). Notice sated participants must not actually dispro-
regulations are published in the Federal
2006–69, 2006–31 I.R.B. 107, amplified, portionately elect qualified benefits. Fi-
Register.
Notice 2007–2, 2007–2 I.R.B. 254. nally, the new rules provide guidance on
Published guidance under §105(b)
the safe harbor for cafeteria plans provid-
V. New Prop. states that if any person has the right
ing health benefits and create a safe harbor
§1.125–7—Nondiscrimination to receive cash or any other taxable or
for premium-only-plans that satisfy certain
rules nontaxable benefit under a health FSA
requirements.
other than the reimbursement of section
The example in Prop. §1.125–1,
Discriminatory benefits provided to 213(d) medical expenses of the employee,
Q & A–11 (1984) is deleted because it
highly compensated participants and indi- employee’s spouse or employee’s depen-
concerns a qualified legal services plan,
viduals and key employees are included dents, then all distributions made from
which is no longer a qualified benefit.
in these employees’ gross income. See the arrangement are included in the em-
section 125(b), (c). The new proposed Other issues ployee’s gross income, even amounts
regulations reflect changes in tax law since paid to reimburse medical care. See Rev.
Prop. §1.125–1, Q & A–9 through 13 and These proposed regulations provide Rul. 2006–36, 2006–36 I.R.B. 353; Rev.
19 were proposed in 1984, including the guidance under section 125 (26 U.S.C. Rul. 2005–24, 2005–1 C.B. 892; Rev.
key employee concentration test, statutory 125). Other statutes may impose addi- Rul. 2003–102, 2003–2 C.B. 559; No-
nontaxable benefits (enacted in the Deficit tional requirements (for example, the Em- tice 2002–45, 2002–2 C.B. 93; Rev. Rul.
Reduction Act of 1984 (DEFRA), Public ployee Retirement Income Security Act 2002–41, 2002–2 C.B. 75; Rev. Rul.
Law 98–369, section 531(b), (98 Stat. 881 of 1974 (ERISA) (29 U.S.C. 1000), the 69–141, 1969–1 C.B. 48. New section
(1984)), and the change in definition of Health Insurance Portability and Account- 106(e) provides that a health FSA will
dependent in WFTRA. ability Act of 1996 (HIPAA), (sections not fail to satisfy the requirements of sec-
The new proposed regulations provide 9801–9803); and the continuation cover- tions 105 or 106 merely because the plan
additional guidance on the cafeteria plan age requirements under the Consolidated provides for a qualified HSA distribu-
nondiscrimination rules, including defini- Omnibus Budget Reconciliation Act of tion. Amounts rolled into an HSA may
tions of key terms, guidance on the eligi- 1985 (COBRA) (section 4980B). be used for purposes other than reimburs-
bility test and the contributions and ben- ing the section 213(d) medical expenses
efits tests, descriptions of employees al- Proposed Effective Date of the employee, spouse or dependents.
lowed to be excluded from testing and a Accordingly, Rev. Rul. 2006–36, Rev.
safe harbor nondiscrimination test for pre- With the exceptions noted in the “Effect Rul. 2005–24, Rev. Rul. 2003–102,
mium-only-plans. on other documents” section of this pre- Notice 2002–45, Rev. Rul. 2002–41,
Specifically, the new proposed regula- amble and under the “Debit cards” section and Rev. Rul. 69–141 are modified with
tions define several key terms, including of the preamble, it is proposed that these respect to qualified HSA distributions
highly compensated individual or partic- regulations apply for plan years beginning described in section 106(e). See No-
ipant (consistent with the section 414(q) on or after January 1, 2009. Taxpayers tice 2007–22, 2007–10 I.R.B. 670, see
definition of highly compensated em- may rely on these regulations for guidance §601.601(d)(2)(ii)(b).

2007–39 I.R.B. 688 September 24, 2007

Special Analyses 1. Whether, consistent with section personnel from other offices of the IRS and
125 of the Internal Revenue Code, mul- Treasury Department participated in their
It has been determined that this notice tiple employers (other than members of development.
of proposed rulemaking is not a significant a controlled group described in section
regulatory action as defined in Executive 125(g)(4)) may sponsor a single cafeteria *****
Order 12866. Therefore, a regulatory as- plan;
sessment is not required. It also has been Withdrawal of Proposed Regulations
2. Whether salary reduction contribu-
determined that section 553(b) of the Ad- tions may be based on employees’ tips and
ministrative Procedure Act (5 U.S.C. chap- Accordingly, under the authority of 26
how that would work; U.S.C. 7805, the notice of proposed rule-
ter 5) does not apply to this regulation. It 3. For cafeteria plans adopting the
is hereby certified that the collection of in- making (EE–16–79) that was published in
change in status rules in §1.125–4, when the Federal Register on Monday, May 7,
formation in this regulation will not have a a participant has a change in status
significant economic impact on a substan- 1984 (49 FR 19321), and Monday, De-
and changes his or her salary reduction cember 31, 1984 (49 FR 50733), the no-
tial number of small entities. This certi- amount, how should the participant’s uni-
fication is based on the fact that the reg- tice of proposed rulemaking (EE–130–86)
form coverage amount be computed after that was published in the Federal Regis-
ulations will only minimally increase the the change in status.
burdens on small entities. The require- ter on Tuesday, March 7, 1989 (54 FR
All comments will be available for pub- 9460), and Friday, November 7, 1997 (62
ments under these regulations relating to lic inspection and copying.
maintaining a section 125 cafeteria plan FR 60196) and the notice of proposed rule-
A public hearing has been scheduled making (REG–117162–99) that was pub-
are a minimal additional burden indepen- for November 15, 2007, beginning at 10
dent of the burdens encompassed under ex- lished in the Federal Register on Thurs-
a.m. in the Auditorium, Internal Revenue day, March 23, 2000 (65 FR 15587) are
isting rules for underlying employee ben- Service, 1111 Constitution Avenue, NW,
efit plans, which exist whether or not the withdrawn.
Washington, DC. Due to building security
benefits are provided through a cafeteria procedures, visitors must enter at the Con- Proposed Amendment to the
plan. In addition, most small entities that stitution Avenue entrance. In addition, all Regulations
will maintain cafeteria plans already use a visitors must present photo identification
third-party plan administrator to adminis- to enter the building. Because of access Accordingly, 26 CFR Part 1 is proposed
ter the cafeteria plan. The collection of restrictions, visitors will not be admitted to be amended as follows:
information required in these regulations, beyond the immediate entrance area more
which is required to comply with the exist- than 30 minutes before the hearing starts. PART 1—INCOME TAXES
ing substantiation requirements of sections For information about having your name
105, 106, 129 and 125, and the recordkeep- placed on the building access list to attend Paragraph 1. The authority citation for
ing requirements of section 6001, will only the hearing, see the “FOR FURTHER IN- part 1 continues to read, in part, as follows:
minimally increase the third-party admin- FORMATION CONTACT” section of this Authority: 26 U.S.C. 7805 * * *
istrator’s burden with respect to the cafete- preamble. Par. 2. Sections 1.125–0, 1.125–1 and
ria plan. Therefore, an analysis under the The rules of 26 CFR 601.601(a)(3) ap- 1.125–2 are added to read as follows:
Regulatory Flexibility Act (5 U.S.C. chap- ply to the hearing. Persons who wish to
ter 6) is not required. Pursuant to section present oral comments at the hearing must §1.125–0 Table of contents.
7805(f) of the Internal Revenue Code, this submit written or electronic comments and
proposed regulation has been submitted to an outline of the topics to be discussed This section lists captions contained
the Chief Counsel for Advocacy of the and the amount of time to be devoted to in §§1.125–1, 1.125–2, 1.125–5, 1.125–6
Small Business Administration for com- each topic (a signed original and eight (8) and §1.125–7.
ment on its impact on small business. copies) by October 25, 2007. A period of
10 minutes will be allotted to each person §1.125–1 Cafeteria plans; general rules.
Comments and Public Hearing
for making comments. An agenda show-
(a) Definitions.
Before these proposed regulations are ing the scheduling of the speakers will be
(b) General rules.
adopted as final regulations, consideration prepared after the deadline for receiving
(c) Written plan requirements.
will be given to any written comments outlines has passed. Copies of the agenda
(d) Plan year requirements.
(a signed original and eight (8) copies) will be available free of charge at the hear-
(e) Grace period.
or electronic comments that are submitted ing.
(f) Run-out period.
timely to the IRS. The IRS and Treasury (g) Employee for purpose of Section
Drafting Information
Department specifically request comments 125.
on the clarity of the proposed rules and The principal author of these proposed (h) After-tax employee contributions.
how they can be made easier to understand. regulations is Mireille T. Khoury, Office of (i) Prohibited taxable benefits.
In addition, comments are requested on the Division Counsel/Associate Chief Coun- (j) Coordination with other rules.
following issues: sel (Tax Exempt and Government Enti- (k) Group-term life insurance.
ties), Internal Revenue Service. However, (l) COBRA premiums.

September 24, 2007 689 2007–39 I.R.B.

 (m) Payment or reimbursement of em- §1.125–6 Substantiation of expenses for regulations, that is maintained by an em-
ployees’ individual accident and health in- all cafeteria plans. ployer for the benefit of its employees and
surance premiums. that is operated in compliance with the re-
(n) Section 105 rules for accident and (a) Cafeteria plan payments and reim- quirements of section 125 and the regula-
health plan offered through a cafeteria bursements. tions. All participants in a cafeteria plan
plan. (b) Rules for claims substantiation for must be employees. A cafeteria plan must
(o) Prohibition against deferred com- cafeteria plans. offer at least one permitted taxable benefit
pensation. (c) Debit cards — overview. (as defined in paragraph (a)(2) of this sec-
(p) Benefits relating to more than one (d) Mandatory rules for all debit cards tion) and at least one qualified benefit (as
year. usable to pay or reimburse medical ex- defined in paragraph (a)(3) of this section).
(q) Nonqualified benefits. penses. A cafeteria plan must not provide for defer-
(r) Employer contributions to a cafete- (e) Substantiation of expenses incurred ral of compensation (except as specifically
ria plan. at medical care providers and certain other permitted in paragraph (o) of this section).
(s) Effective/applicability date. stores with Drug Stores and Pharmacies (2) The term permitted taxable benefit
merchant category code. means cash and certain other taxable ben-
§1.125–2 Cafeteria plans; elections. (f) Inventory information approval sys- efits treated as cash for purposes of sec-
tem. tion 125. For purposes of section 125,
(a) Rules relating to making elections
(g) Debit cards used to pay or reimburse cash means cash compensation (includ-
and revoking elections.
dependent care assistance. ing salary reduction), payments for annual
(b) Automatic elections.
(h) Effective/applicability date. leave, sick leave, or other paid time off
(c) Election rules for salary reduction
and severance pay. A distribution from a
contributions to HSAs.
§1.125–7 Cafeteria plan trust described in section 401(a) is not cash
(d) Optional election for new employ-
nondiscrimination rules. for purposes of section 125. Other tax-
ees.
able benefits treated as cash for purposes
(e) Effective/applicability date.
(a) Definitions. of section 125 are:
§1.125–5 Flexible spending (b) Nondiscrimination as to eligibility. (i) Property;
arrangements. (c) Nondiscrimination as to contribu- (ii) Benefits attributable to employer
tions and benefits. contributions that are currently taxable
(a) Definition of flexible spending ar- (d) Key employees. to the employee upon receipt by the em-
rangement. (e) Section 125(g)(2) safe harbor for ployee; and
(b) Flex-credits allowed. cafeteria plans providing health benefits. (iii) Benefits purchased with after-tax
(c) Use-or-lose rule. (f) Safe harbor test for premium-only- employee contributions, as described in
(d) Uniform coverage rules applicable plans. paragraph (h) of this section.
to health FSAs. (g) Permissive disaggregation for (3) Qualified benefit. Except as other-
(e) Required period of coverage for a nondiscrimination testing. wise provided in section 125(f) and para-
health FSA, dependent care FSA and adop- (h) Optional aggregation of plans for graph (q) of this section, the term quali-
tion assistance FSA. nondiscrimination testing. fied benefit means any benefit attributable
(f) Coverage on a month-by-month or (i) Employees of certain controlled to employer contributions to the extent that
expense-by-expense basis prohibited. groups. such benefit is not currently taxable to the
(g) FSA administrative practices. (j) Time to perform nondiscrimination employee by reason of an express provi-
(h) Qualified benefits permitted to be testing. sion of the Internal Revenue Code (Code)
offered through a FSA. (k) Discrimination in actual operation and which does not defer compensation
(i) Section 129 rules for dependent care prohibited. (except as provided in paragraph (o) of this
assistance program offered through a cafe- (l) Anti-abuse rule. section). The following benefits are qual-
teria plan. (m) Tax treatment of benefits in a cafe- ified benefits that may be offered under a
(j) Section 137 rules for adoption assis- teria plan. cafeteria plan and are excludible from em-
tance program offered through a cafeteria (n) Employer contributions to employ- ployees’ gross income when provided in
plan. ees’ Health Savings Accounts. accordance with the applicable provisions
(k) FSAs and the rules governing the (o) Effective/applicability date. of the Code—
tax-favored treatment of employer-pro- (A) Group-term life insurance on the
vided health benefits. §1.125–1 Cafeteria plans; general rules. life of an employee in an amount that is
(l) Section 105(h) requirements. less than or equal to the $50,000 excludible
(m) HSA-compatible FSAs- lim- (a) Definitions. The definitions set forth from gross income under section 79(a), but
ited-purpose health FSAs and post-de- in this paragraph (a) apply for purposes of not combined with any permanent benefit
ductible health FSAs. section 125 and the regulations. within the meaning of §1.79–0;
(n) Qualified HSA distributions. (1) The term cafeteria plan means a (B) An accident and health plan ex-
(o) FSA experience gains or forfeitures. separate written plan that complies with cludible from gross income under section
(p) Effective/applicability date. the requirements of section 125 and the 105 or 106, including self-insured medical

2007–39 I.R.B. 690 September 24, 2007

reimbursement plans (such as health FSAs criminatory cafeteria plan is not includible Employer A’s health plan allows former employees
described in §1.125–5); in the employee’s gross income merely to elect to have distributions from the qualified re-
(C) Premiums for COBRA continuation because the employee has the opportu- tirement plan applied to pay for the health insurance
premiums through the cafeteria plan.
coverage (if excludible under section 106) nity to choose among cash and qualified (ii) Amounts distributed from the qualified retire-
under the accident and health plan of the benefits (within the meaning of section ment plan which the former employees elect to have
employer sponsoring the cafeteria plan or 125(e)) through the cafeteria plan. Sec- applied to pay health insurance premiums through the
premiums for COBRA continuation cover- tion 125(a), (d)(1). However, if a plan cafeteria plan are includible in their gross income.
age of an employee of the employer spon- offering an employee an election between The same result occurs if distributions from the quali-
fied retirement plan are applied directly to reimburse
soring the cafeteria plan under an accident taxable benefits (including cash) and non- section 213(d) medical care expenses incurred by a
and health plan sponsored by a different taxable qualified benefits does not meet former employee or his or her spouse or dependents.
employer; the section 125 requirements, the election These distributions are includible in their income, and
(D) An accidental death and dismem- between taxable and nontaxable benefits are not cash for purposes of section 125. The plan is
berment insurance policy (section 106); results in gross income to the employee, not a cafeteria plan with respect to former employees.
Example 2. Severance pay used to pay COBRA
(E) Long-term or short-term disability regardless of what benefit is elected and premiums. Employer B maintains a cafeteria plan,
coverage (section 106); when the election is made. An employee which offers employees an election between cash
(F) Dependent care assistance program who has an election among nontaxable and employer-provided accident and health insur-
(section 129); benefits and taxable benefits (including ance (excludible from employees’ gross income
(G) Adoption assistance (section 137); cash) that is not through a cafeteria plan under section 106). Employer B pays terminating
employees severance pay. The cafeteria plan also
(H) A qualified cash or deferred ar- that satisfies section 125 must include allows a terminating employee to elect between re-
rangement that is part of a profit-sharing in gross income the value of the taxable ceiving severance pay and using the severance pay
plan or stock bonus plan, as described in benefit with the greatest value that the em- to pay the COBRA premiums for the accident and
paragraph (o)(3) of this section (section ployee could have elected to receive, even health insurance. These provisions in the cafeteria
401(k)); if the employee elects to receive only the plan are consistent with the requirements in section
125.
(I) Certain plans maintained by educa- nontaxable benefits offered. The amount
(4) Election by participants. (i) In gen-
tional organizations (section 125(d)(2)(C) of the taxable benefit is includible in the
eral. A cafeteria plan must offer partici-
and paragraph (o)(3)(iii) of this section); employee’s income in the year in which
pants the opportunity to elect between at
and the employee would have actually re-
least one permitted taxable benefit and at
(J) Contributions to Health Savings ceived the taxable benefit if the employee
least one qualified benefit. For example,
Accounts (HSAs) (sections 223 and had elected such benefit. This is the result
if employees are given the opportunity to
125(d)(2)(D)). even if the employee’s election between
elect only among two or more nontaxable
(4) Dependent. The term dependent the nontaxable benefits and taxable bene-
benefits, the plan is not a cafeteria plan.
generally means a dependent as defined in fits is made prior to the year in which the
Similarly, a plan that only offers the elec-
section 152. However, the definition of de- employee would actually have received
tion among salary, permitted taxable bene-
pendent is modified to conform with the the taxable benefits. See paragraph (q) in
fits, paid time off or other taxable benefits
underlying Code section for the qualified §1.125–1 for nonqualified benefits.
is not a cafeteria plan. See section 125(a),
benefit. For example, for purposes of a (2) Nondiscrimination rules for qual-
(d). See §1.125–2 for rules on elections.
benefit under section 105, the term depen- ified benefits. Accident and health plan
(ii) Premium-only-plan. A cafeteria
dent means a dependent as defined in sec- coverage, group-term life insurance cov-
plan may be a premium-only-plan.
tion 152, determined without regard to sec- erage, and benefits under a dependent
(iii) Examples. The following examples
tion 152(b)(1), (b)(2) or (d)(1)(B). care assistance program or adoption assis-
illustrate the rules of paragraph (b)(4)(i) of
(5) Premium-only-plan. A pre- tance program do not fail to be qualified
this section.
mium-only-plan is a cafeteria plan that benefits under a cafeteria plan merely be- Example 1. No election. Employer C covers all
offers as its sole benefit an election be- cause they are includible in gross income its employees under its accident and health plan (ex-
tween cash (for example, salary) and because of applicable nondiscrimina- cludible from employees’ gross income under sec-
payment of the employee share of the tion requirements (for example, sections tion 106). Coverage is mandatory (that is, employees
employer-provided accident and health 79(d), 105(h),129(d), 137(c)(2)). See also have no election between cash and the Employer C’s
accident and health plan). This plan is not a cafeteria
insurance premium (excludible from the §§1.105–11(k) and 1.125–7. plan, because the plan offers employees no election
employee’s gross income under section (3) Examples. The following examples between taxable and nontaxable benefits. The acci-
106). illustrate the rules of paragraph (b)(1) of dent and health coverage is excludible from employ-
(b) General rules—(1) Cafeteria plans. this section. ees’ gross income.
Section 125 is the exclusive means by Example 1. Distributions from qualified pension Example 2. Election between cash and at least
plan used for health insurance premiums. (i) Em- one qualified benefit. Employer D offers its employ-
which an employer can offer employees ees a plan with an election between cash and an em-
ployer A maintains a qualified section 401(a) retire-
an election between taxable and nontax- ment plan for employees. Employer A also provides ployer-provided accident and health plan (excludible
able benefits without the election itself accident and health insurance (as described in sec- from employees’ gross income under section 106). If
resulting in inclusion in gross income by tion 106) for employees and former employees, their the plan also satisfies all the other requirements of
the employees. Section 125 provides that spouses and dependents. The health insurance premi- section 125, the plan is a cafeteria plan because it of-
ums are partially paid through a cafeteria plan. None fers an election between at least one taxable benefit
cash (including certain taxable benefits) and at least one nontaxable qualified benefit.
of Employer A’s employees are public safety officers.
offered to an employee through a nondis-

September 24, 2007 691 2007–39 I.R.B.

 Example 3. Election between employer flex-cred- ployees beyond the current plan year or elective contributions through the plan by
its and qualified benefits. Employer E offers its em- group-term life insurance with a perma- employees.
ployees an election between an employer flex-credit nent benefit, as defined under §1.79–0. (vi) The plan year of the cafeteria plan;
(as defined in paragraph (b) in §1.125–5) and quali-
fied benefits. If an employee does not elect to apply
(c) Written plan requirements—(1) (vii) If the plan offers paid time off, the
the entire employer flex-credit to qualified benefits, General rule. A cafeteria plan must con- required ordering rule for use of nonelec-
the employee will receive no cash or other taxable tain in writing the information described tive and elective paid time off in paragraph
benefit for the unused employer flex-credit. The plan in this paragraph (c), and depending on (o)(4) of this section;
is not a cafeteria plan because it does not offer an elec- the qualified benefits offered in the plan, (viii) If the plan includes flexible
tion between at least one taxable benefit and at least
one nontaxable qualified benefit.
may also be required to contain additional spending arrangements (as defined in
Example 4. No election between cash and information described in paragraphs (c)(2) §1.125–5(a)), the plan’s provisions com-
qualified benefits for certain employees. (i) Em- and (c)(3) of this section. The cafeteria plying with any additional requirements
ployer F maintains a calendar year plan offering plan must be adopted and effective on or for those FSAs (for example, the uniform
employer-provided accident and health insurance before the first day of the cafeteria plan coverage rule and the use-or-lose rules in
coverage which includes employee-only and family
coverage options.
year to which it relates. The terms of the paragraphs (d) and (c) in §1.125–5);
(ii) The plan provides for an automatic enrollment plan must apply uniformly to all partici- (ix) If the plan includes a grace period,
process when a new employee is hired, or during the pants. The cafeteria plan document may the plan’s provisions complying with para-
annual election period under the plan: only employ- be comprised of multiple documents. The graph (e) of this section; and
ees who certify that they have other health coverage written cafeteria plan must contain all of (x) If the plan includes distributions
are permitted to elect to receive cash. Employees who
cannot certify are covered by the accident and health
the following information— from a health FSA to employees’ HSAs,
insurance on a mandatory basis. Employer F does (i) A specific description of each of the the plan’s provisions complying with para-
not otherwise request or collect information from em- benefits available through the plan, includ- graph (n) in §1.125–5.
ployees regarding other health coverage as part of the ing the periods during which the benefits (2) Additional requirements under sec-
enrollment process. If the employee has a spouse or are provided (the periods of coverage); tions 105(h), 129, and 137. A written plan
child, the employee can elect between cash and fam-
ily coverage.
(ii) The plan’s rules governing partic- is required for self-insured medical re-
(iii) When an employee is hired, the employee re- ipation, and specifically requiring that all imbursement plans (§1.105–11(b)(1)(i)),
ceives a notice explaining the plan’s automatic enroll- participants in the plan be employees; dependent care assistance programs (sec-
ment process. The notice includes the salary reduc- (iii) The procedures governing employ- tion 129(d)(1)), and adoption assistance
tion amounts for employee-only coverage and family ees’ elections under the plan, including the (section 137(c)). Any of these plans or
coverage, procedures for certifying whether the em-
ployee has other health coverage, elections for family
period when elections may be made, the programs offered through a cafeteria plan
coverage, information on the time by which a certi- periods with respect to which elections are that satisfies the written plan require-
fication or election must be made, and the period for effective, and providing that elections are ment in this paragraph (c) for the benefits
which a certification or election will be effective. The irrevocable, except to the extent that the under these plans and programs also sat-
notice is also given to each current employee before optional change in status rules in §1.125–4 isfies the written plan requirements in
the beginning of each plan year, (except that the no-
tice for a current employee includes a description of
are included in the cafeteria plan; §1.105–11(b)(1)(i), section 129(d)(1), and
the employee’s existing coverage, if any). (iv) The manner in which employer section 137(c) (whichever is applicable).
(iv) For a new employee, an election to receive contributions may be made under the plan, Alternatively, a self-insured medical re-
cash or to have family coverage is effective if made (for example, through an employee’s imbursement plan, a dependent care assis-
when the employee is hired. For a current employee, salary reduction election or by non- tance program, or an adoption assistance
an election is effective if made prior to the start of
each calendar year or under any other circumstances
elective employer contributions (that is, program is permitted to satisfy the re-
permitted under §1.125–4. An election for any prior flex-credits, as defined in paragraph (b) in quirements in §1.105–11(b)(1)(i), section
year carries over to the next succeeding plan year §1.125–5) or both); 129(d)(1), or section 137(c) (whichever
unless changed. Certification that the employee has (v) The maximum amount of employer is applicable) through a separate written
other health coverage must be made annually. contributions available to any employee plan, and not as part of the written cafete-
(v) Contributions used to purchase employer-pro-
vided accident and health coverage under section 125
through the plan, by stating: ria plan.
are not includible in an employee’s gross income if (A) The maximum amount of elective (3) Additional requirements under sec-
the employee can elect cash. Section 125 does not contributions (i.e., salary reduction) avail- tion 401(k). See §1.401(k)–1(e)(7) for ad-
apply to the employee-only coverage of an employee able to any employee through the plan, ex- ditional requirements that must be satisfied
who cannot certify that he or she has other health cov- pressed as a maximum dollar amount or a in the written plan if the plan offers defer-
erage and, therefore, does not have the ability to elect
cash in lieu of health coverage.
maximum percentage of compensation or rals into a section 401(k) plan.
(5) No deferred compensation. Except the method for determining the maximum (4) Cross-reference allowed. In de-
as provided in paragraph (o) of this section, dollar amount; and scribing the benefits available through the
in order for a plan to be a cafeteria plan, the (B) For contributions to section 401(k) cafeteria plan, the written cafeteria plan
qualified benefits and the permitted tax- plans, the maximum amount of elective need not be self-contained. For example,
able benefits offered through the cafeteria contributions available to any employee the written cafeteria plan may incorpo-
plan must not defer compensation. For ex- through the plan, expressed as a maximum rate by reference benefits offered through
ample, a cafeteria plan may not provide for dollar amount or maximum percentage of other separate written plans, such as a
retirement health benefits for current em- compensation that may be contributed as section 401(k) plan, or coverage under a
dependent care assistance program (sec-

2007–39 I.R.B. 692 September 24, 2007

tion 129), without describing in full the (E) Failing to comply with the use-or- Example 1. Employer with calendar year. Em-
benefits established through these other lose rule in paragraph (c) in §1.125–5; ployer G, with a calendar taxable year, first estab-
plans. But, for example, if the cafeteria (F) Allowing employees to revoke elec- lishes a cafeteria plan effective July 1, 2009. The
cafeteria plan specifies a calendar plan year. The first
plan offers different maximum levels of tions or make new elections, except as pro- cafeteria plan year is the period beginning on July 1,
coverage for dependent care assistance vided in §1.125–4 and paragraph (a) in 2009, and ending on December 31, 2009. Employer
programs, the descriptions in the separate §1.125–2; G has a business purpose for a short first cafeteria
written plan must specify the available (G) Failing to comply with the substan- plan year.
maximums. tiation requirements of §1.125–6; Example 2. Employer changes insurance carrier.
Employer H establishes a cafeteria plan effective
(5) Amendments to cafeteria plan. Any (H) Paying or reimbursing expenses in January 1, 2009, with a calendar year plan year.
amendment to the cafeteria plan must be an FSA other than expenses expressly per- The cafeteria plan offers an accident and health plan
in writing. A cafeteria plan is permitted mitted in paragraph (h) in §1.125–5; through Insurer X. In March 2010, Employer H
to be amended at any time during a plan (I) Allocating experience gains other contracts to provide accident and health insurance
year. However, the amendment is only than as expressly permitted in paragraph through another insurance company, Y. Y’s accident
and health insurance is offered on a July 1-June 30
permitted to be effective for periods after (o) in §1.125–5; benefit year. Effective July 1, 2010, Employer H
the later of the adoption date or effective (J) Failing to comply with the grace pe- amends the plan to change to a July 1-June 30 plan
date of the amendment. For an amend- riod rules in paragraph (e) of this section; year. Employer H has a business purpose for chang-
ment adding a new benefit, the cafeteria or ing the cafeteria plan year and for the short plan year
plan must pay or reimburse only those ex- (K) Failing to comply with the qualified ending June 30, 2010.

penses for new benefits incurred after the HSA distribution rules in paragraph (n) in (5) Significance of plan year. The plan
later of the amendment’s adoption date or §1.125–5. year generally is the coverage period for
effective date. (d) Plan year requirements—(1) Twelve benefits provided through the cafeteria
(6) Failure to satisfy written plan re- consecutive months. The plan year must plan to which annual elections for these
quirements. If there is no written cafete- be specified in the cafeteria plan. The plan benefits apply. Benefits elected pursuant
ria plan, or if the written plan fails to sat- year of a cafeteria plan must be twelve con- to the employee’s election for a plan year
isfy any of the requirements in this para- secutive months, unless a short plan year is generally may not be carried forward to
graph (c) (including cross-referenced re- allowed under this paragraph (d). A plan subsequent plan years. However, see the
quirements), the plan is not a cafeteria year is permitted to begin on any day of grace period rule in paragraph (e) of this
plan and an employee’s election between any calendar month and must end on the section.
taxable and nontaxable benefits results in preceding day in the immediately follow- (e) Grace period—(1) In general. A
gross income to the employee. ing year (for example, a plan year that be- cafeteria plan may, at the employer’s op-
(7) Operational failure—(i) In general. gins on October 15, 2007, must end on Oc- tion, include a grace period of up to the fif-
If the cafeteria plan fails to operate accord- tober 14, 2008). A calendar year plan year teenth day of the third month immediately
ing to its written plan or otherwise fails is a period of twelve consecutive months following the end of each plan year. If a
to operate in compliance with section 125 beginning on January 1 and ending on De- cafeteria plan provides for a grace period,
and the regulations, the plan is not a cafete- cember 31 of the same calendar year. A an employee who has unused benefits or
ria plan and employees’ elections between plan year specified in the cafeteria plan is contributions relating to a qualified benefit
taxable and nontaxable benefits result in effective for the first plan year of a cafete- (for example, health flexible spending ar-
gross income to the employees. ria plan and for all subsequent plan years, rangement (health FSA) or dependent care
(ii) Failure to operate according to writ- unless changed as provided in paragraph assistance) from the immediately preced-
ten cafeteria plan or section 125. Exam- (d)(2) of this section. ing plan year, and who incurs expenses
ples of failures resulting in section 125 not (2) Changing plan year. The plan year for that same qualified benefit during the
applying to a plan include the following— is permitted to be changed only for a valid grace period, may be paid or reimbursed
(A) Paying or reimbursing expenses for business purpose. A change in the plan for those expenses from the unused bene-
qualified benefits incurred before the later year is not permitted if a principal pur- fits or contributions as if the expenses had
of the adoption date or effective date of the pose of the change in plan year is to cir- been incurred in the immediately preced-
cafeteria plan, before the beginning of a cumvent the rules of section 125 or these ing plan year. A grace period is available
period of coverage or before the later of the regulations. If a change in plan year does for all qualified benefits described in para-
date of adoption or effective date of a plan not satisfy this subparagraph, the attempt graph (a)(3) of this section, except that the
amendment adding a new benefit; to change the plan year is ineffective and grace period does not apply to paid time
(B) Offering benefits other than permit- the plan year of the cafeteria plan remains off and elective contributions under a sec-
ted taxable benefits and qualified benefits; the same. tion 401(k) plan. The effect of the grace
(C) Operating to defer compensation (3) Short plan year. A short plan year period is that the employee may have as
(except as permitted in paragraph (o) of of less than twelve consecutive months is long as 14 months and 15 days (that is, the
this section); permitted for a valid business purpose. 12 months in the current cafeteria plan year
(D) Failing to comply with the uni- (4) Examples. The following examples plus the grace period) to use the benefits or
form coverage rule in paragraph (d) in illustrate the rules in paragraph (d) of this contributions for a plan year before those
§1.125–5; section: amounts are forfeited under the use-or-lose
rule in paragraph (c) in §1.125–5. If the

September 24, 2007 693 2007–39 I.R.B.

grace period is added to a cafeteria plan nate during the grace period are partici- of unused benefits or contributions remaining for the
through an amendment, all requirements in pants for purposes of the grace period. See plan year ending December 31, 2009. The unused
paragraph (c) of this section must be satis- §54.4980B–2, Q & A–8 of this chapter; $50 cannot be cashed-out, converted to any other tax-
able or nontaxable benefit, or used in any other plan
fied. (ii) The grace period provision in the year (including the plan year ending December 31,
(2) Grace period optional features. A cafeteria plan must state that unused ben- 2009). The unused $50 is subject to the use-or-lose
grace period provision may contain any or efits or contributions relating to a particu- rule in paragraph (c) in §1.125–5 and is forfeited. As
all of the following— lar qualified benefit may only be used to of March 16, 2010, X has the entire $1,500 elected
(i) The grace period may apply to some pay or reimburse expenses incurred with in the health FSA for the plan year ending December
31, 2010.
qualified benefits described in paragraph respect to the same qualified benefit. For Example 3. Terminated participants. (i) Em-
(a)(3) of this section, but not to others; example, unused amounts elected to pay ployer J’s cafeteria plan includes a grace period al-
(ii) The grace period provision may or reimburse medical expenses in a health lowing all participants to apply unused benefits or
limit the amount of unused benefits or FSA may not be used to pay or reimburse contributions remaining at the end of the plan year
contributions available during the grace dependent care expenses incurred during to qualified benefits incurred during the grace period
immediately following that plan year. For the plan
period. The limit must be uniform and the grace period; and year ending on December 31, 2009, the grace period
apply to all participants. However, the (iii) The grace period provision in the ends March 15, 2010.
limit must not be based on a percentage cafeteria plan must state that to the extent (ii) Employees A, B, C, and D each timely elected
of the amount of the unused benefits or any unused benefits or contributions from $1,200 salary reduction for a health FSA for the plan
contributions remaining at the end of the the immediately preceding plan year ex- year ending December 31, 2009. Employees A and
B terminated employment on September 15, 2009.
immediately prior plan year; ceed the expenses for the qualified benefit Each has $500 of unused benefits or contributions in
(iii) The last day of the grace period incurred during the grace period, those re- the health FSA.
may be sooner than the fifteenth day of maining unused benefits or contributions (iii) Employee A elected COBRA for the health
the third month immediately following the may not be carried forward to any sub- FSA. Employee A is a participant in the cafeteria plan
end of the plan year (that is, the grace pe- sequent period (including any subsequent as of December 31, 2009, the last day of the 2009
plan year. Employee A has $500 of unused benefits
riod may be shorter than two and one half plan year), cannot be cashed-out and must or contributions available during the grace period for
months); be forfeited under the use-or-lose rule. See the 2009 plan year (ending March 15, 2010).
(iv) The grace period provision is per- paragraph (c) in §1.125–5. (iv) Employee B did not elect COBRA for the
mitted to treat expenses for qualified ben- (4) Examples. The following examples health FSA. Employee B is not a participant in the
efits incurred during the grace period ei- illustrate the rules in this paragraph (e). cafeteria plan as of December 31, 2009. The grace
period does not apply to Employee B.
ther as expenses incurred during the im- Example 1. Expenses incurred during grace
(v) Employee C has $500 of unused benefits in
mediately preceding plan year or as ex- period and immediately following plan year. (i)
Employer I’s calendar year cafeteria plan includes a his health FSA as of December 31, 2009, and termi-
penses incurred during the current plan grace period allowing all participants to apply unused
nated employment on January 15, 2010. Employee C
year (for example, the plan may first apply is a participant in the cafeteria plan as of December
benefits or contributions remaining at the end of the
the unused contributions or benefits from plan year to qualified benefits incurred during the 31, 2009 and has $500 of unused benefits or contribu-
tions available during the grace period ending March
the immediately preceding year to pay or grace period immediately following that plan year.
15, 2010, even though he terminated employment on
reimburse grace period expenses and then, The grace period for the plan year ending December
31, 2009, ends on March 15, 2010. January 15, 2010.
when the unused contributions and bene- (ii) Employee X timely elected salary reduction
(vi) Employee D continues to work for Employer
fits from the prior year are exhausted, the H throughout 2009 and 2010, also has $500 of unused
of $1,000 for a health FSA for the plan year ending
grace period expenses may be paid from December 31, 2009. As of December 31, 2009, X has benefits or contributions in his health FSA as of De-
cember 31, 2009, but made no health FSA election
current year contributions and benefits.); $200 remaining unused in his health FSA. X timely
for 2010. Employee D is a participant in the cafe-
and elected salary reduction for a health FSA of $1,500
for the plan year ending December 31, 2010. teria plan as of December 31, 2009 and has $500 of
(v) The grace period provision may per- (iii) During the grace period from January 1
unused benefits or contributions available during the
mit the employer to defer the allocation of grace period ending March 15, 2010, even though he
through March 15, 2010, X incurs $300 of unre-
expenses described in paragraph (e)(2)(iv) imbursed medical expenses (as defined in section is not a participant in a health FSA for the 2010 plan
year.
of this section until after the end of the 213(d)). The unused $200 from the plan year ending
December 31, 2009, is applied to pay or reimburse (f) Run-out period. A cafeteria plan is
grace period.
$200 of X’s $300 of medical expenses incurred permitted to contain a run-out period as
(3) Grace period requirements. A grace during the grace period. Therefore, as of March designated by the employer. A run-out pe-
period must satisfy the requirements in 16, 2010, X has no unused benefits or contributions riod is a period after the end of the plan
paragraph (c) of this section and all of the remaining for the plan year ending December 31,
2009.
year (or grace period) during which a par-
following requirements:
(iv) The remaining $100 of medical expenses in- ticipant can submit a claim for reimburse-
(i) The grace period provisions in the
curred between January 1 and March 15, 2010, is paid ment for a qualified benefit incurred dur-
cafeteria plan (including optional provi- or reimbursed from X’s health FSA for the plan year ing the plan year (or grace period). Thus, a
sions in paragraph (e)(2) of this section) ending December 31, 2010. As of March 16, 2010, X plan is also permitted to provide a deadline
must apply uniformly to all participants has $1,400 remaining in the health FSA for the plan
year ending December 31, 2010.
on or after the end of the plan year (or grace
in the cafeteria plan, determined as of the
Example 2. Unused benefits exceed expenses in- period) for submitting a claim for reim-
last day of the plan year. Participants in
curred during grace period. Same facts as Example bursement for the plan year. Any run-out
the cafeteria plan through COBRA and 1, except that X incurs $150 of section 213(d) medical period must be provided on a uniform and
participants who were participants as of expenses during the grace period (January 1 through
the last day of the plan year but termi- March 15, 2010). As of March 16, 2010, X has $50

2007–39 I.R.B. 694 September 24, 2007

consistent basis with respect to all partici- Example 1. Two-percent shareholders of an a section 401(k) plan, Health Savings Ac-
pants. S corporation. (i) Employer K, an S corporation, count, or certain group-term life insurance
(g) Employee for purposes of section maintains a cafeteria plan for its employees (other offered through the cafeteria plan. See
than 2-percent shareholders of an S corporation).
125—(1) Current employees, former em- Employer K’s taxable year and the plan year are
§54.4980B–2, Q & A 8 and §54.4980B–4,
ployees. The term employee includes any the calendar year. On January 1, 2009, individual Z Q & A–1 of this chapter on COBRA rights
current or former employee (including any owns 5 percent of the outstanding stock in Employer of a participant’s spouse or dependents.
laid-off employee or retired employee) of K. Y, who owns no stock in Employer K, is married (5) Employees of certain controlled
the employer. See paragraph (g)(3) of this to Z. Y and Z are employees of Employer K. Z is a groups. All employees who are treated
2-percent shareholder in Employer K (as defined in
section concerning limits on participation section 1372(b)). Y is also a 2-percent shareholder
as employed by a single employer under
by former employees. Specifically, the in Employer K by operation of the attribution rules section 414(b), (c), (m), or (o) are treated
term employee includes the following— in section 318(a)(1)(A)(i). as employed by a single employer for pur-
(i) Common law employee; (ii) On July 15, 2009, Z sells all his stock in Em- poses of section 125. Section 125(g)(4);
(ii) Leased employee described in sec- ployer K to an unrelated third party, and ceases to be section 414(t).
a 2-percent shareholder. Y and Z continue to work
tion 414(n); as employees of Employer K during the entire 2009
(h) After-tax employee contribu-
(iii) Full-time life insurance salesman calendar year. Y and Z are ineligible to participate in tions—(1) Certain after-tax employee
(as defined in section 7701(a)(20)); and Employer K’s cafeteria plan for the 2009 plan year. contributions treated as cash. In addition
(iv) A current employee or former em- Example 2. Director and employee. T is an em- to the cash benefits described in paragraph
ployee described in paragraphs (g)(1)(i) ployee and also a director of Employer L, a C corp (a)(2) of this section, in general, a benefit
that sponsors a cafeteria plan. The cafeteria plan al-
through (iii) of this section. lows only employees of Employer L to participate in
is treated as cash for purposes of section
(2) Self-employed individual not an em- the cafeteria plan. T’s annual compensation as an em- 125 if the benefit does not defer compen-
ployee. (i) In general. The term employee ployee is $50,000; T is also paid $3,000 annually in sation (except as provided in paragraph
does not include a self-employed individ- director’s fees. T makes a timely election to salary (o) of this section) and an employee who
ual or a 2-percent shareholder of an S cor- reduce $5,000 from his employee compensation for receives the benefit purchases such benefit
dependent care benefits. T makes no election with
poration, as defined in paragraph (g)(2)(ii) respect to his compensation as a director. T may par-
with after-tax employee contributions or
of this subsection. For example, a sole ticipate in the cafeteria plan in his capacity as an em- is treated, for all purposes under the Code
proprietor, a partner in a partnership, or a ployee of Employer L. (including, for example, reporting and
director solely serving on a corporation’s (3) Limits on participation by former withholding purposes), as receiving, at
board of directors (and not otherwise pro- employees. Although former employees the time that the benefit is received, cash
viding services to the corporation as an are treated as employees, a cafeteria plan compensation equal to the full value of the
employee) is not an employee for purposes may not be established or maintained pre- benefit at that time and then purchasing
of section 125, and thus is not permitted to dominantly for the benefit of former em- the benefit with after-tax employee con-
participate in a cafeteria plan. However, ployees of the employer. Such a plan is not tributions. Thus, for example, long-term
a sole proprietor may sponsor a cafete- a cafeteria plan. disability coverage is treated as cash for
ria plan covering the sole proprietor’s em- (4) No participation by the spouse or purposes of section 125 if the cafeteria
ployees (but not the sole proprietor). Sim- dependent of an employee. (i) Benefits al- plan provides that an employee may pur-
ilarly, a partnership or S corporation may lowed to participant’s spouse or depen- chase the coverage through the cafeteria
sponsor a cafeteria plan covering employ- dents but not participation. The spouse or plan with after-tax employee contributions
ees (but not a partner or 2-percent share- dependents of employees may not be par- or provides that the employee receiving
holder of an S corporation). ticipants in a cafeteria plan unless they are such coverage is treated as having received
(ii) Two percent shareholder of an also employees. However, a cafeteria plan cash compensation equal to the value of
S corporation. A 2-percent shareholder of may provide benefits to spouses and de- the coverage and then as having purchased
an S corporation has the meaning set forth pendents of participants. For example, al- the coverage with after-tax employee con-
in section 1372(b). though an employee’s spouse may benefit tributions. Also, for example, a cafeteria
(iii) Certain dual status individuals. If from the employee’s election of accident plan may offer employees the opportu-
an individual is an employee of an em- and health insurance coverage or of cov- nity to purchase, with after-tax employee
ployer and also provides services to that erage through a dependent care assistance contributions, group-term life insurance
employer as an independent contractor or program, the spouse may not participate in on the life of an employee (providing
director (for example, an individual is both a cafeteria plan (that is, the spouse may not no permanent benefits), an accident and
a director and an employee of a C corp), be given the opportunity to elect or pur- health plan, or a dependent care assistance
the individual is eligible to participate in chase benefits offered by the plan). program.
that employer’s cafeteria plan solely in his (ii) Certain elections after employee’s (2) Accident and health coverage pur-
or her capacity as an employee. This rule death. An employee’s spouse is not a par- chased for someone other than the em-
does not apply to partners or to 2-percent ticipant in a cafeteria plan merely because ployee’s spouse or dependents with af-
shareholders of an S corporation. the spouse has the right, upon the death of ter-tax employee contributions. If the
(iv) Examples. The following examples the employee, to elect among various set- requirements of section 106 are satisfied,
illustrate the rules in paragraphs (g)(2)(ii) tlement options or to elect among permis- employer-provided accident and health
and (g)(2)(iii) of this section: sible distribution options with respect to coverage for an employee and his or her
the deceased employee’s benefits through spouse or dependents is excludible from

September 24, 2007 695 2007–39 I.R.B.

the employee’s gross income. The fair must be satisfied in order to exclude the age is includible in the employee’s gross
market value of coverage for any other coverage from gross income. income. The amount includible in the
individual, provided with respect to the (2) Section 125 nondiscrimination employee’s income is determined using
employee, is includible in the employee’s rules. Qualified benefits are includible the rules of §1.79–3 and Table I (Uni-
gross income. §1.106–1; §1.61–21(a)(4), in the gross income of highly compen- form Premiums for $1,000 of Group-Term
and §1.61–21(b)(1). A cafeteria plan is sated participants or key employees if the Life Insurance Protection). See subpara-
permitted to allow employees to elect acci- nondiscrimination rules of section 125 are graph (C) of this paragraph (k)(2)(i) for
dent and health coverage for an individual not satisfied. See §1.125–7. determining the amount paid by the em-
who is not the spouse or dependent of the (3) Taxable benefits. If a benefit that is ployee for purposes of reducing the Ta-
employee as a taxable benefit. includible in gross income when offered ble I amount includible in income under
(3) Example. The following example separately is offered through a cafeteria §1.79–3.
illustrates the rules of this paragraph (h): plan, the benefit continues to be includible (C) In determining the amount paid by
Example. Accident and health plan coverage for in gross income. the employee toward the purchase of the
individuals who are not a spouse or dependent of an (k) Group-term life insurance—(1) group-term life insurance for purposes of
employee. (i) Employee C participates in Employer
M’s cafeteria plan. Employee C timely elects salary
In general. In addition to offering up §1.79–3, only an employee’s after-tax con-
reduction for employer-provided accident and health to $50,000 in group-term life insurance tributions are treated as an amount paid by
coverage for himself and for accident and health cov- coverage excludible under section 79(a), the employee.
erage for his former spouse. C’s former spouse is not a cafeteria plan may offer coverage in (ii) Examples. The rules in this para-
C’s dependent. A former spouse is not a spouse as excess of that amount. The cost of cov- graph (k) are illustrated by the following
defined in section 152.
(ii) The fair market value of the coverage for the
erage in excess of $50,000 in group-term examples, in which the group-term life
former spouse is $1,000. Employee C has $1,000 in- life insurance coverage provided under a insurance coverage satisfies the nondis-
cludible in gross income for the accident and health policy or policies carried directly or indi- crimination rules in section 79(d), provides
coverage of his former spouse, because the section rectly by one or more employers (taking no permanent benefits, is for a 12-month
106 exclusion applies only to employer-provided ac- into account all coverage provided both period, is the only group-term life insur-
cident and health coverage for the employee or the
employee’s spouse or dependents.
through a cafeteria plan and outside a cafe- ance coverage provided under a policy car-
(iii) No payments or reimbursements received un- teria plan) is includible in an employee’s ried directly or indirectly by the employer,
der the accident and health coverage result in gross gross income. Group-term life insurance and applies Table I (Uniform Premiums for
income to Employee C or to the former spouse. The combined with permanent benefits, within $1,000 of Group-Term Life Insurance Pro-
result is the same if the $1,000 for coverage of C’s the meaning of §1.79–0, is a prohibited tection) effective July 1, 1999:
former spouse is paid from C’s after-tax income out-
benefit in a cafeteria plan. Example 1. Excess group-term life insurance cov-
side the cafeteria plan.
(2) Determining cost of insurance in- erage provided through salary reduction in a cafete-
(i) Prohibited taxable benefits. Any ria plan. (i) Employer N provides group-term life in-
taxable benefit not described in paragraph cludible in employee’s gross income. (i) surance coverage to its employees only through its
(a)(2) of this section and not treated as cash In general. If the aggregate group-term cafeteria plan. Employer N’s cafeteria plan allows
for purposes of section 125 in paragraph life insurance coverage on the life of the employees to elect salary reduction for group-term
employee (under policies carried directly life insurance. Employee B, age 42, elected salary
(h) of this section is not permitted to be in- reduction of $200 for $150,000 of group-term life in-
cluded in a cafeteria plan. A plan that of- or indirectly by the employer) exceeds
surance. None of the group-term life insurance is paid
fers taxable benefits other than the taxable $50,000, all or a portion of the insurance through after-tax employee contributions.
benefits described in paragraph (a)(2) and is provided through a cafeteria plan, and (ii) B’s $200 of salary reduction for group-term
(h) of this section is not a cafeteria plan. the group-term life insurance is provided life insurance is excludible from B’s gross income
through a plan that meets the nondis- under paragraph (k)(2)(i)(A).
(j) Coordination with other rules—(1) (iii) B has a total of $150,000 of group-term life
In general. If a benefit is excludible from crimination rules of section 79(d), the
insurance. The group-term life insurance in excess
an employee’s gross income when pro- amount includible in an employee’s gross of the dollar limitation of section 79 is $100,000
vided separately, the benefit is excludible income is determined under paragraphs (150,000 - 50,000).
from gross income when provided through (k)(2)(i)(A) through (C) of this section. (iv) The Table I cost is $120 for $100,000 of
For each employee— group-term life insurance for an individual between
a cafeteria plan. Thus, a qualified benefit ages 40 to 44. The Table I cost of $120 is reduced
is excludible from gross income if both the (A) The entire amount of salary reduc-
by zero (because B paid no portion of the group-term
rules under section 125 and the specific tion and employer flex-credits through a life insurance with after-tax employee contributions),
rules providing for the exclusion of the cafeteria plan for group-term life insur- under paragraphs (k)(2)(i)(A)-(B) of this section.
benefit from gross income are satisfied. ance coverage on the life of the employee (v) The amount includible in B’s gross income for
is excludible from the employee’s gross the $100,000 of excess group-term life insurance is
For example, if the nondiscrimination $120.
rules for specific qualified benefits (for ex- income, regardless of the amount of em-
Example 2. Excess group-term life insurance
ample, sections 79(d), 105(h), 129(d)(2), ployer-provided group-term life insurance coverage provided through salary reduction in a
137(c)(2)) are not satisfied, those qualified on the employee’s life (that is, whether or cafeteria plan where employee purchases a portion
benefits are includible in gross income. not the coverage provided to the employee of group-term life insurance coverage with after-tax
both through the cafeteria plan and outside contributions. (i) Same facts as Example 1, except
Thus, if $50,000 in group-term life insur- that B elected salary reduction of $100 and makes an
ance is offered through a cafeteria plan, the the cafeteria plan exceeds $50,000);
after-tax contribution of $100 toward the purchase of
nondiscrimination rules in section 79(d) (B) The cost of the group-term life in- group-term life insurance coverage.
surance in excess of $50,000 of cover-

2007–39 I.R.B. 696 September 24, 2007

 (ii) B’s $100 of salary reduction for group-term (v) The amount includible in C’s gross income (vii) The operation of Employer O’s cafeteria
life insurance is excludible from B’s gross income, for the $10,000 of excess group-term life insurance plan satisfies the requirements of this paragraph (l).
under paragraph (k)(2)(i)(A) of this section. coverage is $12. (m) Payment or reimbursement of em-
(iii) B has a total of $150,000 of group-term life (l) COBRA premiums—(1) Paying ployees’ individual accident and health in-
insurance. The group-term life insurance in excess
COBRA premiums through a cafeteria surance premiums—(1) In general. The
of the dollar limitation of section 79 is $100,000
(150,000 - 50,000).
plan. Under §1.125–4(c)(3)(iv), COBRA payment or reimbursement of employees’
(iv) The Table I cost is $120 for $100,000 of premiums for an employer-provided group substantiated individual health insurance
group-term life insurance for an individual between health plan are qualified benefits if: premiums is excludible from employees’
ages 40 to 44, under paragraph (k)(2)(i)(B). The (i) The premiums are excludible from gross income under section 106 and is a
Table I cost of $120 is reduced by $100 (because
an employee’s income under section 106; qualified benefit for purposes of section
B paid $100 for the group-term life insurance with
after-tax employee contributions), under paragraphs
or 125.
(k)(2)(i)(B) and (k)(2)(i)(C) of this section. (ii) The premiums are for the accident (2) Example. The following example
(v) The amount includible in B’s gross income and health plan of the employer spon- illustrates the rule of this paragraph (m):
for the $100,000 of excess group-term life insurance soring the cafeteria plan, even if the fair Example. Payment or reimbursement of premi-
coverage is $20. ums. (i) Employer P’s cafeteria plan offers the fol-
market value of the premiums is includi-
Example 3. Excess group-term life insurance lowing benefits for employees who are covered by
coverage provided through salary reduction in a
ble in an employee’s gross income. See
an individual health insurance policy. The employee
cafeteria plan and outside a cafeteria plan. (i) Same also paragraph (e)(2) in §1.125–5 and substantiates the expenses for the premiums for the
facts as Example 1 except that Employer N also §54.4980B–2, Q & A–8 of this chapter for policy (as required in paragraph (b)(2) in §1.125–6)
provides (at no cost to employees) group-term life COBRA rules for health FSAs. before any payments or reimbursements to the em-
insurance coverage equal to each employee’s annual ployee for premiums are made. The payments or re-
(2) Example. The following example
salary. Employee B’s annual salary is $150,000. B imbursements are made in the following ways:
has $150,000 of group-term life insurance directly
illustrates the rules of this paragraph (l):
(ii) The cafeteria plan reimburses each employee
Example. COBRA premiums. (i) Employer O
from Employer N, and also $150,000 coverage directly for the amount of the employee’s substanti-
maintains a cafeteria plan for full-time employees,
through Employer N’s cafeteria plan. ated health insurance premium;
offering an election between cash and employer-pro-
(ii) B’s $200 of salary reduction for group-term (iii) The cafeteria plan issues the employee a
vided accident and health insurance and other quali-
life insurance is excludible from B’s gross income, check payable to the health insurance company for
fied benefits. Employees A, B, and C participate in
under paragraph (k)(2)(i)(A) of this section. the amount of the employee’s health insurance pre-
the cafeteria plan. On July 1, 2009, Employee A has
(iii) B has a total of $300,000 of group-term life mium, which the employee is obligated to tender to
a qualifying event (as defined in §54.4980B–4 of this
insurance. The group-term life insurance in excess the insurance company;
chapter).
of the dollar limitation of section 79 is $250,000 (iv) The cafeteria plan issues a check in the same
(ii) Employee A was a full-time employee and be-
(300,000 - 50,000). manner as (iii), except that the check is payable
came a part-time employee and for that reason, is no
(iv) The Table I cost is $300 for $250,000 of jointly to the employee and the insurance company;
longer covered by Employer O’s accident and health
group-term life insurance for an individual between or
plan. Under §1.125–4(f)(3)(ii), Employee A changes
ages 40 to 44. The Table I cost of $300 is reduced (v) Under these circumstances, the individual
her election to salary reduce to pay her COBRA pre-
by zero (because B paid no portion of the group-term health insurance policies are accident and health
miums.
life insurance with after-tax employee contributions), plans as defined in §1.106–1. This benefit is a quali-
(iii) Employee B previously worked for another
under paragraphs (k)(2)(i)(B) and (k)(2)(i)(C) of this fied benefit under section 125.
employer, quit and elected COBRA. Employee B be-
section.
gins work for Employer O on July 1, 2009, and be- (n) Section 105 rules for accident and
(v) The amount includible in B’s gross income for
the $250,000 of excess group-term life insurance is
comes eligible to participate in Employer O’s cafe- health plan offered through a cafeteria
teria plan on July 1, 2009, but will not be eligible to plan—(1) General rule. In order for an
$300.
participate in Employer O’s accident and health plan
Example 4. Excess group-term life insurance cov- accident and health plan to be a qualified
until October 1, 2009. Employee B elects to salary
erage provided through salary reduction in a cafete- benefit that is excludible from gross in-
reduce to pay COBRA premiums for coverage under
ria plan and outside a cafeteria plan. (i) Same facts
the accident and health plan sponsored by B’s former come if elected through a cafeteria plan,
as Example 3 except that Employee C’s annual salary
is $30,000. C has $30,000 of group-term life insur-
employer. the cafeteria plan must satisfy section 125
(iv) Employee C and C’s spouse are covered by and the accident and health plan must sat-
ance coverage provided directly from Employer N,
Employer O’s accident and health plan until July 1,
and elects an additional $30,000 of coverage for $40 isfy section 105(b) and (h).
2009, when C’s divorce from her spouse became
through Employer N’s cafeteria plan. C is 42 years (2) Section 105(b) requirements in gen-
final. C continues to be covered by the accident
old.
and health plan. On July 1, 2009, C requests to pay eral. Section 105(b) provides an exclusion
(ii) C’s $40 of salary reduction for group-term life
insurance is excludible from C’s gross income, under
COBRA premiums for her former spouse (who is from gross income for amounts paid to
not C’s dependent (as defined in section 152)) with an employee from an employer-funded
paragraph (k)(2)(i)(A) of this section.
after-tax employee contributions.
(iii) C has a total of $60,000 of group-term life accident and health plan specifically to
(v) Salary reduction elections for COBRA premi-
insurance. The group-term life insurance in excess of reimburse the employee for certain ex-
ums for Employees A and B are qualified benefits for
the dollar limitation of section 79 is $10,000 (60,000
purposes of section 125 and are excludible from the penses for medical care (as defined in
- 50,000).
(iv) The Table I cost is $12 for $10,000 of group-
gross income of Employees A and B. Employer O al- section 213(d)) incurred by the employee
lows A and B to salary reduce for these COBRA pre- or the employee’s spouse or dependents
term life insurance for an individual between ages 40
miums.
to 44. The Table I cost of $12 is reduced by zero during the period for which the benefit is
(vi) Employer O allows C to pay for COBRA
(because C paid no portion of the group-term life in- provided to the employee (that is, when
premiums for C’s former spouse, with after-tax em-
surance with after-tax employee contributions), under
ployee contributions because although accident and the employee is covered by the accident
paragraphs (k)(2)(i)(B) and (k)(2)(i)(C) of this sec-
tion.
health coverage for C’s former spouse is permitted in and health plan).
a cafeteria plan, the premiums are includible in C’s (o) Prohibition against deferred com-
gross income.
pensation—(1) In general. Any plan that

September 24, 2007 697 2007–39 I.R.B.

offers a benefit that defers compensa- after-tax employee contributions under a not permit the employee to convert, in any
tion (except as provided in this paragraph qualified plan subject to section 401(m) subsequent plan year, the unused paid time
(o)) is not a cafeteria plan. See section are permitted through a cafeteria plan. The off into any other benefit.
125(d)(2)(A). A plan that permits em- right to make such contributions does not (ii) Ordering of elective and nonelec-
ployees to carry over unused elective cause a plan to fail to be a cafeteria plan tive paid time off. In determining whether
contributions, after-tax contributions, or merely because, under the qualified plan, a plan providing paid time off operates
plan benefits from one plan year to an- employer matching contributions (as de- to permit the deferral of compensation, a
other (except as provided in paragraphs fined in section 401(m)(4)(A)) are made cafeteria plan must provide that employees
(e), (o)(3) and (4) and (p) of this sec- with respect to elective or after-tax em- are deemed to use paid time off in the fol-
tion) defers compensation. This is the ployee contributions. lowing order:
case regardless of how the contributions (iii) Additional permitted deferred com- (A) Nonelective paid time off. Nonelec-
or benefits are used by the employee in pensation arrangements. A plan main- tive paid time off (that is, paid time off with
the subsequent plan year (for example, tained by an educational organization de- respect to which the employee has no elec-
whether they are automatically or elec- scribed in section 170(b)(1)(A)(ii) to the tion) is used first;
tively converted into another taxable or extent of amounts which a covered em- (B) Elective paid time off. Elective paid
nontaxable benefit in the subsequent plan ployee may elect to have the employer pay time off is used after all nonelective paid
year or used to provide additional benefits as contributions for post-retirement group time off is used.
of the same type). Similarly, a cafeteria life insurance is permitted through a cafe- (iii) Cashing out or forfeiture of un-
plan also defers compensation if the plan teria plan, if— used elective paid time off, in general. The
permits employees to use contributions for (A) All contributions for such insurance cafeteria plan must provide that all unused
one plan year to purchase a benefit that must be made before retirement; and elective paid time off (determined as of the
will be provided in a subsequent plan year (B) Such life insurance does not have a last day of the plan year) must either be
(for example, life, health or disability if cash surrender value at any time. paid in cash (within the time specified in
these benefits have a savings or investment (iv) Contributions to HSAs. Contribu- this paragraph (o)(4)) or be forfeited. This
feature, such as whole life insurance). See tions to covered employees’ HSAs as de- provision must apply uniformly to all par-
also Q & A–5 in §1.125–3, prohibiting de- fined in section 223 (but not contributions ticipants in the cafeteria plan.
ferring compensation from one cafeteria to Archer MSAs). (A) Cash out of unused elective paid
plan year to a subsequent cafeteria plan (4) Paid time off. (i) In general. A cafe- time off. A plan does not operate to permit
year. See paragraph (e) of this section for teria plan is permitted to include elective the deferral of compensation merely be-
grace period rules. A plan does not defer paid time off (that is, vacation days, sick cause the plan provides that an employee
compensation merely because it allocates days or personal days) as a permitted tax- who has not used all elective paid time off
experience gains (or forfeitures) among able benefit through the plan by permit- for a plan year receives in cash the value
participants in compliance with paragraph ting employees to receive more paid time of such unused paid time off. The em-
(o) in §1.125–5. off than the employer otherwise provides ployee must receive the cash on or before
(2) Effect if a plan includes a benefit to the employees on a nonelective basis, the last day of the cafeteria plan’s plan year
that defers the receipt of compensation or but only if the inclusion of elective paid to which the elective contributions used to
a plan operates to defer compensation. If time off through the plan does not operate purchase the unused elective paid time off
a plan violates paragraph (o)(1) of this sec- to permit the deferral of compensation. In relate.
tion, the availability of an election between addition, a plan that only offers the choice (B) Forfeiture of unused elective paid
taxable and nontaxable benefits under such of cash or paid time off is not a cafete- time off. If the cafeteria plan provides for
a plan results in gross income to the em- ria plan and is not subject to the rules of forfeiture of unused elective paid time off,
ployees. section 125. In order to avoid deferral of the forfeiture must be effective on the last
(3) Cash or deferred arrangements that compensation, the cafeteria plan must pre- day of the plan year to which the elective
may be offered in a cafeteria plan. (i) In clude any employee from using the paid contributions relate.
general. A cafeteria plan may offer the time off or receiving cash, in a subsequent (iv) No grace period for paid time off.
benefits set forth in this paragraph (o)(3), plan year, for any portion of such paid time The grace period described in paragraph
even though these benefits defer compen- off remaining unused as of the end of the (e) of this section does not apply to paid
sation. plan year. (See paragraph (o)(4)(iii) of this time off.
(ii) Elective contributions to a section section for the deadline to cash out unused (v) Examples. The following examples
401(k) plan. A cafeteria plan may permit elective paid time off.) For example, a plan illustrate the rules of this paragraph (o)(4):
a covered employee to elect to have the that offers employees the opportunity to Example 1. Plan cashes out unused elective paid
employer, on behalf of the employee, pay purchase paid time off (or to receive cash time off on or before the last day of the plan year. (i)
Employer Q provides employees with two weeks of
amounts as contributions to a trust that is or other benefits through the plan in lieu of paid time off for each calendar year. Employer Q’s
part of a profit-sharing or stock bonus plan paid time off) is not a cafeteria plan if em- human resources policy (that is, outside the cafeteria
or rural cooperative plan (within the mean- ployees who purchase the paid time off for plan), permits employees to carry over one nonelec-
ing of section 401(k)(7)), which includes a a plan year are allowed to use any unused tive week of paid time off to the next year. Employer
qualified cash or deferred arrangement (as paid time off in a subsequent plan year. Q maintains a calendar year cafeteria plan that per-

defined in section 401(k)(2)). In addition, This is the case even though the plan does

2007–39 I.R.B. 698 September 24, 2007

mits the employee to purchase, with elective contri- plan’s terms and operations do not violate the prohi- (2) Benefits under a long-term disabil-
butions, an additional week of paid time off. bition against deferring compensation. ity policy relating to more than one year.
(ii) For the 2009 plan year, Employee A (with a (p) Benefits relating to more than one A long-term disability policy paying dis-
calendar tax year), timely elects to purchase one addi-
year—(1) Benefits in an accident and ability benefits over more than one year
tional week of paid time off. During 2009, Employee
A uses only two weeks of paid time off. Employee
health insurance policy relating to more does not violate the prohibition against de-
A is deemed to have used two weeks of nonelective than one year. Consistent with section ferring compensation.
paid time off and zero weeks of elective paid time off. 125(d), an accident and health insurance (3) Reasonable premium rebates or pol-
(iii) Pursuant to the cafeteria plan, the plan pays policy may include certain benefits, as icy dividends. Reasonable premium re-
Employee A the value of the unused elective paid
set forth in this paragraph (p)(1), without bates or policy dividends paid with re-
time off week in cash on December 31, 2009. Em-
ployer Q includes this amount on the 2009 Form W–2
violating the prohibition against deferred spect to benefits provided through a cafe-
for Employee A. This amount is included in Em- compensation. teria plan do not constitute impermissi-
ployee A’s gross income in 2009. The cafeteria plan’s (i) Permitted benefits. The following ble deferred compensation if such rebates
terms and operations do not violate the prohibition features or benefits of insurance policies or dividends are paid before the close of
against deferring compensation.
do not defer compensation— the 12-month period immediately follow-
Example 2. Unused nonelective paid time off car-
ried over to next plan year. (i) Same facts as Exam-
(A) Credit toward the deductible for un- ing the cafeteria plan year to which such
ple 1, except that Employee A uses only one week of reimbursed covered expenses incurred in rebates and dividends relate.
paid time off during the year. Pursuant to the cafeteria prior periods; (4) Mandatory two-year election for vi-
plan, Employee A is deemed to have used one non- (B) Reasonable lifetime maximum limit sion or dental insurance. When a cafeteria
elective week, and having retained one nonelective
on benefits; plan offers vision or dental insurance that
week and one elective week of paid time off. Em-
ployee A receives in cash the value of the unused
(C) Level premiums; requires a mandatory two-year coverage
elective paid time off on December 31, 2009. Em- (D) Premium waiver during disability; period, but not longer (sometimes referred
ployer Q includes this amount on the 2009 Form W–2 (E) Guaranteed policy renewability of to as a “two-year lock-in”), the mandatory
for Employee A. Employee A must report this amount coverage, without further evidence of in- two-year coverage period does not result in
as gross income in 2009.
surability (but not guaranty of the amount deferred compensation in violation of sec-
(ii) Pursuant to Employer Q’s human resources
policy, Employee A is permitted to carry over the one
of premium upon renewal); tion 125(d)(2), provided both of the fol-
nonelective week of paid time off to the next year. (F) Coverage for a specified accidental lowing requirements are satisfied—
Nonelective paid time off is not part of the cafeteria injury; (i) The premiums for each plan year are
plan (that is, neither Employer Q nor the cafeteria (G) Coverage for a specified disease or paid no less frequently than annually; and
plan permit employees to exchange nonelective paid
illness, including payments at initial diag- (ii) In no event does a cafeteria plan
time off for other benefits).
(iii) The cafeteria plan’s terms and operations do
nosis of the specified disease or illness, use salary reduction or flex-credits relating
not violate the prohibition against deferring compen- and progressive payments of a set amount to the first year of a two-year election to
sation. per month following the initial diagnosis apply to vision or dental insurance for the
Example 3. Forfeiture of unused elective paid (sometimes referred to as progressive di- second year of the two-year election.
time off. Same facts as Example 2, except that pur-
agnosis payments); and (5) Using salary reduction amounts
suant to the cafeteria plan, Employee A forfeits the
remaining one week of elective paid time off. The
(H) Payment of a fixed amount per day from one plan year to pay accident and
cafeteria plan’s terms and operations do not violate (or other period) of hospitalization. health insurance premiums for the first
the prohibition against deferring compensation. (ii) Requirements of permitted bene- month of the immediately following plan
Example 4. Unused elective paid time off carried fits. All benefits described in paragraph year.
over to next plan year. Same facts as Example 1,
(p)(1)(i) of this section must in addition (i) In general. Salary reduction
except that Employee A uses only two weeks of paid
time off during the 2009 plan year, and, under the
satisfy all of the following requirements— amounts from the last month of one plan
terms of the cafeteria plan, Employee A is treated as (A) No part of any benefit is used in year of a cafeteria plan may be applied to
having used the two nonelective weeks and as having one plan year to purchase a benefit in a pay accident and health insurance premi-
retained the one elective week. The one remaining subsequent plan year; ums for insurance during the first month
week (that is, the elective week) is carried over to the
(B) The policies remain in force only so of the immediately following plan year,
next plan year (or the value thereof used for any other
purpose in the next plan year). The plan operates to
long as premiums are timely paid on a cur- if done on a uniform and consistent basis
permit deferring compensation and is not a cafeteria rent basis, and, irrespective of the amount with respect to all participants (based on
plan. of premiums paid in prior plan years, if the the usual payroll interval for each group
Example 5. Paid time off exchanged for accident current premiums are not paid, all cover- of participants).
and health insurance premiums. Employer R pro-
age for new diseases or illnesses lapses. (ii) Example. The following example il-
vides employees with four weeks of paid time off for
a year. Employer R’s calendar year cafeteria plan
See paragraph (p)(1)(i)(D), allowing pre- lustrates the rules in this paragraph (p)(5):
permits employees to exchange up to one week of mium waiver during disability; Example. Salary reduction payments in Decem-
paid time off to pay the employee’s share of accident (C) There is no investment fund or cash ber of calendar plan year to pay accident and health
and health insurance premiums. For the 2009 plan insurance premiums for January. Employer S main-
value to rely upon for payment of premi-
year, Employee B (with a calendar tax year), timely tains a calendar year cafeteria plan. The cafeteria plan
ums; and offers employees a salary reduction election for ac-
elects to exchange one week of paid time off (valued
at $769) to pay accident and health insurance premi-
(D) No part of any premium is held in cident and health insurance. The plan provides that
ums for 2009. The $769 is excludible from Employee a separate account for any participant or employees’ salary reduction amounts for the last pay
B’s gross income under section 106. The cafeteria beneficiary, or otherwise segregated from period in December are applied to pay accident and
health insurance premiums for the immediately fol-
the assets of the insurance company.

September 24, 2007 699 2007–39 I.R.B.

lowing January. All employees are paid bi-weekly. (3) Long-term care insurance or ser- (4) Elective contributions to a section
For the plan year ending December 31, 2009, Em- vices purchased through an HSA. Al- 401(k) plan. See §1.401(k)–1 for general
ployee C elects salary reduction of $3,250 for acci- though long-term care insurance is not a rules relating to contributions to section
dent and health coverage. For the last pay period
in December 2009, $125 (3,250/26) is applied to the
qualified benefit and may not be offered in 401(k) plans.
accident and health insurance premium for January a cafeteria plan, a cafeteria plan is permit- (s) Effective/applicability date. It is
2010. This plan provision does not violate the prohi- ted to offer an HSA as a qualified benefit, proposed that these regulations apply on
bition against deferring compensation. and funds from the HSA may be used and after plan years beginning on or af-
(q) Nonqualified benefits—(1) In gen- to pay eligible long-term care premiums ter January 1, 2009, except that the rule in
eral. The following benefits are nonqual- on a qualified long-term care insurance paragraph (k)(2)(i)(B) of this section is ef-
ified benefits that are not permitted to be contract or for qualified long-term care fective as of the date the proposed regula-
offered in a cafeteria plan— services. tions are published in the Federal Regis-
(i) Scholarships described in section (r) Employer contributions to a cafete- ter.
117; ria plan—(1) Salary reduction-in general.
(ii) Employer-provided meals and lodg- The term employer contributions means §1.125–2 Cafeteria plans; elections.
ing described in section 119; amounts that are not currently available
(iii) Educational assistance described in (a) Rules relating to making and revok-
(after taking section 125 into account) to
section 127; ing elections—(1) Elections in general. A
the employee but are specified in the cafe-
(iv) Fringe benefits described in section plan is not a cafeteria plan unless the plan
teria plan as amounts that an employee
132; provides in writing that employees are per-
may use for the purpose of electing ben-
(v) Long-term care insurance, or any mitted to make elections among the per-
efits through the plan. A plan may provide
product which is advertised, marketed or mitted taxable benefits and qualified ben-
that employer contributions may be made,
offered as long-term care insurance; efits offered through the plan for the plan
in whole or in part, pursuant to employ-
(vi) Long-term care services (but see year (and grace period, if applicable). All
ees’ elections to reduce their compensation
paragraph (q)(3) of this section); elections must be irrevocable by the date
or to forgo increases in compensation and
(vii) Group-term life insurance on the described in paragraph (a)(2) of this sec-
to have such amounts contributed, as em-
life of any individual other than an em- tion except as provided in paragraph (a)(4)
ployer contributions, by the employer on
ployee (whether includible or excludible of this section. An election is not irrevo-
their behalf. See also §1.125–5 (flexible
from the employee’s gross income); cable if, after the earlier of the dates speci-
spending arrangements). Also, a cafeteria
(viii) Health reimbursement arrange- fied in paragraph (a)(2) of this section, em-
plan is permitted to require employees to
ments (HRAs) that provide reimburse- ployees have the right to revoke their elec-
elect to pay the employees’ share of any
ments up to a maximum dollar amount tions of qualified benefits and instead re-
qualified benefit through salary reduction
for a coverage period and that all or any ceive the taxable benefits for such period,
and not with after-tax employee contribu-
unused amount at the end of a coverage without regard to whether the employees
tions. A cafeteria plan is also permitted to
period is carried forward to increase the actually revoke their elections.
pay reasonable cafeteria plan administra-
maximum reimbursement amount in sub- (2) Timing of elections. In order for
tive fees through salary reduction amounts,
sequent coverage periods; employees to exclude qualified benefits
and these salary reduction amounts are ex-
(ix) Contributions to Archer MSAs from employees’ gross income, benefit
cludible from an employee’s gross income.
(section 220); and elections in a cafeteria plan must be made
(2) Salary reduction as employer con-
(x) Elective deferrals to a section 403(b) before the earlier of—
tribution. Salary reduction contributions
plan. (i) The date when taxable benefits are
are employer contributions. An em-
(2) Nonqualified benefits not permit- currently available; or
ployee’s salary reduction election is an
ted in a cafeteria plan. The benefits de- (ii) The first day of the plan year (or
election to receive a contribution by the
scribed in this paragraph (q) are not qual- other coverage period).
employer in lieu of salary or other com-
ified benefits or taxable benefits or cash (3) Benefit currently available to an em-
pensation that is not currently available
for purposes of section 125 and thus may ployee-in general. Cash or another taxable
to the employee as of the effective date
not be offered in a cafeteria plan regard- benefit is currently available to the em-
of the election and that does not subse-
less of whether any such benefit is pur- ployee if it has been paid to the employee
quently become currently available to the
chased with after-tax employee contribu- or if the employee is able currently to re-
employee.
tions or on any other basis. A plan that of- ceive the cash or other taxable benefit at
(3) Employer flex-credits. A cafeteria
fers a nonqualified benefit is not a cafeteria the employee’s discretion. However, cash
plan may also provide that the employer
plan. Employees’ elections between tax- or another taxable benefit is not currently
contributions will or may be made on be-
able and nontaxable benefits through such available to an employee if there is a sig-
half of employees equal to (or up to) spec-
plan result in gross income to the partici- nificant limitation or restriction on the em-
ified amounts (or specified percentages of
pants for any benefit elected. See section ployee’s right to receive the benefit cur-
compensation) and that such nonelective
125(f). See paragraph (q)(3) of this sec- rently. Similarly, a benefit is not currently
contributions are available to employees
tion for special rule on long-term care in- available as of a date if the employee may
for the election of benefits through the
surance purchased through an HSA. under no circumstances receive the benefit
plan.
before a particular time in the future. The

2007–39 I.R.B. 700 September 24, 2007

determination of whether a benefit is cur- as having received the $5,000 in cash even if they tion elections allowed. Contributions may
rently available to an employee does not do not revoke their elections. The same result occurs be made to an HSA through a cafeteria
depend on whether it has been construc- even though the cash is not payable until the end of plan. A cafeteria plan offering HSA con-
the plan year.
tively received by the employee for pur- tributions through salary reduction may
(b) Automatic elections—(1) In gen-
poses of section 451. permit employees to make prospective
eral. For new employees or current em-
(4) Exceptions to rule on making and salary reduction elections or change or
ployees who fail to timely elect between
revoking elections. If a cafeteria plan in- revoke salary reduction elections for HSA
permitted taxable benefits and qualified
corporates the change in status rules in contributions (for example, to increase
benefits, a cafeteria plan is permitted, but
§1.125–4, to the extent provided in those or decrease salary reduction elections for
is not required, to provide default elections
rules, an employee who experiences a HSA contributions) at any time during the
for one or more qualified benefits (for ex-
change in status (as defined in §1.125–4) plan year, effective before salary becomes
ample, an election made for any prior year
is permitted to revoke an existing election currently available. If a cafeteria plan
is deemed to be continued for every suc-
and to make a new election with respect offers HSA contributions as a qualified
ceeding plan year, unless changed).
to the remaining portion of the period of benefit, the plan must—
(2) Example. The following example
coverage, but only with respect to cash or (i) Specifically describe the HSA con-
illustrates the rules in this paragraph (b):
other taxable benefits that are not yet cur- Example. Automatic elections for accident and
tribution benefit;
rently available. See paragraph (c)(1) of health insurance. (i) Employer B maintains a cal- (ii) Allow a participant to prospectively
this section for a special rule for changing endar year cafeteria plan. The cafeteria plan offers change his or her salary reduction election
elections prospectively for HSA contri- accident and health insurance with an option for em- for HSA contributions on a monthly basis
butions and paragraph (r)(4) in §1.125–1 ployee-only or family coverage. All employees are (or more frequently); and
eligible to participate in the cafeteria plan immedi-
for section 401(k) elections. Also, only ately upon hire.
(iii) Allow a participant who becomes
an employee of the employer sponsoring a (ii) The cafeteria plan provides for an automatic ineligible to make HSA contributions to
cafeteria plan is allowed to make, revoke enrollment process: each new employee and each prospectively revoke his or her salary re-
or change elections in the employer’s current employee is automatically enrolled in em- duction election for HSA contributions.
cafeteria plan. The employee’s spouse, ployee-only coverage under the accident and health (2) Example. The following example
insurance plan, and the employee’s salary is reduced
dependent or any other individual other to pay the employee’s share of the accident and
illustrates the rules in this paragraph (c):
than the employee may not make, revoke Example. Prospective HSA salary reduction elec-
health insurance premium, unless the employee affir-
or change elections under the plan. tions. (i) A cafeteria plan with a calendar plan year
matively elects cash. Alternatively, if the employee
allows employees to make salary reduction elections
(5) Elections not required on written has a spouse or child, the employee can elect family
for HSA contributions through the plan. The cafe-
paper documents. A cafeteria plan does coverage.
teria plan permits employees to prospectively make,
(iii) When an employee is hired, the employee re-
not fail to meet the requirements of section ceives a notice explaining the automatic enrollment
change or revoke salary contribution elections for
125 merely because it permits employees HSA contributions, limited to one election, change
process and the employee’s right to decline coverage
to use electronic media for such transac- or revocation per month.
and have no salary reduction. The notice includes the
(ii) Employee M participates in the cafeteria plan.
tions. The safe harbor in §1.401(a)–21 ap- salary reduction amounts for employee-only cover-
Before salary becomes currently available to M, M
plies to electronic elections, revocations age and family coverage, procedures for exercising
makes the following elections. On January 2, 2009,
the right to decline coverage, information on the time
and changes in elections under section 125. by which an election must be made, and the period
M elects to contribute $100 for each pay period to an
(6) Examples. The following examples HSA, effective January 3, 2009. On March 15, 2009,
for which an election is effective. The notice is also
illustrate the rules in this paragraph (a): M elects to reduce the HSA contribution to $35 per
given to each current employee before the beginning
pay period, effective April 1, 2009. On May 1, 2009,
Example 1. Election not revocable during plan of each subsequent plan year, except that the notice
M elects to discontinue all HSA contributions, effec-
year. Employer A’s cafeteria plan offers each em- for a current employee includes a description of the
ployee the opportunity to elect, for a plan year, tive May 15, 2009. The cafeteria plan implements all
employee’s existing coverage, if any.
of Employee M’s elections,
between $5,000 cash for the plan year and a de- (iv) For a new employee, an election to receive
(iii) The cafeteria plan’s operation is consistent
pendent care assistance program of up to $5,000 of cash or to have family coverage rather than em-
dependent care expenses incurred by the employee with the section 125 election, change and revocation
ployee-only coverage is effective if made when
rules for HSA contributions.
during the plan year. The cafeteria plan requires the employee is hired. For a current employee, an
employees to elect between these benefits before the election is effective if made prior to the start of (d) Optional election for new employ-
beginning of the plan year. After the year has com- each calendar year or under any other circumstances ees. A cafeteria plan may provide new
menced, employees are prohibited from revoking permitted under §1.125–4. An election made for employees 30 days after their hire date to
their elections. The cafeteria plan allows revocation any prior year is deemed to be continued for every make elections between cash and qualified
of elections based on changes in status (as described succeeding plan year, unless changed.
in §1.125–4). Employees who elected the dependent (v) Contributions used to purchase accident and
benefits. The election is effective as of the
care assistance program do not include the $5,000 health insurance through a cafeteria plan are not in- employee’s hire date. However, salary re-
cash in gross income. The cafeteria plan satisfies the cludible in the gross income of the employee solely duction amounts used to pay for such an
requirements in this paragraph (a). because the plan provides for automatic enrollment election must be from compensation not
Example 2. Election revocable during plan year. as a default election whereby the employee’s salary yet currently available on the date of the
Same facts as Example 1 except that Employer A’s is reduced each year to pay for a portion of the acci-
cafeteria plan allows employees to revoke their elec- dent and health insurance through the plan (unless the
election. The written cafeteria plan must
tions for dependent care assistance at any time dur- employee affirmatively elects cash). provide that any employee who terminates
ing the plan year and receive the unused amount of (c) Election rules for salary reduction employment and is rehired within 30 days
dependent care assistance as cash. The cafeteria plan after terminating employment (or who re-
contributions to HSAs—(1) Prospective
fails to satisfy the requirements in this paragraph (a), turns to employment following an unpaid
and is not a cafeteria plan. All employees are treated
elections and changes in salary reduc-

September 24, 2007 701 2007–39 I.R.B.

leave of absence of less than 30 days) is not ble to participate in the employer’s cafete- the payment schedule for the required
a new employee eligible for the election in ria plan, to be used at the employee’s elec- amount for coverage under a health FSA
this paragraph (d). tion only for one or more qualified benefits may not be based on the rate or amount of
(e) Effective/applicability date. It is (but not as cash or a taxable benefit). See covered claims incurred during the cover-
proposed that these regulations apply on §1.125–1 for definitions of qualified bene- age period. Employees’ salary reduction
and after plan years beginning on or after fits, cash and taxable benefits. payments must not be accelerated based
January 1, 2009. (2) Example. The following example on employees’ incurred claims and reim-
Par. 3. Sections 1.125–5, 1.125–6 and illustrates the rules in this paragraph (b): bursements.
1.125–7 are added to read as follows: Example. Flex-credit. Contribution to health (2) Reimbursement available at all
FSA for employees electing employer-provided ac- times. Reimbursement is deemed to be
§1.125–5 Flexible spending cident and health plan. Employer A maintains a
cafeteria plan offering employees an election be-
available at all times if it is paid at least
arrangements. monthly or when the total amount of the
tween cash or taxable benefits and premiums for
employer-provided accident and health insurance or claims to be submitted is at least a spec-
(a) Definition of flexible spending ar- coverage through an HMO. The plan also provides ified, reasonable minimum amount (for
rangement—(1) In general. An FSA an employer contribution of $200 to the health FSA example, $50).
generally is a benefit program that pro- of every employee who elects accident and health
insurance or HMO coverage. In addition, these
(3) Terminated participants. When an
vides employees with coverage which
employees may elect to reduce their salary to make employee ceases to be a participant, the
reimburses specified, incurred expenses
additional contributions to their health FSAs. The cafeteria plan must pay the former partic-
(subject to reimbursement maximums and benefits offered in this cafeteria plan are consistent ipant any amount the former participant
any other reasonable conditions). An with the requirements of section 125 and this para- previously paid for coverage or benefits to
expense for qualified benefits must not graph (b).
the extent the previously paid amount re-
be reimbursed from the FSA unless it (c) Use-or-lose rule—(1) In general.
lates to the period from the date the em-
is incurred during a period of coverage. An FSA may not defer compensation. No
ployee ceases to be a participant through
See paragraph (e) of this section. After contribution or benefit from an FSA may
the end of that plan year. See paragraph
an expense for a qualified benefit has be carried over to any subsequent plan
(e)(2) in this section for COBRA elections
been incurred, the expense must first be year or period of coverage. See paragraph
for health FSAs.
substantiated before the expense is reim- (k)(3) in this section for specific excep-
(4) Example. The following example
bursed. See paragraphs (a) through (f) in tions. Unused benefits or contributions re-
illustrates the rules in this paragraph (d):
§1.125–6. maining at the end of the plan year (or at Example. Uniform coverage. (i) Employer C
(2) Maximum amount of reimburse- the end of a grace period, if applicable) are maintains a calendar year cafeteria plan, offering an
ment. The maximum amount of reim- forfeited. election between cash and a health FSA. The cafeteria
bursement that is reasonably available (2) Example. The following example plan prohibits accelerating employees’ salary reduc-
to an employee for a period of coverage illustrates the rules in this paragraph (c): tion payments based on employees’ incurred claims
and reimbursements.
must not be substantially in excess of Example. Use-or-lose rule. (i) Employer B main-
(ii) For the 2009 plan year, Employee N timely
the total salary reduction and employer tains a calendar year cafeteria plan, offering an elec-
tion between cash and a health FSA. The cafeteria elects salary reduction of $3,000 for a health FSA.
flex-credit for such participant’s coverage. plan has no grace period.
Employee N pays the $3,000 salary reduction amount
A maximum amount of reimbursement through salary reduction of $250 per month through-
(ii) Employee A plans to have eye surgery in
is not substantially in excess of the total 2009. For the 2009 plan year, Employee A timely out the coverage period. Employee N is eligible to
receive the maximum amount of reimbursement of
salary reduction and employer flex-credit elects salary reduction of $3,000 for a health FSA.
$3,000 at all times throughout the coverage period
if such maximum amount is less than 500 During the 2009 plan year, Employee A learns that
she cannot have eye surgery performed, but in- (reduced by prior reimbursements).
percent of the combined salary reduction curs other section 213(d) medical expenses totaling
(iii) N incurs $2,500 of section 213(d) medical
and employer flex-credit. A single FSA expenses in January, 2009. The full $2,500 is re-
$1,200. As of December 31, 2009, she has $1,800 of
may provide participants with different unused benefits and contributions in the health FSA. imbursed although Employee N has made only one
salary reduction payment of $250. N incurs $500 in
levels of coverage and maximum amounts Consistent with the rules in this paragraph (c), she
medical expenses in February, 2009. The remaining
of reimbursement. See paragraph (r) in forfeits $1,800.
$500 of the $3,000 is reimbursed. After Employee N
§1.125–1 and paragraphs (b) and (d) in (d) Uniform coverage rules applicable submits a claim for reimbursement and substantiates
this section for the definition of salary to health FSAs—(1) Uniform coverage the medical expenses, the cafeteria plan reimburses N
reduction, employer flex-credit, and uni- throughout coverage period—in general. for the $2,500 and $500 medical expenses. Employer
The maximum amount of reimbursement C’s cafeteria plan satisfies the uniform coverage rule.
form coverage rule.
from a health FSA must be available at (5) No uniform coverage rule for FSAs
(b) Flex-credits allowed—(1) In gen-
all times during the period of coverage for dependent care assistance or adoption
eral. An FSA in a cafeteria plan must in-
(properly reduced as of any particular time assistance. The uniform coverage rule ap-
clude an election between cash or taxable
for prior reimbursements for the same plies only to health FSAs and does not ap-
benefits (including salary reduction) and
period of coverage). Thus, the maximum ply to FSAs for dependent care assistance
one or more qualified benefits, and may
amount of reimbursement at any particular or adoption assistance. See paragraphs (i)
include, in addition, “employer flex-cred-
time during the period of coverage cannot and (j) of this section for the rules for FSAs
its.” For this purpose, flex-credits are non-
relate to the amount that has been con- for dependent care assistance and adoption
elective employer contributions that the
tributed to the FSA at any particular time assistance.
employer makes for every employee eligi-
prior to the end of the plan year. Similarly,

2007–39 I.R.B. 702 September 24, 2007

 (e) Required period of coverage for vide that only those employees who partic- contributions made at the employer’s dis-
a health FSA, dependent care FSA ipate in one or more specified employer- cretion, at the employee’s discretion, or
and adoption assistance FSA—(1) provided accident and health plans may pursuant to a collective bargaining agree-
Twelve-month period of coverage—in participate in a health FSA. See §1.125–7 ment. Arrangements formally outside of
general. An FSA’s period of coverage for nondiscrimination rules. the cafeteria plan providing for the ad-
must be 12 months. However, in the case (2) Interval for employees’ salary re- justment of an employee’s compensation
of a short plan year, the period of coverage duction contributions. The cafeteria plan or an employee’s receipt of any other
is the entire short plan year. See paragraph is permitted to specify any interval for benefits on the basis of the assistance or
(d) in §1.125–1 for rules on plan years and employees’ salary reduction contributions. reimbursements received by the employee
changing plan years. The interval specified in the plan must be are considered in determining whether a
(2) COBRA elections for health FSAs. uniform for all participants. dependent care benefit is a dependent care
For the application of the health care con- (h) Qualified benefits permitted to be assistance program under section 129.
tinuation rules of section 4980B of the offered through an FSA. Dependent care (j) Section 137 rules for adoption assis-
Code to health FSAs, see Q & A–2 in assistance (section 129), adoption assis- tance program offered through a cafeteria
§54.4980B–2 of this chapter. tance (section 137) and a medical reim- plan—(1) General rule. In order for adop-
(3) Separate period of coverage per- bursement arrangement (section 105(b)) tion assistance to be a qualified benefit that
mitted for each qualified benefit offered are permitted to be offered through an is excludible from gross income if elected
through FSA. Dependent care assistance, FSA in a cafeteria plan. through a cafeteria plan, the cafeteria plan
adoption assistance, and a health FSA are (i) Section 129 rules for dependent care must satisfy section 125 and the adoption
each permitted to have a separate period of assistance program offered through a cafe- assistance must satisfy section 137.
coverage, which may be different from the teria plan—(1) General rule. In order for (2) Adoption assistance in general.
plan year of the cafeteria plan. dependent care assistance to be a quali- Section 137(a) provides an employee
(f) Coverage on a month-by-month or fied benefit that is excludible from gross with an exclusion from gross income for
expense-by-expense basis prohibited. In income if elected through a cafeteria plan, amounts paid or expenses incurred by the
order for reimbursements from an accident the cafeteria plan must satisfy section 125 employer for qualified adoption expenses
and health plan to qualify for the section and the dependent care assistance must sat- in connection with an employee’s adop-
105(b) exclusion, an employer-funded ac- isfy section 129. tion of a child, if the amounts are paid or
cident and health plan offered through a (2) Dependent care assistance in gen- incurred through an adoption assistance
cafeteria plan may not operate in a man- eral. Section 129(a) provides an employee program. Certain limits on amount of
ner that enables employees to purchase the with an exclusion from gross income both expenses and employee’s income apply.
accident and health plan coverage only for for an employer-funded dependent care as- (3) Reimbursement exclusively for
periods when employees expect to incur sistance program and for amounts paid or adoption assistance. Rules and require-
medical care expenses. Thus, for example, incurred by the employer for dependent ments similar to the rules and requirements
if a cafeteria plan permits employees to re- care assistance provided to the employee, in paragraph (i)(3) of this section for de-
ceive accident and health plan coverage on if the amounts are paid or incurred through pendent care assistance apply to adoption
a month-by-month or an expense-by-ex- a dependent care assistance program. See assistance.
pense basis, reimbursements from the ac- paragraph (a)(4) in §1.125–6 on when de- (k) FSAs and the rules governing the
cident and health plan fail to qualify for the pendent care expenses are incurred. tax-favored treatment of employer-pro-
section 105(b) exclusion. If, however, the (3) Reimbursement exclusively for de- vided health benefits—(1) Medical ex-
period of coverage under an accident and pendent care assistance. A dependent penses. Health plans that are flexible
health plan offered through a cafeteria plan care assistance program may not provide spending arrangements, as defined in
is twelve months and the cafeteria plan reimbursements other than for dependent paragraph (a)(1) of this section, must
does not permit an employee to elect spe- care expenses; in particular, if an em- conform to the generally applicable rules
cific amounts of coverage, reimbursement, ployee has dependent care expenses less under sections 105 and 106 in order for
or salary reduction for less than twelve than the amount specified by salary re- the coverage and reimbursements under
months, the cafeteria plan does not operate duction, the plan may not provide other such plans to qualify for tax-favored treat-
to enable participants to purchase coverage taxable or nontaxable benefits for any por- ment under such sections. Thus, health
only for periods during which medical care tion of the specified amount not used for FSAs must qualify as accident and health
will be incurred. See §1.125–4 and para- the reimbursement of dependent care ex- plans. See paragraph (n) in §1.125–1. A
graph (a) in §1.125–2 regarding the revo- penses. Thus, if an employee has elected health FSA is only permitted to reimburse
cation of elections during a period of cov- coverage under the dependent care assis- medical expenses as defined in section
erage on account of changes in family sta- tance program and the period of coverage 213(d). Thus, for example, a health FSA
tus. has commenced, the employee must not is not permitted to reimburse dependent
(g) FSA administrative practices—(1) have the right to receive amounts from care expenses.
Limiting health FSA enrollment to employ- the program other than as reimburse- (2) Limiting payment or reimburse-
ees who participate in the employer’s ac- ments for dependent care expenses. This ment to certain section 213(d) medical
cident and health plan. At the employer’s is the case regardless of whether cover- expenses. A health FSA is permitted to
option, a cafeteria plan is permitted to pro- age under the program is purchased with limit payment or reimbursement to only

September 24, 2007 703 2007–39 I.R.B.

certain section 213(d) medical expenses surance, long-term disability or short-term limited-purpose health FSA and a post-de-
(except health insurance, long-term care disability insurance or for health coverage ductible health FSA.
services or insurance). See paragraph (q) under a plan maintained by the employer (3) Limited-purpose health FSA. A
in §1.125–1. For example, a health FSA in of the employee or the employer of the limited-purpose health FSA is a health
a cafeteria plan is permitted to provide in employee’s spouse or dependent. Also, a FSA described in the cafeteria plan that
the written plan that the plan reimburses all health FSA is not permitted to reimburse only pays or reimburses permitted cov-
section 213(d) medical expenses allowed expenses for long-term care insurance erage benefits (as defined in section
to be paid or reimbursed under a cafeteria premiums or for long-term care services 223(c)(2)(C)), such as vision care, dental
plan except over-the-counter drugs. for the employee or employee’s spouse or care or preventive care (as defined for
(3) Application of prohibition against dependent. See paragraph (q) in §1.125–1 purposes of section 223(c)(2)(C)). See
deferred compensation to medical ex- for nonqualified benefits. paragraph (k) in this section.
penses. (i) Certain advance payments for (l) Section 105(h) requirements. Sec- (4) Post-deductible health FSA—(i) In
orthodontia permitted. A cafeteria plan is tion 105(h) applies to health FSAs. Sec- general. A post-deductible health FSA is a
permitted, but is not required to, reimburse tion 105(h) provides that the exclusion health FSA described in the cafeteria plan
employees for orthodontia services before provided by section 105(b) is not available that only pays or reimburses medical ex-
the services are provided but only to the with respect to certain amounts received penses (as defined in section 213(d)) for
extent that the employee has actually made by a highly compensated individual (as preventive care or medical expenses in-
the payments in advance of the orthodon- defined in section 105(h)(5)) from a dis- curred after the minimum annual HDHP
tia services in order to receive the services. criminatory self-insured medical reim- deductible under section 223(c)(2)(A)(i) is
These orthodontia services are deemed to bursement plan, which includes health satisfied. See paragraph (k) in this sec-
be incurred when the employee makes the FSAs. See §1.105–11. For purposes of tion. No medical expenses incurred be-
advance payment. Reimbursing advance section 105(h), coverage by a self-insured fore the annual HDHP deductible is sat-
payments does not violate the prohibition accident and health plan offered through a isfied may be reimbursed by a post-de-
against deferring compensation. cafeteria plan is an optional benefit (even ductible FSA, regardless of whether the
(ii) Example. The following example if only one level and type of coverage HDHP covers the expense or whether the
illustrates the rules in paragraph (k)(3): is offered) and, for purposes of the op- deductible is later satisfied. For example,
Example. Advance payment to orthodontist. tional benefit rule in §1.105–11(c)(3)(i), even if chiropractic care is not covered un-
Employer D sponsors a calendar year cafeteria employer contributions are treated as em- der the HDHP, expenses for chiropractic
plan which offers a health FSA. Employee K elects
to salary reduce $3,000 for a health FSA for the
ployee contributions to the extent that care incurred before the HDHP deductible
2009 plan year. Employee K’s dependent requires taxable benefits are offered by the plan. is satisfied are not reimbursable at any time
orthodontic treatment. K’s accident and health insur- (m) HSA-compatible FSAs-limited-pur- by a post-deductible health FSA.
ance does not cover orthodontia. The orthodontist, pose health FSAs and post-deductible (ii) HDHP and health FSA deductibles.
following the normal practice, charges $3,000, all health FSAs—(1) In general. Limited-pur- The deductible for a post-deductible health
due in 2009, for treatment, to begin in 2009 and end
in 2010. K pays the $3,000 in 2009. In 2009, Em-
pose health FSAs and post-deductible FSA need not be the same amount as the
ployer D’s cafeteria plan may reimburse $3,000 to health FSAs which satisfy all the require- deductible for the HDHP, but in no event
K, without violating the prohibition against deferring ments of section 125 are permitted to be may the post-deductible health FSA or
compensation in section 125(d)(2). offered through a cafeteria plan. other coverage provide benefits before
(iii) Reimbursements for durable medi- (2) HSA-compatible FSAs. Section the minimum annual HDHP deductible
cal equipment. A health FSA in a cafeteria 223(a) allows a deduction for certain con- under section 223(c)(2)(A)(i) is satisfied
plan that reimburses employees for equip- tributions to a “Health Savings Account” (other than benefits permitted under a
ment (described in section 213(d)) with a (HSA) (as defined in section 223(d)). An limited-purpose health FSA). In addition,
useful life extending beyond the period of eligible individual (as defined in section although the deductibles of the HDHP
coverage during which the expense is in- 223(c)(1)) may contribute to an HSA. An and the other coverage may be satisfied
curred does not provide deferred compen- eligible individual must be covered under independently by separate expenses, no
sation. For example, a health FSA is per- a “high deductible health plan” (HDHP) benefits may be paid before the mini-
mitted to reimburse the cost of a wheel- and not, while covered under an HDHP, mum annual deductible under section
chair for an employee. under any health plan which is not an 223(c)(2)(A)(i) has been satisfied. An
(4) No reimbursement of premiums HDHP. A general purpose health FSA is individual covered by a post-deductible
for accident and health insurance or not an HDHP and an individual covered health FSA (if otherwise an eligible in-
long-term care insurance or services. A by a general purpose health FSA is not el- dividual) is an eligible individual for the
health FSA is not permitted to treat em- igible to contribute to an HSA. However, purpose of contributing to the HSA.
ployees’ premium payments for other an individual covered by an HDHP (and (5) Combination of limited-purpose
health coverage as reimbursable expenses. who otherwise satisfies section 223(c)(1)) health FSA and post-deductible health
Thus, for example, a health FSA is not does not fail to be an eligible individual FSA. An FSA is a combination of a lim-
permitted to reimburse employees for pay- merely because the individual is also cov- ited-purpose health FSA and post-de-
ments for other health plan coverage, in- ered by a limited-purpose health FSA or ductible health FSA if each of the bene-
cluding premiums for COBRA coverage, post-deductible health FSA (as defined in fits and reimbursements provided under
accidental death and dismemberment in- this paragraph (m)) or a combination of a the FSA are permitted under either a

2007–39 I.R.B. 704 September 24, 2007

limited-purpose health FSA or post-de- (iii) The distribution does not exceed claims reimbursements for the year. Ex-
ductible health FSA. For example, be- the lesser of the balance of the health FSA perience gains (or forfeitures) may be—
fore the HDHP deductible is satisfied, a on— (i) Retained by the employer maintain-
combination limited-purpose and post-de- (A) September 21, 2006; or ing the cafeteria plan; or
ductible health FSA may reimburse only (B) The date of the distribution; (ii) If not retained by the employer, may
preventive, vision or dental expenses. A (iv) For purposes of this paragraph be used only in one or more of the follow-
combination limited-purpose and post-de- (n)(1), balances as of any date are de- ing ways—
ductible health FSA may also reimburse termined on a cash basis, without taking (A) To reduce required salary reduc-
any medical expense that may otherwise into account expenses incurred but not tion amounts for the immediately follow-
be paid by an FSA (that is, no insurance reimbursed as of a date, and applying the ing plan year, on a reasonable and uniform
premiums or long-term care benefits) that uniform coverage rule in paragraph (d) in basis, as described in paragraph (o)(2) of
is incurred after the HDHP deductible is this section; this section;
satisfied. (v) The distribution is made no later (B) Returned to the employees on a rea-
(6) Substantiation. The substantiation than December 31, 2011; and sonable and uniform basis, as described in
rules in this section apply to limited-pur- (vi) The employer makes the distri- paragraph (o)(2) of this section; or
pose health FSAs and to post-deductible bution directly to the trustee of the em- (C) To defray expenses to administer
health FSAs. In addition to providing ployee’s HSA. the cafeteria plan.
third-party substantiation of medical ex- (2) Taxation of qualified HSA distribu- (2) Allocating experience gains among
penses, a participant in a post-deductible tions. A qualified HSA distribution from employees on reasonable and uniform ba-
health FSA must provide information from the health FSA covering the participant sis. If not retained by the employer or
an independent third party that the HDHP to his or her HSA is a rollover to the used to defray expenses of administering
deductible has been satisfied. A partici- HSA (as defined in section 223(f)(5)) and the plan, the experience gains must be al-
pant in a limited-purpose health FSA must thus is generally not includible in gross in- located among employees on a reasonable
provide information from an independent come. However, if the participant is not and uniform basis. It is permissible to al-
third-party that the medical expenses are an eligible individual (as defined in section locate these amounts based on the differ-
for vision care, dental care or preventive 223(c)(1)) at any time during a testing pe- ent coverage levels of employees under the
care. riod following the qualified HSA distribu- FSA. Experience gains allocated in com-
(7) Plan amendments. See paragraph tion, the amount of the distribution is in- pliance with this paragraph (o) are not a
(c) in §1.125–1 on the required effective cludible in the participant’s gross income deferral of the receipt of compensation.
date for amendments adopting or chang- and he or she is also subject to an addi- However, in no case may the experience
ing limited-purpose, post-deductible or tional 10 percent tax (with certain excep- gains be allocated among employees based
combination limited-purpose and post-de- tions). Section 106(e)(3). (directly or indirectly) on their individual
ductible health FSAs. (3) No effect on health FSA elections, claims experience. Experience gains may
(n) Qualified HSA distributions—(1) coverage, use-or-lose rule. A qualified not be used as contributions directly or in-
In general. A health FSA in a cafeteria HSA distribution does not alter an em- directly to any deferred compensation ben-
plan is permitted to offer employees the ployee’s irrevocable election under para- efit plan.
right to elect qualified HSA distributions graph (a) of §1.125–2, or constitute a (3) Example. The following example
described in section 106(e). No quali- change in status under §1.125–4(a). If a illustrates the rules in this paragraph (o):
fied HSA distribution may be made in a qualified HSA distribution is made to an Example. Allocating experience gains. (i) Em-
plan year unless the employer amends the employee’s HSA, even if the balance in ployer L maintains a cafeteria plan for its 1,200 em-
ployees, who may elect one of several different an-
health FSA written plan with respect to a health FSA is reduced to zero, the em- nual coverage levels under a health FSA in $100 in-
all employees, effective by the last day of ployee’s health FSA coverage continues to crements from $500 to $2,000.
the plan year, to allow a qualified HSA the end of the plan year. Unused benefits (ii) For the 2009 plan year, 1,000 employees elect
distribution satisfying all the requirements and contributions remaining at the end of levels of coverage under the health FSA. For the 2009
in this paragraph (n). See also section a plan year (or at the end of a grace period, plan year, the health FSA has an experience gain of
$5,000.
106(e)(5)(B). In addition, a distribution if applicable) must be forfeited. (iii) The $5,000 may be allocated to all partici-
with respect to an employee is not a qual- (o) FSA experience gains or forfei- pants for the plan year on a per capita basis weighted
ified HSA distribution unless all of the tures—(1) Experience gains in general. to reflect the participants’ elected levels of coverage.
following the requirements are satisfied— An FSA experience gain (sometimes re- (iv) Alternatively, the $5,000 may be used to re-
(i) No qualified HSA distribution has ferred to as forfeitures in the use-or-lose duce the required salary reduction amount under the
health FSA for all 2009 participants (for example, a
been previously made on behalf of the em- rule in paragraph (c) in this section) with $500 health FSA for the next year is priced at $480) or
ployee from this health FSA; respect to a plan year (plus any grace to reimburse claims incurred above the elective limit
(ii) The employee elects to have the em- period following the end of a plan year in 2010 as long as such reimbursements are made on
ployer make a qualified HSA distribution described in paragraph (e) in §1.125–1), a reasonable and uniform level.
from the health FSA to the HSA of the em- equals the amount of the employer con- (p) Effective/applicability date. It is
ployee; tributions, including salary reduction con- proposed that these regulations apply on
tributions, and after-tax employee contri- and after plan years beginning on or after
butions to the FSA minus the FSA’s total January 1, 2009.

September 24, 2007 705 2007–39 I.R.B.

§1.125–6 Substantiation of expenses for (ii) Under the rules in paragraph (a)(2) of this sec- sation or an employee’s receipt of any
all cafeteria plans. tion, the cafeteria plan is prohibited from reimbursing other benefits on the basis of the expenses
any portion of the $500 medical expense because, at incurred or reimbursements the employee
(a) Cafeteria plan payments and reim- the time the medical expense is incurred, G is not a
participant in the cafeteria plan.
receives are considered in determining
bursements—(1) In general. A cafeteria whether the reimbursements are through
(3) Section 105(b) requirements for re-
plan may pay or reimburse only those sub- a plan eligible for the exclusions under
imbursement of medical expenses through
stantiated expenses for qualified benefits sections 106 and 105(b).
a cafeteria plan. (i) In general. In order
incurred on or after the later of the effec- (4) Reimbursements of dependent care
for medical care reimbursements paid to
tive date of the cafeteria plan and the date expenses. (i) Dependent care expenses
an employee through a cafeteria plan to
the employee is enrolled in the plan. This must be incurred. In order to satisfy sec-
be excludible under section 105(b), the
requirement applies to all qualified bene- tion 129, dependent care expenses may not
reimbursements must be paid pursuant to
fits offered through the cafeteria plan. See be reimbursed before the expenses are in-
an employer-funded accident and health
paragraph (b) of this section for substanti- curred. For purposes of this rule, depen-
plan, as defined in section 105(e) and
ation rules. dent care expenses are incurred when the
§§1.105–2 and 1.105–5.
(2) Expenses incurred. (i) Employees’ care is provided and not when the em-
(ii) Reimbursement exclusively for sec-
medical expenses must be incurred during ployee is formally billed, charged for, or
tion 213(d) medical expenses. A cafeteria
the period of coverage. In order for re- pays for the dependent care.
plan benefit through which an employee
imbursements to be excludible from gross (ii) Dependent care provided during the
receives reimbursements of medical ex-
income under section 105(b), the medical period of coverage. In order for depen-
penses is excludable under section 105(b)
expenses reimbursed by an accident and dent care assistance to be provided through
only if reimbursements from the plan are
health plan elected through a cafeteria plan a dependent care assistance program eligi-
made specifically to reimburse the em-
must be incurred during the period when ble for the section 129 exclusion, the care
ployee for medical expenses (as defined in
the participant is covered by the accident must be provided to or on behalf of the
section 213(d)) incurred by the employee
and health plan. A participant’s period of employee during the period for which the
or the employee’s spouse or dependents
coverage includes COBRA coverage. See employee is covered by the program. For
during the period of coverage. Amounts
§54.4980B–2 of this chapter. Medical ex- example, if for a plan year, an employee
paid to an employee as reimbursement are
penses incurred before the later of the ef- elects a dependent care assistance program
not paid specifically to reimburse the em-
fective date of the plan and the date the em- providing for reimbursement of dependent
ployee for medical expenses if the plan
ployee is enrolled in the plan are not in- care expenses, only reimbursements for
provides that the employee is entitled, or
curred during the period for which the em- dependent care expenses incurred during
operates in a manner that entitles the em-
ployee is covered by the plan. However, that plan year are provided from a depen-
ployee, to receive the amounts, in the form
the actual reimbursement of covered med- dent care assistance program within the
of cash (for example, routine payment of
ical care expenses may be made after the scope of section 129. Also, for purposes of
salary) or any other taxable or nontax-
applicable period of coverage. this rule, expenses incurred before the later
able benefit irrespective of whether the
(ii) When medical expenses are in- of the program’s effective date and the date
employee (or the employee’s spouse or de-
curred. For purposes of this rule, medical the employee is enrolled in the program
pendents) incurs medical expenses during
expenses are incurred when the employee are not incurred during the period when the
the period of coverage. This rule applies
(or the employee’s spouse or dependents) employee is covered by the program. Sim-
even if the employee will not receive such
is provided with the medical care that ilarly, if the dependent care assistance pro-
amounts until the end or after the end of
gives rise to the medical expenses, and gram furnishes the dependent care in-kind
the period. A plan under which employees
not when the employee is formally billed, (for example, through an employer-main-
(or their spouses and dependents) will re-
charged for, or pays for the medical care. tained child care facility), only dependent
ceive reimbursement for medical expenses
(iii) Example. The following example care provided during the plan year of cov-
up to a specified amount and, if they incur
illustrates the rules in this paragraph (a)(2): erage is provided through a dependent care
Example. Medical expenses incurred after ter- no medical expenses, will receive cash or
any other benefit in lieu of the reimburse- assistance program within the meaning of
mination. (i) Employer E maintains a cafeteria plan
with a calendar year plan year. The cafeteria plan ments is not a benefit qualifying for the ex- section 129. See also §1.125–5 for FSA
provides that participation terminates when an indi- clusion under sections 106 and 105(b). See rules.
vidual ceases to be an employee of Employer E, un-
§1.105–2. This is the case without regard (iii) Period of coverage. In order for de-
less the former employee elects to continue to par- pendent care assistance through a cafete-
ticipate in the health FSA under the COBRA rules to whether the benefit was purchased with
contributions made at the employer’s dis- ria plan to be provided through a depen-
in §54.4980B–2 of this chapter. Employee G timely
elects to salary reduce $1,200 to participate in a health cretion, at the employee’s discretion (for dent care assistance program eligible for
FSA for the 2009 plan year. As of June 30, 2009, example, by salary reduction election), or the section 129 exclusion, the plan may not
Employee G has contributed $600 toward the health
pursuant to a collective bargaining agree- operate in a manner that enables employ-
FSA, but incurred no medical expenses. On June 30, ees to purchase dependent care assistance
2009, Employee G terminates employment and does ment.
(iii) Other arrangements. Arrange- only for periods during which the employ-
not continue participation under COBRA. On July 15,
2009, G incurs a section 213(d) medical expense of ments formally outside of the cafeteria ees expect to receive dependent care as-
$500. plan that adjust an employee’s compen- sistance. If the period of coverage for a
dependent care assistance program offered

2007–39 I.R.B. 706 September 24, 2007

through a cafeteria plan is twelve months expenses incurred after the date an em- dependents. The independent third-party
(or, in the case of a short plan year, at least ployee ceases participation in the cafeteria must provide information describing the
equal to the short plan year) and the plan plan (for example, after termination) and service or product, the date of the service
does not permit an employee to elect spe- through the last day of that plan year (or or sale, and the amount. Self-substanti-
cific amounts of coverage, reimbursement, grace period immediately after that plan ation or self-certification of an expense
or salary reduction for less than twelve year) may be reimbursed from unused ben- by an employee does not satisfy the sub-
months, the plan is deemed not to operate efits, if all of the requirements of section stantiation requirements of this paragraph
to enable employees to purchase coverage 129 are satisfied. (b). The specific requirements in sections
only for periods when dependent care as- (vi) Example. The following example 105(b), 129, and 137 must also be satisfied
sistance will be received. See paragraph illustrates the rules in paragraph (a)(4)(v) as a condition of reimbursing expenses for
(a) in §1.125–2 and §1.125–4 regarding of this section: qualified benefits. For example, a health
the revocation of elections during the pe- Example. Terminated employee’s post-termina- FSA does not satisfy the requirements of
riod of coverage on account of changes in tion dependent care expenses. (i) For calendar year section 105(b) if it reimburses employees
2009, Employee X elects $5,000 salary reduction
family status. See paragraph (e) in this sec- for dependent care assistance through Employer
for expenses where the employees only
tion for required period of coverage for de- G’s cafeteria plan. X works for Employer G from submit information describing medical ex-
pendent care assistance. January 1 through June 30, 2009, when X termi- penses, the amount of the expenses and the
(iv) Examples. The following examples nates employment. As of June 30, 2009, X had paid date of the expenses but fail to provide a
illustrate the rules in paragraphs (a)(4)(i)- $2,500 in salary reduction and had incurred and was statement from an independent third-party
reimbursed for $2,000 of dependent care expenses.
(iii) of this section: (ii) X does not work again until October 1, 2009,
(either automatically or subsequent to the
Example 1. Initial non-refundable fee for child transaction) verifying the expenses. Un-
when X begins work for Employer H. X was em-
care. (i) Employer F maintains a calendar year cafete- der §1.105–2, all amounts paid under a
ployed by Employer H from October 1, 2009 through
ria plan, offering employees an election between cash
December 31, 2009. During this period, X also in- plan that permits self-substantiation or
and qualified benefits, including dependent care as-
curred $500 of dependent care expenses. During all self-certification are includible in gross
sistance. Employee M has a one-year old dependent
the periods of employment in 2009, X satisfied all re-
child. Employee M timely elected $5,000 of depen-
quirements in section 129 for excluding payments for
income, including amounts reimbursed
dent care assistance for 2009. During the entire 2009 for medical expenses, whether or not sub-
dependent care assistance from gross income.
plan year, Employee M satisfies all the requirements stantiated. See paragraph (m) in §1.125–5
(iii) Employer G’s cafeteria plan allows termi-
in section 129 for dependent care assistance.
nated employees to “spend down” unused salary re- for additional substantiation rules for lim-
(ii) On February 1, 2009, Employee M pays an
duction amounts for dependent care assistance, if all ited-purpose and post-deductible health
initial non-refundable fee of $500 to a licensed child
requirements of section 129 are satisfied. After X’s
care center (unrelated to Employer F or to Employee
claim for $500 of dependent care expenses is sub-
FSAs.
M), to reserve a space at the child care center for M’s (ii) Rules for substantiation of health
stantiated, Employer G’s cafeteria plan reimburses X
child. The child care center’s monthly charges for FSA claims using an explanation of ben-
for $500 (the remaining balance) of dependent care
child care are $1,200. When the child care center first
expenses incurred during X’s employment for Em- efits provided by an insurance company.
begins to care for M’s child, the $500 non-refundable
ployer H between October 1, 2009 and December 31, (A) Written statement from an indepen-
fee is applied toward the first month’s charges for
2009. Employer G’s cafeteria plan and operation are
child care.
consistent with section 125.
dent third-party. If the employer is pro-
(iii) On March 1, 2009, the child care center be- vided with information from an indepen-
gins caring for Employee M’s child, and continues
(b) Rules for claims substantiation for
cafeteria plans—(1) Substantiation re- dent third-party (such as an “explanation
to care for the child through December 31, 2009. On
March 1, 2009, M pays the child care center $700 (the quired before reimbursing expenses for of benefits” (EOB) from an insurance com-
balance of the $1,200 in charges for child care to be qualified benefits. This paragraph (b) sets pany) indicating the date of the section
provided in March 2009). On April 1, 2009, M pays
forth the substantiation requirements that 213(d) medical care and the employee’s
the child care center $1,200 for the child care to be responsibility for payment for that medi-
provided in April 2009.
a cafeteria plan must satisfy before paying
or reimbursing any expense for a qualified cal care (that is, coinsurance payments and
(iv) Dependent care expenses are incurred when
the services are provided. For dependent care ser- benefit. amounts below the plan’s deductible), and
vices provided in March 2009, the $500 nonrefund- (2) All claims must be substantiated. As the employee certifies that any expense
able fee paid on February 1, 2009, and the $700 paid
a precondition of payment or reimburse- paid through the health FSA has not been
on March 1, 2009 may be reimbursed on or after the reimbursed and that the employee will not
later of the date when substantiated or April 1, 2009.
ment of expenses for qualified benefits, a
cafeteria plan must require substantiation seek reimbursement from any other plan
For dependent care services provided in April 2009,
the $1,200 paid on April 1, 2009 may be reimbursed in accordance with this section. Substanti- covering health benefits, the claim is fully
on or after the later of the date when substantiated or ating only a percentage of claims, or sub- substantiated without the need for submis-
May 1, 2009.
stantiating only claims above a certain dol- sion of a receipt by the employee or further
Example 2. Non-refundable fee forfeited. Same review.
facts as Example 1, except that the child care center
lar amount, fails to comply with the sub-
stantiation requirements in §1.125–1 and (B) Example. The following exam-
never cared for M’s child (who was instead cared for
at Employer F’s onsite child care facility). Because this section. ple illustrates the rules in this paragraph
the child care center never provided child care ser- (3) Substantiation by independent (b)(3):
vices to Employee M’s child, the $500 non-refund- Example. Explanation of benefits. (i) During the
third-party. (i) In general. All expenses plan year ending December 31, 2009, Employee Q
able fee is not reimbursable.
must be substantiated by information from is a participant in the health FSA sponsored by Em-
(v) Optional spend-down provision. At
a third-party that is independent of the ployer J and is enrolled in Employer J’s accident and
the employer’s option, the written cafete- health plan.
employee and the employee’s spouse and
ria plan may provide that dependent care

September 24, 2007 707 2007–39 I.R.B.

 (ii) On March 1, 2009, Q visits a physician’s of- certain stores with the Drug Stores and a location by location basis, 90 percent of
fice for medical care as defined in section 213(d). The Pharmacies merchant category code and the store’s gross receipts during the prior
charge for the physician’s services is $150. Under the that may be used for medical expenses taxable year consisted of items which qual-
plan, Q is responsible for 20 percent of the charge for
the physician’s services (that is, $30). Q has suffi-
incurred at all merchants. ify as expenses for medical care described
cient FSA coverage for the $30 claim. (2) Debit cards used for dependent care in section 213(d); and
(iii) Employer J has coordinated with the accident assistance. Paragraph (g) of this section (iii) Stores that have implemented the
and health plan so that Employer J or its agent au- sets forth additional rules for debit cards inventory information approval system un-
tomatically receives an EOB from the plan indicat- usable for reimbursing dependent care ex- der paragraph (f).
ing that Q is responsible for payment of 20 percent
of the $150 charged by the physician. Because Em-
penses. (6) The employer substantiates claims
ployer J has received a statement from an independent (3) Additional guidance. The Com- based on payments to medical care
third-party that Q has incurred a medical expense, the missioner may prescribe additional guid- providers and stores described in para-
date the expense was incurred, and the amount of the ance of general applicability, published graphs (d)(5)(i) and (ii) of this section in
expense, the claim is substantiated without the need in the Internal Revenue Bulletin (see accordance with either paragraph (e) or
for J to submit additional information regarding the
expense. Employer J’s FSA reimburses Q the $30
§601.601(d)(2)(ii)(b) of this chapter), to paragraph (f) of this section.
medical expense without requiring Q to submit a re- provide additional rules for debit cards. (7) The employer follows all of the fol-
ceipt or a statement from the physician. The substan- (d) Mandatory rules for all debit cards lowing correction procedures for any im-
tiation rules in paragraph (b) in this section are satis- usable to pay or reimburse medical ex- proper payments using the debit card—
fied. penses. A health FSA paying or reim- (i) Until the amount of the improper
(4) Advance reimbursement of expenses bursing section 213(d) medical expenses payment is recovered, the debit card must
for qualified benefits prohibited. Reim- through a debit card must satisfy all of the be de-activated and the employee must
bursing expenses before the expense has following requirements— request payments or reimbursements of
been incurred or before the expense is sub- (1) Before any employee participating medical expenses from the health FSA
stantiated fails to satisfy the substantiation in a health FSA receives the debit card, the through other methods (for example, by
requirements in §1.105–2, §1.125–1 and employee agrees in writing that he or she submitting receipts or invoices from a
this section. will only use the card to pay for medical merchant or service provider showing the
(5) Purported loan from employer to expenses (as defined in section 213(d)) of employee incurred a section 213(d) medi-
employee. In determining whether, un- the employee or his or her spouse or depen- cal expense);
der all the facts and circumstances, em- dents, that he or she will not use the debit (ii) The employer demands that the em-
ployees are being reimbursed for unsub- card for any medical expense that has al- ployee repay the cafeteria plan an amount
stantiated claims, special scrutiny will be ready been reimbursed, that he or she will equal to the improper payment;
given to other arrangements such as em- not seek reimbursement under any other (iii) If, after the demand for repayment
ployer-to-employee loans based on actual health plan for any expense paid for with of improper payment (as described in para-
or projected employee claims. a debit card, and that he or she will ac- graph (d)(7)(ii) of this section), the em-
(6) Debit cards. For purposes of this quire and retain sufficient documentation ployee fails to repay the amount of the im-
section, a debit card is a debit card, credit (including invoices and receipts) for any proper charge, the employer withholds the
card, or stored value card. See also para- expense paid with the debit card. amount of the improper charge from the
graphs (c) through (g) of this section for (2) The debit card includes a statement employee’s pay or other compensation, to
additional rules on payments or reimburse- providing that the agreements described in the full extent allowed by applicable law;
ments made through debit cards. paragraph (d)(1) of this section are reaf- (iv) If any portion of the improper pay-
(c) Debit cards-overview—(1) Manda- firmed each time the employee uses the ment remains outstanding after attempts to
tory rules for all debit cards usable to pay card. recover the amount (as described in para-
or reimburse medical expenses. Paragraph (3) The amount available through the graph (d)(7)(ii) and (iii) of this section),
(d) of this section sets forth the mandatory debit card equals the amount elected by the the employer applies a claims substitution
procedures for debit cards to substantiate employee for the health FSA for the cafe- or offset to resolve improper payments,
section 213(d) medical expenses. These teria plan year, and is reduced by amounts such as a reimbursement for a later sub-
rules apply to all debit cards used to pay paid or reimbursed for section 213(d) med- stantiated expense claim is reduced by the
or reimburse medical expenses. Paragraph ical expenses incurred during the plan year. amount of the improper payment. So,
(e) of this section sets forth additional (4) The debit card is automatically can- for example, if an employee has received
substantiation rules that may be used for celled when the employee ceases to partic- an improper payment of $200 and subse-
medical expenses incurred at medical care ipate in the health FSA. quently submits a substantiated claim for
providers and certain stores with the Drug (5) The employer limits use of the debit $250 incurred during the same coverage
Stores and Pharmacies merchant category card to— period, a reimbursement for $50 is made;
code. Paragraph (f) in this section sets (i) Physicians, dentists, vision care and
forth the requirements for an inventory offices, hospitals, other medical care (v) If, after applying all the procedures
information approval system which must providers (as identified by the merchant described in paragraph (d)(7)(ii) through
be used to substantiate medical expenses category code); (iv) of this section, the employee remains
incurred at merchants or service providers (ii) Stores with the merchant category indebted to the employer for improper pay-
that are not medical care providers or code for Drugstores and Pharmacies if, on ments, the employer, consistent with its

2007–39 I.R.B. 708 September 24, 2007

business practice, treats the improper pay- (A) Tiered copayments. If a health plan gross income, including amounts paid for
ment as it would any other business indebt- has multiple copayments for the same ben- medical care whether or not substantiated.
edness. efit, (for example, tiered copayments for a See paragraph (b) in this section.
(e) Substantiation of expenses incurred pharmacy benefit), exact matches of mul- (4) Certain recurring medical expenses.
at medical care providers and certain tiples or combinations of up to five co- Automatic payment or reimbursement
other stores with Drug Stores and Phar- payments are similarly fully substantiated satisfies the substantiation rules in this
macies merchant category code—(1) In without the need for submission of a re- paragraph (e) for payment of recurring
general. A health FSA paying or reim- ceipt or further review. expenses that match expenses previously
bursing section 213(d) medical expenses (B) Copayment match must be exact approved as to amount, medical care
through a debit card is permitted to com- multiple. If the dollar amount of the trans- provider and time period (for example,
ply with the substantiation provisions of action is not an exact multiple of the co- for an employee who refills a prescrip-
this paragraph (e), instead of complying payment (or an exact match of a multiple tion drug on a regular basis at the same
with the provisions of paragraph (f), for or combination of different copayments for provider and in the same amount). The
medical expenses incurred at providers de- a benefit in the case of multiple copay- payment is substantiated without the need
scribed in paragraph (e)(2) of this section. ments), the transaction must be treated as for submission of a receipt or further re-
(2) Medical care providers and certain conditional pending confirmation of the view.
other stores with Drug Stores and Phar- charge, even if the amount is less than five (5) Real-time substantiation. If a third
macies merchant category code. Medical times the copayment. party that is independent of the employee
expenses may be substantiated using the (C) No match for multiple of six or more and the employee’s spouse and dependents
methods described in paragraph (e)(3) of times copayment. If the dollar amount of (for example, medical care provider, mer-
this section if incurred at physicians, phar- the transaction at a medical care provider chant, or pharmacy benefit manager) pro-
macies, dentists, vision care offices, hospi- equals a multiple of six or more times the vides, at the time and point of sale, infor-
tals, other medical care providers (as iden- dollar amount of the copayment for the mation to verify to the employer (includ-
tified by the merchant category code) and specific service, the transaction must be ing electronically by email, the internet, in-
at stores with the Drug Stores and Pharma- treated as conditional pending confirma- tranet or telephone) that the charge is for
cies merchant category code, if, on a store tion of the charge by the submission of ad- a section 213(d) medical expense, the ex-
location-by-location basis, 90 percent of ditional third-party information. See para- pense is substantiated without the need for
the store’s gross receipts during the prior graph (d) of this section. In the case of further review.
taxable year consisted of items which qual- a plan with multiple copayments for the (6) Substantiation requirements for
ify as expenses for medical care described same benefit, if the dollar amount of the all other medical expenses paid or reim-
in section 213(d). transaction exceeds five times the maxi- bursed through a health FSA debit card.
(3) Claims substantiation for copay- mum copayment for the benefit, the trans- All other charges to the debit card (other
ment matches, certain recurring medical action must also be treated as conditional than substantiated copayments, recurring
expenses and real-time substantiation. pending confirmation of the charge by the medical expenses or real-time substantia-
If all of the requirements in this para- submission of additional third-party infor- tion, or charges substantiated through the
graph (e)(3) are satisfied, copayment mation. In these cases, the employer must inventory information approval system
matches, certain recurring medical ex- require that additional third-party informa- described in paragraph (f) of this section)
penses and medical expenses substantiated tion, such as merchant or service provider must be treated as conditional, pending
in real-time are substantiated without the receipts, be submitted for review and sub- substantiation of the charge through addi-
need for submission of receipts or further stantiation, and the third-party information tional independent third-party information
review. must satisfy the requirements in paragraph describing the goods or services, the date
(i) Matching copayments—multiples of (b)(3) of this section. of the service or sale and the amount of the
five or fewer. If an employer’s accident (D) Independent verification of copay- transaction. All such debit card payments
or health plan covering the employee (or ment required. The copayment schedule must be substantiated, regardless of the
the employee’s spouse or dependents) has required under the accident or health amount of the payment.
copayments in specific dollar amounts, plan must be independently verified by (f) Inventory information approval
and the dollar amount of the transaction the employer. Statements or other rep- system—(1) In general. An inventory in-
at a medical care provider equals an ex- resentations by the employee are not formation approval system that complies
act multiple of not more than five times sufficient. Self-substantiation or self-cer- with this paragraph (f) may be used to
the dollar amount of the copayment for tification of an employee’s copayment in substantiate payments made using a debit
the specific service (for example, phar- connection with copayment matching pro- card, including payments at merchants and
macy benefit copayment, copayment for cedures through debit cards or otherwise service providers that are not described in
a physician’s office visit) under the acci- does not constitute substantiation. If a paragraph (e)(2) of this section. Debit
dent or health plan covering the specific plan’s copayment matching system relies card transactions using this system are
employee-cardholder, then the charge is on an employee to provide a copayment fully substantiated without the need for
fully substantiated without the need for amount without verification of the amount, submission of a receipt by the employee
submission of a receipt or further review. claims have not been substantiated, and all or further review.
amounts paid from the plan are included in

September 24, 2007 709 2007–39 I.R.B.

 (2) Operation of inventory information must ensure that the inventory infor- lect information matching expenses pre-
approval system. An inventory informa- mation approval system complies with viously substantiated and approved as to
tion approval system must operate in the the requirements in §§1.105–2, 1.125–1, dependent care provider and time period
manner described in this paragraph (f)(2). and §1.125–6 for substantiating, paying may be treated as substantiated without
(i) When an employee uses the card, or reimbursing section 213(d) medical further review if the transaction is for an
the payment card processor’s or participat- expenses and with the recordkeeping re- amount equal to or less than the previously
ing merchant’s system collects informa- quirements in section 6001. substantiated expenses. Similarly, depen-
tion about the items purchased using the (g) Debit cards used to pay or reim- dent care expenses previously substanti-
inventory control information (for exam- burse dependent care assistance—(1) In ated and approved through nonelectronic
ple, stock keeping units (SKUs)). The sys- general. An employer may use a debit methods may also be treated as substanti-
tem compares the inventory control infor- card to provide benefits under its depen- ated without further review. In both cases,
mation for the items purchased against a dent care assistance program (including a if there is an increase in previously sub-
list of items, the purchase of which qual- dependent care assistance FSA). However, stantiated amounts or a change in the de-
ifies as expenses for medical care under dependent care expenses may not be reim- pendent care provider, the employee must
section 213(d) (including nonprescription bursed before the expenses are incurred. submit a statement or receipt from the de-
medications). See paragraph (a)(4) in this section. Thus, pendent care provider substantiating the
(ii) The section 213(d) medical ex- if a dependent care provider requires pay- claimed expenses before amounts relating
penses are totaled and the merchant’s ment before the dependent care services to the increased amounts or new providers
or payment card processor’s system ap- are provided, the expenses cannot be reim- may be added to the card.
proves the use of the card only for the bursed at the time of payment through use (4) Example. The following example
amount of the section 213(d) medical of a debit card or otherwise. illustrates the rules in this paragraph (g):
expenses eligible for coverage under the (2) Reimbursing dependent care assis- Example. Recurring dependent care expenses.
health FSA (taking into consideration the tance through a debit card. An employer (i) Employer K sponsors a dependent care assistance
FSA through its cafeteria plan. Salary reduction
uniform coverage rule in paragraph (d) of offering a dependent care assistance FSA amounts for participating employees are made on a
§1.125–5); may adopt the following method to pro- weekly payroll basis, which are available for depen-
(iii) If the transaction is only partially vide reimbursements for dependent care dent care coverage on a weekly basis. As a result,
approved, the employee is required to ten- expenses through a debit card— the amount of available dependent care coverage
der additional amounts, resulting in a split- (i) At the beginning of the plan year equals the employee’s salary reduction amount mi-
nus claims previously paid from the plan. Employer
tender transaction. For example, if, after or upon enrollment in the dependent care K has adopted a payment card program for its depen-
matching inventory information, it is de- assistance program, the employee pays dent care FSA.
termined that all items purchased are sec- initial expenses to the dependent care (ii) For the plan year ending December 31, 2009,
tion 213(d) medical expenses, the entire provider and substantiates the initial ex- Employee F is a participant in the dependent care
transaction is approved, subject to the cov- penses by submitting to the employer or FSA and elected $5,000 of dependent care coverage.
Employer K reduces F’s salary by $96.15 on a weekly
erage limitations of the health FSA; plan administrator a statement from the basis to pay for coverage under the dependent care
(iv) If, after matching inventory infor- dependent care provider substantiating the FSA.
mation, it is determined that only some dates and amounts for the services pro- (iii) At the beginning of the 2009 plan year, F is
of the items purchased are section 213(d) vided. issued a debit card with a balance of zero. F’s child-
medical expenses, the transaction is ap- (ii) After the employer or plan admin- care provider, ABC Daycare Center, requires a $250
advance payment at the beginning of the week for
proved only as to the section 213(d) medi- istrator receives the substantiation (but not dependent care services that will be provided during
cal expenses. In this case, the merchant or before the date the services are provided as the week. The dependent care services provided for
service-provider must request additional indicated by the statement provided by the F by ABC qualify for reimbursement under section
payment from the employee for the items dependent care provider), the plan makes 129. However, because as of the beginning of the
that do not satisfy the definition of medical available through the debit card an amount plan year, no services have yet been provided, F can-
not be reimbursed for any of the amounts until the end
care under section 213(d); equal to the lesser of— of the first week of the plan year (that is, the week
(v) The merchant or service-provider (A) The previously incurred and sub- ending January 5, 2009), after the services have been
must also request additional payment stantiated expense; or provided.
from the employee if the employee does (B) The employee’s total salary reduc- (iv) F submits a claim for reimbursement that in-
not have sufficient health FSA coverage to tion amount to date. cludes a statement from ABC with a description of the
services, the amount of the services, and the dates of
purchase the section 213(d) medical items; (iii) The card may be used to pay for the services. Employer K increases the balance of F’s
(vi) Any attempt to use the card subsequently incurred dependent care ex- payment card to $96.15 after the services have been
at non-participating merchants or ser- penses. provided (i.e., the lesser of F’s salary reduction to date
vice-providers must fail. (iv) The amount available through the or the incurred dependent care expenses). F uses the
(3) Employer’s responsibility for en- card may be increased in the amount of any card to pay ABC $96.15 on the first day of the next
week (January 8, 2009) and pays ABC the remaining
suring inventory information approval additional dependent care expenses only balance due for that week ($153.85) by check.
system’s compliance with §1.105–2, after the additional expenses have been in- (v) To the extent that this card transaction and
§1.125–1, §1.125–6 and recordkeeping curred. each subsequent transaction is with ABC and is for
requirements. An employer that uses the (3) Substantiating recurring dependent an amount equal to or less than the previously sub-
inventory information approval system care expenses. Card transactions that col- stantiated amount, the charges are fully substantiated

2007–39 I.R.B. 710 September 24, 2007

without the need for the submission by F of a state- which he or she is elected or appointed, (13) Premium-only-plan. A premium-
ment from the provider or further review by the em- and the nature and extent of his or her du- only-plan is described in paragraph (a)(5)
ployer. However, the subsequent amount is not made ties. Generally, the term officer means an in §1.125–1.
available on the card until the end of the week when
the services have been provided. Employer K’s de-
administrative executive who is in regu- (14) Statutory nontaxable benefits.
pendent care debit card satisfies the substantiation re- lar and continued service. The term offi- Statutory nontaxable benefits are qualified
quirements of this paragraph (g). cer implies continuity of service and ex- benefits that are excluded from gross in-
(h) Effective/applicability date. It is cludes individuals performing services in come (for example, an employer-provided
proposed that these regulations apply on connection with a special and single trans- accident and health plan excludible under
and after plan years beginning on or after action. An individual who merely has the section 106 or a dependent care assistance
January 1, 2009. However, the effective title of an officer but not the authority of an program excludible under section 129).
dates for the previously issued guidance on officer, is not an officer. Similarly, an in- Statutory nontaxable benefits also include
debit cards, which is incorporated in this dividual without the title of an officer but group-term life insurance on the life of
section, remain applicable. who has the authority of an officer is an an employee includible in the employee’s
officer. Sole proprietorships, partnerships, gross income solely because the coverage
§1.125–7 Cafeteria plan associations, trusts and labor organizations exceeds the limit in section 79(a).
nondiscrimination rules also may have officers. See §§301.7701–1 (15) Total benefits. Total benefits are
through –3. qualified benefits and permitted taxable
(a) Definitions—(1) In general. The (8) Five percent shareholder. A five benefits.
definitions set forth in this paragraph (a) percent shareholder is an individual who (b) Nondiscrimination as to eligibil-
apply for purposes of section 125(b), (c), in either the preceding plan year or current ity—(1) In general. A cafeteria plan
(e) and (g) and this section. plan year owns more than five percent of must not discriminate in favor of highly
(2) Compensation. The term compen- the voting power or value of all classes of compensated individuals as to eligibil-
sation means compensation as defined in stock of the employer, determined without ity to participate for that plan year. A
section 415(c)(3). attribution. cafeteria plan does not discriminate in
(3) Highly compensated individual. (i) (9) Highly compensated. The term favor of highly compensated individuals
In general. The term highly compensated highly compensated means any individual if the plan benefits a group of employees
individual means an individual who is— or participant who for the preceding plan who qualify under a reasonable classi-
(A) An officer; year (or the current plan year in the case fication established by the employer, as
(B) A five percent shareholder (as de- of the first year of employment) had com- defined in §1.410(b)–4(b), and the group
fined in paragraph (a)(8) of this section); pensation from the employer in excess of employees included in the classifica-
or of the compensation amount specified in tion satisfies the safe harbor percentage
(C) Highly compensated. section 414(q)(1)(B), and, if elected by the test or the unsafe harbor percentage com-
(ii) Spouse or dependent. A spouse or a employer, was also in the top-paid group ponent of the facts and circumstances
dependent of any highly compensated in- of employees (determined by reference to test in §1.410(b)–4(c). (In applying the
dividual described in (a)(3)(i) of this sec- section 414(q)(3)) for such preceding plan §1.410(b)–4 test, substitute highly com-
tion is a highly compensated individual. year (or for the current plan year in the pensated individual for highly compen-
Section 125(e). case of the first year of employment). sated employee and substitute nonhighly
(4) Highly compensated participant. (10) Key employee. A key employee is a compensated individual for nonhighly
The term highly compensated participant participant who is a key employee within compensated employee).
means a highly compensated individual the meaning of section 416(i)(1) at any (2) Deadline for participation in cafe-
who is eligible to participate in the cafete- time during the preceding plan year. A key teria plan. Any employee who has com-
ria plan. employee covered by a collective bargain- pleted three years of employment (and
(5) Nonhighly compensated individual. ing agreement is a key employee. who satisfies any conditions for partici-
The term nonhighly compensated individ- (11) Collectively bargained plan. A pation in the cafeteria plan that are not
ual means an individual who is not a highly collectively bargained plan is a plan or related to completion of a requisite length
compensated individual. the portion of a plan maintained under an of employment) must be permitted to elect
(6) Nonhighly compensated partici- agreement which is a collective bargaining to participate in the cafeteria plan no later
pant. The term nonhighly compensated agreement between employee representa- than the first day of the first plan year
participant means a participant who is not tives and one or more employers, if there is beginning after the date the employee
a highly compensated participant. evidence that cafeteria plan benefits were completed three years of employment (un-
(7) Officer. The term officer means any the subject of good faith bargaining be- less the employee separates from service
individual or participant who for the pre- tween such employee representatives and before the first day of that plan year).
ceding plan year (or the current plan year such employer or employers. (3) The safe harbor percentage test. (i)
in the case of the first year of employment) (12) Year of employment. For purposes In general. For purposes of the safe har-
was an officer. Whether an individual is an of section 125(g)(3)(B)(i), a year of em- bor percentage test and the unsafe harbor
officer is determined based on all the facts ployment is determined by reference to the percentage component of the facts and cir-
and circumstances, including the source elapsed time method of crediting service. cumstances test, if the cafeteria plan pro-
of the individual’s authority, the term for See §1.410(a)–7. vides that only employees who have com-

September 24, 2007 711 2007–39 I.R.B.

pleted three years of employment are per- annual premium for single coverage under Plan X is compensated participants if the aggregate
mitted to participate in the plan, employees $15,000 per year, and $8,000 per year for Plan Y. Em- contributions utilized by highly compen-
who have not completed three years of em- ployer B’s cafeteria plan provides that highly com- sated participants, measured as a per-
pensated participants may elect salary reduction of
ployment may be excluded from consider- $15,000 for coverage under Plan X, and that non-
centage of the aggregate compensation
ation. However, if the cafeteria plan pro- highly compensated participants may elect salary re- of highly compensated participants, ex-
vides that employees are allowed to par- duction of $8,000 for coverage under Plan Y. The ceed the aggregate contributions utilized
ticipate before completing three years of cafeteria plan fails the eligibility test. by nonhighly compensated participants
employment, all employees with less than Example 4. Accident and health plans of unequal measured as a percentage of the aggregate
value for unequal salary reduction amounts. Same
three years of employment must be in- facts as Example 3, except that the amount of salary
compensation of nonhighly compensated
cluded in applying the safe harbor percent- reduction for highly compensated participants to elect participants.
age test and the unsafe harbor percentage Plan X is $8,000. The cafeteria plan fails the eligibil- (3) Example. The following example
component of the facts and circumstances ity test. illustrates the rules in paragraph (c) of this
test. See paragraph (g) of this section for a (c) Nondiscrimination as to contribu- section:
permissive disaggregation rule. tions and benefits—(1) In general. A cafe- Example. Contributions and benefits test. Em-
(ii) Employees excluded from consider- teria plan must not discriminate in favor of ployer C’s cafeteria plan satisfies the eligibility test
in paragraph (b) of this section. Highly compen-
ation. In addition, for purposes of the safe highly compensated participants as to con-
sated participants in the cafeteria plan elect aggre-
harbor percentage test and the unsafe har- tributions and benefits for a plan year. gate qualified benefits equaling 5 percent of aggre-
bor percentage component of the facts and (2) Benefit availability and benefit elec- gate compensation; nonhighly compensated partici-
circumstances test, the following employ- tion. A cafeteria plan does not discrim- pants elect aggregate qualified benefits equaling 10
ees are excluded from consideration — inate with respect to contributions and percent of aggregate compensation. Employer C’s
cafeteria plan passes the contribution and benefits
(A) Employees (except key employees) benefits if either qualified benefits and
test.
covered by a collectively bargained plan total benefits, or employer contributions
(d) Key employees—(1) In general. If
as defined in paragraph (a)(11) of this sec- allocable to statutory nontaxable benefits
for any plan year, the statutory nontaxable
tion; and employer contributions allocable to
benefits provided to key employees exceed
(B) Employees who are nonresident total benefits, do not discriminate in favor
25 percent of the aggregate of statutory
aliens and receive no earned income of highly compensated participants. A
nontaxable benefits provided for all em-
(within the meaning of section 911(d)(2)) cafeteria plan must satisfy this paragraph
ployees through the cafeteria plan, each
from the employer which constitutes in- (c) with respect to both benefit availability
key employee includes in gross income
come from sources within the United and benefit utilization. Thus, a plan must
an amount equaling the maximum taxable
States (within the meaning of section give each similarly situated participant
benefits that he or she could have elected
861(a)(3)); and a uniform opportunity to elect qualified
for the plan year. However, see safe harbor
(C) Employees participating in the cafe- benefits, and the actual election of quali-
for premium-only-plans in paragraph (f) of
teria plan under a COBRA continuation fied benefits through the plan must not be
this section.
provision. disproportionate by highly compensated
(2) Example. The following example
(iv) Examples. The following examples participants (while other participants elect
illustrates the rules in paragraph (d) of this
illustrate the rules in paragraph (b) of this permitted taxable benefits). Qualified
section:
section: benefits are disproportionately elected by Example. (i) Key employee concentration test.
Example 1. Same qualified benefit for same highly compensated participants if the Employer D’s cafeteria plan offers all employees an
salary reduction amount. Employer A has one em- aggregate qualified benefits elected by election between taxable benefits and qualified ben-
ployer-provided accident and health insurance plan. efits. The cafeteria plan satisfies the eligibility test
highly compensated participants, mea-
The cost to participants electing the accident and in paragraph (b) of this section. Employer D has two
health plan is $10,000 per year for single coverage.
sured as a percentage of the aggregate
key employees and four nonhighly compensated em-
All employees have the same opportunity to salary compensation of highly compensated par- ployees. The key employees each elect $2,000 of
reduce $10,000 for accident and health plan. The ticipants, exceed the aggregate qualified qualified benefits. Each nonhighly compensated em-
cafeteria plan satisfies the eligibility test. benefits elected by nonhighly compen- ployee also elects $2,000 of qualified benefits. The
Example 2. Same qualified benefit for unequal qualified benefits are statutory nontaxable benefits.
sated participants measured as a percent-
salary reduction amounts. Same facts as Example 1 (ii) Key employees receive $4,000 of statutory
except the cafeteria plan offers nonhighly compen-
age of the aggregate compensation of
nontaxable benefits and nonhighly compensated
sated employees the election to salary reduce $10,000 nonhighly compensated participants. A employees receive $8,000 of statutory nontaxable
to pay premiums for single coverage. The cafete- plan must also give each similarly situ- benefits, for a total of $12,000. Key employees
ria plan provides an $8,000 employer flex-credit to ated participant a uniform election with receive 33 percent of statutory nontaxable benefits
highly compensated employees to pay a portion of the (4,000/12,000). Because the cafeteria plan provides
respect to employer contributions, and
premium, and provides an election to them to salary more than 25 percent of the aggregate of statutory
reduce $2,000 to pay the balance of the premium. The
the actual election with respect to em-
nontaxable benefits to key employees, the plan fails
cafeteria plan fails the eligibility test. ployer contributions for qualified benefits the key employee concentration test.
Example 3. Accident and health plans of unequal through the plan must not be dispropor- (e) Safe harbor for cafeteria plans pro-
value. Employer B’s cafeteria plan offers two em- tionate by highly compensated participants
ployer-provided accident and health insurance plans:
viding health benefits—(1) In general. A
(while other participants elect to receive cafeteria plan that provides health benefits
Plan X, available only to highly compensated partici-
pants, is a low-deductible plan. Plan Y, available only
employer contributions as permitted tax- is not treated as discriminatory as to bene-
to nonhighly compensated participants, is a high de- able benefits). Employer contributions fits and contributions if:
ductible plan (as defined in section 223(c)(2)). The are disproportionately utilized by highly

2007–39 I.R.B. 712 September 24, 2007

 (i) Contributions under the plan on be- (ii) The premium-only-plan satisfies the nondis- (i) Employees of certain controlled
half of each participant include an amount crimination rules in section 125(b) and (c) and this groups. All employees who are treated
which equals 100 percent of the cost of section. as employed by a single employer under
the health benefit coverage under the plan (g) Permissive disaggregation for section 414(b), (c), (m), or (o) are treated
of the majority of the highly compensated nondiscrimination testing—(1) General as employed by a single employer for pur-
participants similarly situated, or equals rule. If a cafeteria plan benefits employ- poses of section 125. Section 125(g)(4);
or exceeds 75 percent of the cost of the ees who have not completed three years of section 414(t).
health benefit coverage of the participant employment, the cafeteria plan is permit- (j) Time to perform nondiscrimination
(similarly situated) having the highest cost ted to test for nondiscrimination under this testing—(1) In general. Nondiscrimina-
health benefit coverage under the plan, and section as if the plan were two separate tion testing must be performed as of the
(ii) Contributions or benefits under the plans— last day of the plan year, taking into ac-
plan in excess of those described in para- (i) One plan benefiting the employees count all non-excludable employees (or
graph (e)(1)(i) of this section bear a uni- who completed one day of employment former employees) who were employees
form relationship to compensation. but less than three years of employment; on any day during the plan year.
(2) Similarly situated. In determining and (2) The following example illustrates
which participants are similarly situated, (ii) Another plan benefiting the employ- the rules in paragraph (j) of this section:
reasonable differences in plan benefits ees who have completed three years of em- Example. When to perform discrimination test-
may be taken into account (for example, ployment. ing. (i) Employer H employs three employees and
(2) Disaggregated plans tested sepa- maintains a calendar year cafeteria plan. During the
variations in plan benefits offered to em- 2009 plan year, Employee J was an employee the
ployees working in different geographical rately for eligibility test and contributions
entire calendar year, Employee K was an employee
locations or to employees with family cov- and benefits test. If a cafeteria plan is dis- from May 1, through August 31, 2009, and Employee
erage versus employee-only coverage). aggregated into two separate plans for pur- L worked from January 1, 2009 to April 15, 2009,
(3) Health benefits. Health benefits for poses of nondiscrimination testing, the two when he retired.
separate plans must be tested separately for (ii) Nondiscrimination testing for the 2009 plan
purposes of this rule are limited to major year must be performed on December 31, 2009, tak-
medical coverage and exclude dental cov- both the nondiscrimination as to eligibility
ing into account employees J, K, and L’s compensa-
erage and health FSAs. test in paragraph (b) of this section and the tion in the preceding year.
(4) Example. The following example nondiscrimination as to contributions and (k) Discrimination in actual operation
illustrates the rules in paragraph (e) of this benefits test in paragraph (c) of this sec- prohibited. In addition to not discriminat-
section: tion. ing as to either benefit availability or bene-
Example. (i) All 10 of Employer E’s employees (h) Optional aggregation of plans for fit utilization, a cafeteria plan must not dis-
are eligible to elect between permitted taxable ben- nondiscrimination testing. An employer criminate in favor of highly compensated
efits and salary reduction of $8,000 per plan year who sponsors more than one cafeteria plan
for self-only coverage in the major medical health
participants in actual operation. For exam-
is permitted to aggregate two or more of ple, a plan may be discriminatory in ac-
plan provided by Employer E. All 10 employees elect
$8,000 salary reduction for the major medical plan.
the cafeteria plans for purposes of nondis- tual operation if the duration of the plan
(ii) The cafeteria plan satisfies the section crimination testing. If two or more cafe- (or of a particular nontaxable benefit of-
125(g)(2) safe harbor for cafeteria plans provid- teria plans are aggregated into a combined fered through the plan) is for a period dur-
ing health benefits. plan for this purpose, the combined plan ing which only highly compensated partic-
(f) Safe harbor test for pre- must satisfy the nondiscrimination as to el- ipants utilize the plan (or the benefit). See
mium-only-plans—(1) In general. A igibility test in paragraph (b) of this section also the key employee concentration test in
premium-only-plan (as defined in para- and the nondiscrimination as to contribu- section 125(b)(2).
graph (a)(13) of this section) is deemed to tions and benefits test in paragraph (c) of (l) Anti-abuse rule—(1) Interpretation.
satisfy the nondiscrimination rules in sec- this section, as though the combined plan The provisions of this section must be in-
tion 125(c) and this section for a plan year were a single plan. Thus, for example, in terpreted in a reasonable manner consis-
if, for that plan year, the plan satisfies the order to satisfy the benefit availability and tent with the purpose of preventing dis-
safe harbor percentage test for eligibility benefit election requirements in paragraph crimination in favor of highly compen-
in paragraph (b)(3) of this section. (c)(2) of this section, the combined plan sated individuals, highly compensated par-
(2) Example. The following example must give each similarly situated partici- ticipants and key employees.
illustrates the rules in paragraph (f) of this pant a uniform opportunity to elect qual- (2) Change in plan testing procedures.
section: ified benefits and the actual election of
Example. Premium-only-plan. (i) Employer F’s
A plan will not be treated as satisfying the
qualified benefits by highly compensated requirements of this section if there are re-
cafeteria plan is a premium-only-plan (as defined in
paragraph (a)(13) of this section). The written cafe-
participants must not be disproportionate. peated changes to plan testing procedures
teria plan offers one employer-provided accident and However, if a principal purpose of the ag- or plan provisions that have the effect of
health plan and offers all employees the election to gregation is to manipulate the nondiscrimi- manipulating the nondiscrimination test-
salary reduce same amount or same percentage of nation testing requirements or to otherwise
the premium for self-only or family coverage. All
ing requirements of this section, if a princi-
discriminate in favor of highly compen- pal purpose of the changes was to achieve
key employees and all highly compensated employ-
ees elect salary reduction for the accident and health
sated individuals or participants, the plans this result.
plan, but only 20 percent of nonhighly compensated will not be permitted to be aggregated for (m) Tax treatment of benefits in a
employees elect the accident and health plan. nondiscrimination testing. cafeteria plan—(1) Nondiscriminatory

September 24, 2007 713 2007–39 I.R.B.

cafeteria plan. A participant in a nondis- Notice of Proposed hearing, Kelly Banks, (202) 622–7180
criminatory cafeteria plan (including a Rulemaking and Notice of (not toll-free numbers).
highly compensated participant or key Public Hearing
employee) who elects qualified benefits is SUPPLEMENTARY INFORMATION:
not treated as having received taxable ben-
efits offered through the plan, and thus the Medical and Accident Background
qualified benefits elected by the employee Insurance Benefits Under
This document contains proposed
are not includible in the employee’s gross Qualified Plans amendments to 26 CFR part 1 under
income merely because of the availability
section 402(a) of the Code, as well as con-
of taxable benefits. But see paragraph (j) REG–148393–06
forming amendments under sections 72,
in §1.125–1 on nondiscrimination rules
AGENCY: Internal Revenue Service 105, 106, 401, 402(c), 403(a), and 403(b).
for sections 79(d), 105(h), 129(d), and
(IRS), Treasury. Section 104(a)(3) provides, in gen-
137(c)(2), and limitations on exclusion.
eral, that gross income does not include
(2) Discriminatory cafeteria plan. A
ACTION: Notice of proposed rulemaking amounts received through accident or
highly compensated participant or key
and notice of public hearing. health insurance (or through an arrange-
employee participating in a discrimina-
ment having the effect of accident or
tory cafeteria plan must include in gross SUMMARY: This document contains pro- health insurance) for personal injuries or
income (in the participant’s taxable year posed regulations under section 402(a) of sickness. This exclusion does not apply
within which ends the plan year with re- the Internal Revenue Code (Code) regard- to amounts attributable to (and not in ex-
spect to which an election was or could ing the tax treatment of payments by qual- cess of) deductions allowed under section
have been made) the value of the taxable ified plans for medical or accident insur- 213 for any prior taxable year, or to other
benefit with the greatest value that the ance. These regulations would affect ad- amounts received by an employee to the
employee could have elected to receive, ministrators of, participants in, and benefi- extent such amounts either are attributable
even if the employee elects to receive only ciaries of qualified retirement plans. This to contributions by the employer that were
the nontaxable benefits offered. document also provides notice of a public not includible in the gross income of the
(n) Employer contributions to employ- hearing on these proposed regulations. employee or are paid by the employer.
ees’ Health Savings Accounts. If an em-
Section 105(a) provides that, except as
ployer contributes to employees’ Health DATES: Written or electronic comments
otherwise provided, amounts received by
Savings Accounts (HSAs) through a cafe- must be received by November 19, 2007.
an employee through accident or health in-
teria plan (as defined in §54.4980G–5 Outlines of topics to be discussed at the
surance for personal injuries or sickness
of this chapter) those contributions are public hearing scheduled for December 6,
are included in gross income to the extent
subject to the nondiscrimination rules in 2007, at 10 a.m., must be received by
such amounts (1) are attributable to con-
section 125 and this section and are not November 15, 2007.
tributions by the employer which were not
subject to the comparability rules in sec-
ADDRESSES: Send submissions to: includible in the gross income of the em-
tion 4980G. See §§54.4980G–0 through
CC:PA:LPD:PR (REG–148393–06), ployee or (2) are paid by the employer.
54.4980G–5 of this chapter.
room 5203, Internal Revenue Ser- Section 105(b) generally provides that,
(o) Effective/applicability date. It is
vice, PO Box 7604, Ben Franklin Sta- except in the case of amounts attributable
proposed that these regulations apply on
tion, Washington, DC 20044. Submis- to deductions allowed under section 213
and after plan years beginning on or after
sions may be hand-delivered Monday for any prior taxable year, gross income
January 1, 2009.
through Friday between the hours of does not include amounts referred to in
Kevin M. Brown, 8 a.m. and 4 p.m. to CC:PA:LPD:PR section 105(a) if such amounts are paid,
Deputy Commissioner for (REG–148393–06), Courier’s Desk, In- directly or indirectly, to the taxpayer to re-
Services and Enforcement. ternal Revenue Service, 1111 Constitution imburse the taxpayer for expenses incurred
Avenue, NW, Washington, DC, or sent by the taxpayer for the medical care of the
(Filed by the Office of the Federal Register on August 3, taxpayer and his or her spouse or depen-
2007, 8:45 a.m., and published in the issue of the Federal electronically via the Federal eRulemak-
Register for August 6, 2007, 72 F.R. 43937) ing Portal at www.regulations.gov (IRS dents.
REG–148393–06). The public hearing Section 106 provides that the gross in-
will be held in the IRS Auditorium, Inter- come of an employee does not include em-
nal Revenue Service, 1111 Constitution ployer-provided coverage under an acci-
Avenue, NW, Washington, DC. dent or health plan. Section 1.106–1 pro-
vides that the gross income of an employee
FOR FURTHER INFORMATION does not include contributions that the em-
CONTACT: Concerning the proposed ployer makes to an accident or health plan
regulations, Pamela R. Kinard (202) for compensation (through insurance or a
622–6060; concerning submissions of separate trust or fund) for personal injuries
comments, the hearing, and/or to be placed or sickness to the employee or the em-
on the building access list to attend the ployee’s spouse or dependents.

2007–39 I.R.B. 714 September 24, 2007

 Section 7702B(a)(1) provides that, for ified plan is taxable under section 72 in the efits or benefits for sickness, accident, hos-
purposes of the Code, a qualified long- taxable year in which distributed. pitalization, or medical expenses (except
term care insurance contract is treated as Section 72(a) provides that, except for medical benefits described in section
an accident and health insurance contract. as otherwise provided, gross income in- 401(h)). See §1.401(a)–1(b)(1)(ii).
Section 213 generally allows a deduc- cludes any amount received as an annuity Section 1.401–1(b)(1)(ii) provides that
tion for expenses paid during the taxable (whether for a period certain or during one a profit-sharing plan within the meaning
year, not compensated for by insurance or or more lives) under an annuity, endow- of section 401(a) is primarily a plan of
otherwise, for medical care of the taxpayer, ment, or life insurance contract. Sections deferred compensation, but that amounts
his or her spouse, and dependents, to the 72(d) and (e) provide rules for determining allocated to the account of a participant
extent that the expenses exceed 7.5 percent the portion of any distribution that is not may be used to provide incidental life or
of the taxpayer’s adjusted gross income. includable in gross income as a recovery of accident or health insurance for the partic-
Section 213(d)(1) provides that the term a participant’s investment in the contract ipant and the participant’s family. Section
“medical care” includes amounts paid for (generally the amount of the unrecovered 1.401–1(b)(1)(iii) provides that a stock
insurance covering medical care (includ- after-tax employee contributions) under a bonus plan is a plan established and main-
ing eligible long-term care premiums with qualified employer retirement plan. tained by the employer to provide benefits
respect to qualified long-term care insur- Section 402(l), added by section 845(a) similar to those of a profit-sharing plan.
ance contracts). of the Pension Protection Act of 2006, Rev. Rul. 61–164, 1961–2 C.B. 99, see
Section 401(a) sets forth requirements Public Law 109–280 (120 Stat. 780) §601.601(d)(2) of this chapter, holds that a
for a trust forming part of a pension, profit- (PPA ’06), provides a limited exclusion profit-sharing plan does not violate the in-
sharing, or stock bonus plan to be qualified from gross income for distributions from cidental benefit rule in §1.401–1(b)(1)(ii)
under section 401(a). an eligible retirement plan used to pay merely because, in accordance with the
Section 401(h) provides that a pension health or long-term care insurance pre- terms of the plan, each participant’s ac-
or annuity plan may provide for the pay- miums of an eligible retired public safety count under the plan is charged with the
ment of benefits for sickness, accident, officer to the extent that the aggregate cost of health insurance for the participant
hospitalization, and medical expenses of amount of the distributions for the taxable under group hospitalization insurance for
retired employees, their spouses and their year is not in excess of the qualified health the employer’s employees, provided that
dependents only if certain enumerated insurance premiums of the retired public the total amount used for life or accident or
conditions are met. Those conditions safety officer and his or her spouse or de- health insurance for the employee and the
include: (1) the aggregate actual contri- pendents. The total amount excluded from employee’s family is incidental. The rul-
butions for medical benefits (when added gross income pursuant to section 402(l) ing concludes that such insurance is treated
to actual contributions for life insurance shall not exceed $3,000. as incidental if the amount expended does
protection under the plan) may not exceed Section 1.72–15 provides rules relating not exceed 25 percent of the funds allo-
25 percent of the total actual contributions to the tax treatment of amounts paid from cated to a participant’s account that have
to the plan (other than contributions to an employer-established plan to which not been accumulated for the period pre-
fund past service credits) after the date section 72 applies and which provides for scribed by the plan for the deferment of
on which the account is established; (2) distributions of accident or health ben- distributions. The ruling also concludes
a separate account must be established efits. With respect to benefits that are that the use of profit-sharing plan funds to
and maintained for such benefits; (3) the attributable to employer contributions, pay for medical insurance for a participant
employer’s contributions to the separate §1.72–15(d) provides that any amount and his or her beneficiary is a distribution
account must be reasonable and ascertain- received as an accident or health bene- within the meaning of section 402.
able; (4) it must be impossible, at any time fit is includible in gross income, except Rev. Rul. 73–501, 1973–2 C.B. 127,
prior to the satisfaction of all liabilities un- to the extent excludable from gross in- see §601.601(d)(2) of this chapter, applies
der the plan to provide such benefits, for come under section 105(b) (relating to the incidental benefit rule to the purchase
any part of the corpus or income of such reimbursements of medical care expenses of life insurance by a profit-sharing plan.
separate account to be (within the taxable as defined in section 213(d)).1 Section The ruling states that “[u]nder a qualified
year or thereafter) used for, or diverted to, 1.72–15(e) provides that the taxability of profit-sharing plan, the use of trust funds
any purpose other than the providing of benefits that are not accident or health to pay the cost of life, accident, or health
such benefits; (5) any amount remaining benefits is determined under section 72 insurance for an employee is a distribution
after satisfaction of all liabilities must, without regard to any exclusion under within the purview of section 402 of the
under the terms of the plan, be returned to section 104 or 105. Code.”
the employer; and (6) special limitations Section 1.401–1(b)(1)(i) provides that a Rev. Rul. 2003–62, 2003–1 C.B. 1034,
for the accounts of key employees must be plan is not a pension plan within the mean- see §601.601(d)(2) of this chapter, con-
satisfied. ing of section 401(a) if it provides for the cludes that amounts distributed from a
Section 402(a) provides, in general, that payment of benefits not customarily in- qualified retirement plan that the distribu-
any amount actually distributed by a qual- cluded in a pension plan such as layoff ben- tee elects to have applied to pay health

1 Section 1.72–15(d) also refers to benefits excludible under section 105(c) (relating to certain payments unrelated to absence from work) or 105(d), which was repealed in 1983 (and which
related to certain disability payments).

September 24, 2007 715 2007–39 I.R.B.

insurance premiums under a cafeteria plan sonal injuries or sickness are excludable added by PPA ’06, permits an exclusion
are includible in the distributee’s gross from gross income under section 104(a)(3) from gross income, up to $3,000 annually,
income. The ruling also holds that the and are not treated as distributions from the for distributions paid directly to an insurer
same conclusion applies where amounts plan. to purchase accident or health insurance
distributed from the plan are applied di- A related issue is whether the purchase or qualified long-term care insurance for
rectly to reimburse medical care expenses of accident and health insurance can be an eligible retired public safety officer
incurred by a participant. treated as if the trust merely purchased an and his or her spouse or dependents. The
Rev. Rul. 2005–55, 2005–2 C.B. 284, investment under which an insurer’s pay- existence of narrow exceptions for retiree
see §601.601(d)(2) of this chapter, holds ments for medical expenses are made to medical benefits under section 401(h) and
that a profit-sharing plan that provides the trust and then treated as a return on for distributions for the payment of pre-
a sub-account which permits distribu- that investment. The proposed regulations miums on behalf of eligible retired public
tions only for the purpose of reimbursing would clarify that payments from accident safety officers under section 402(l) is con-
the participant for substantiated medical or health insurance for medical expenses sistent with a general rule for inclusion in
expenses imposes conditions on the en- that are made to the trust (rather than made gross income of the payments of premi-
titlement of the participant to amounts to the medical service provider or the par- ums for accident and health insurance.
held in the sub-account and, as a result of ticipant as reimbursement for covered ex- Section 402(a) provides that amounts
the conditions, does not meet the nonfor- penses) are treated as having been made to actually distributed from a qualified plan
feitability requirements of section 411. the participant and then contributed by the are generally taxable to the distributee
participant to the plan. Comments are re- in the year of the distribution. There is
Explanation of Provisions quested on whether there should be limited no general exception in section 402 for
exceptions to this general rule (such as an a distribution in the form of accident or
The proposed regulations would clarify
exception for a provision that has the ef- health insurance.3 Moreover, Congress
that a payment from a qualified plan for an
fect of a waiver of premium in the case of has carefully prescribed and strictly lim-
accident or health insurance premium gen-
disability). ited the ability to pre-fund accident and
erally constitutes a distribution under sec-
The proposed regulations would health insurance benefits on a tax-favored
tion 402(a) that is taxable to the distribu-
not alter the incidental benefit rule of basis. The rules specifically prescribed
tee under section 72 in the taxable year in
§1.401–1(b)(1)(ii) (which provides that a by Congress relating to the pre-funding
which the premium is paid. The taxable
profit-sharing plan may provide incidental of future health benefits on a tax-favored
amount generally equals the amount of the
life or accident or health insurance for the basis include the rules in section 223
premium charged against the participant’s
participant and the participant’s family) (providing contribution limits and distri-
benefits under the plan. If a defined con-
nor would they alter the tax treatment of bution rules for health savings accounts
tribution plan pays these premiums from a
the payment of life insurance. For the tax (HSAs)); sections 419 and 419A (limiting
current year contribution or forfeiture that
treatment of payments for life insurance, employer deductions for contributions to
has not been allocated to a participant’s ac-
see section 72(m)(3) and §1.72–16. welfare benefit funds); section 501(c)(9)
count, then the amount of the premium for
The general rule that accident and (providing requirements for tax-exempt
each participant will be treated as first be-
health insurance premiums are taxable Voluntary Employee Beneficiary Associ-
ing allocated to the participant and then
distributions would not apply to amounts ations (VEBAs)); section 512 (providing
charged against the participant’s benefits
held under a medical account that satisfies for the taxation of a VEBA’s unrelated
under the plan, so that the amount of the
all the requirements of section 401(h). business income); and by sections 401(h)
distribution is the same as determined un-
Accident or health insurance purchased and 420 (governing retiree health benefits
der the preceding sentence.
through a section 401(h) account does provided through a separate health ben-
These regulations would also provide
not constitute a taxable distribution. See efits account that is part of a pension or
that a distribution for the payment of the
§1.72–15(h), providing that employer annuity plan). Therefore, because Con-
premiums by a qualified plan generally is
contributions to provide medical benefits gress specifically prescribed these limited
not excluded from gross income under sec-
in a section 401(h) account under a qual- provisions for favorable tax-treatment, a
tion 104, 105, or 106, but such distribution
ified plan or annuity are not includible broad exclusion permitting tax-favored
would constitute an amount paid for acci-
in the gross income of the employee on treatment of any distribution used to pay
dent or health insurance under section 213.
whose behalf contributions were made.2 accident or health insurance premiums
Furthermore, to the extent that the payment
The result is the same if the section 401(h) would be inconsistent with this intentional
of premiums for accident or health insur-
account is funded with a transfer from a statutory scheme.
ance has been treated as a distribution from
qualified pension plan in accordance with In addition, the existence of the inciden-
a qualified plan, amounts received through
section 420. Similarly, section 402(l), as tal benefit rule in §1.401–1(b)(1)(ii) is not
the accident or health insurance for per-
th
2 See also H.R. Rep. No. 2317, 87 Cong., 2 nd
Sess. at 4 (1962), stating that no part of the contributions paid by the employer to a section 401(h) account will be taxed currently to the
employee.
3 See, for example, the Joint Committee on Taxation’s Technical Explanation, Technical Explanation of H.R. 4, the “Pension Protection Act of 2006” as passed by the House on July 28, 2006,
th nd
and Considered by the Senate on August 3, 2006 (JCX–38–06), August 3, 2006, 109 Cong., 2 Sess. 244 (2006), relating to the exception under section 402(l), which states that, under
present law, distributions from a qualified plan are generally included in gross income (subject to exceptions for investment in the contract and qualified distributions from a designated Roth
account).

2007–39 I.R.B. 716 September 24, 2007

an indication that distributions used to pro- regulatory action as defined in Executive deadline for receiving outlines has passed.
vide incidental life or accident or health in- Order 12866. Therefore, a regulatory as- Copies of the agenda will be available free
surance benefits are eligible for tax-favor- sessment is not required. It also has been of charge at the hearing.
able treatment because the incidental bene- determined that section 553(b) of the Ad-
fit rule relates solely to the qualification of ministrative Procedure Act (5 U.S.C. chap- Drafting Information
a profit-sharing plan, not to the tax treat- ter 5) does not apply to these regulations,
ment of amounts used to provide medical and because these regulations do not im- The principal authors of these reg-
or accident insurance benefits under such pose a collection of information on small ulations are Pamela R. Kinard and
plan. entities, the Regulatory Flexibility Act (5 Michael P. Brewer, Office of Division
The proposed regulations also contain U.S.C. chapter 6) does not apply. Pursuant Counsel/Associate Chief Counsel (Tax
conforming amendments to the Income to section 7805(f) of the Code, this pro- Exempt and Government Entities). How-
Tax Regulations under sections 72, 105, posed regulation has been submitted to the ever, other personnel from the IRS and the
106, 401, and 402(c). These conforming Chief Counsel for Advocacy of the Small Treasury Department participated in their
amendments would remove obsolete pro- Business Administration for comment on development.
visions, as well as cite to the rules in these its impact on small business. *****
proposed regulations for determining the
tax treatment of the payment of premiums Comments and Public Hearing Proposed Amendments to the
for accident and health insurance from a Regulations
qualified plan. Conforming amendments Before these proposed regulations are
under sections 403(a) and 403(b) would adopted as final regulations, consideration Accordingly, 26 CFR part 1 is proposed
also add a cross-reference to the regu- will be given to any written (a signed origi- to be amended as follows:
lations under section 403(a) and section nal and eight (8) copies) or electronic com-
403(b) that would apply the rules in these ments that are submitted timely to the IRS. PART—INCOME TAXES
proposed regulations to those arrange- The Treasury Department and the IRS re-
ments. In addition, the proposed regula- quest comments on the clarity of the pro- Paragraph 1. The authority citation for
tions would revise the first sentence of posed rules and how they may be made part 1 continues to read in part as follows:
§1.106–1 in order to update the definition easier to understand. All comments will be Authority: 26 U.S.C. 7805 * * *
of dependent in light of section 207 of the available for public inspection and copy- Par. 2. Section 1.72–15 is amended by:
Working Families Tax Relief Act of 2004, ing. 1. Revising paragraphs (d), (h), and (i).
Pub. L. No. 108–311 (118 Stat. 1166) A public hearing has been scheduled for 2. Removing paragraph (f).
and Notice 2004–79, 2004–2 C.B. 898, December 6, 2007, beginning at 10 a.m. in The revisions read as follows:
see §601.601(d)(2). The proposed reg- the Auditorium, Internal Revenue Service,
§1.72–15 Applicability of section 72 to
ulations would also amend §1.402(c)–2, 1111 Constitution Avenue, N.W., Wash-
accident or health plans.
Q&A–4 to add distributions of premiums ington, DC. Due to building security pro-
for accident or health insurance under cedures, visitors must enter at the Consti-
*****
§1.402(a)–1(e)(1) to the list of items that tution Avenue entrance. In addition, all
(d) Accident or health benefits attrib-
are not eligible rollover contributions. Fi- visitors must present photo identification
utable to employer contributions. Any
nally, these proposed regulations would to enter the building. Because of access
amounts received as accident or health
also include a cross-reference to section restrictions, visitors will not be admitted
benefits and not attributable to contri-
402(l), as added by PPA ’06. For ad- beyond the immediate entrance area more
butions of the employee are includible in
ditional guidance on section 402(l), see than 30 minutes before the hearing starts.
gross income except to the extent that such
Notice 2007–7, 2007–5 I.R.B 395, see For information about having your name
amounts are excludable from gross income
§601.601(d)(2). placed on the building access list to attend
under section 105(b) or (c) and the regu-
the hearing, see the “FOR FURTHER IN-
Proposed Effective Date lations thereunder. See §1.402(a)–1(e) for
FORMATION CONTACT” section of this
rules relating to the use of a qualified plan
preamble.
It is expected that the regulations will under section 401(a) to pay premiums for
The rules of 26 CFR 601.601(a)(3) ap-
apply for calendar years after the publi- accident or health insurance.
ply to the hearing. Persons who wish to
cation of final regulations in the Federal
present oral comments at the hearing must *****
Register. However, no inference should
submit written or electronic comments by (h) Medical benefits for retired employ-
be drawn that the payment of premiums
November 19, 2007, and an outline of the ees, etc. See §1.402(a)–1(e)(2) for rules
from a qualified plan does not constitute
topics to be discussed and the amount of relating to the payment of medical benefits
a taxable distribution if made prior to the
time to be devoted to each topic (a signed described in section 401(h) under a quali-
effective date of these regulations.
original and eight (8) copies) by Novem- fied pension or annuity plan.
Special Analyses ber 15, 2007. A period of 10 minutes will (i) Special rules—(1) In general. For
be allotted to each person for making com- purposes of section 72(b) and (d), and this
It has been determined that this notice ments. An agenda showing the scheduling section, the taxpayer shall maintain such
of proposed rulemaking is not a significant of the speakers will be prepared after the records as are necessary to substantiate the

September 24, 2007 717 2007–39 I.R.B.

amount treated as an investment in the tax- graph (a)(1)(ii) and adding a new sentence section 104(a)(3) and are not treated as
payer’s annuity contract. in their place and by adding a new para- distributions from the plan. If amounts
(2) Delegation to Commissioner. The graph (e) to read as follows: received through accident or health in-
Commissioner may prescribe a form and surance are paid to the plan instead of
instructions with respect to the taxpayer’s §1.402(a)–1 Taxability of beneficiary the employee, these amounts are treated
past and current treatment of amounts re- under a trust which meets the requirements as having been paid to the employee and
ceived under section 72 or 105, and the tax- of section 401(a). then contributed by the employee to the
payer’s computation, or recomputation, of plan (and these amounts must satisfy the
(a) * * * (1)(i) * * *
the taxpayer’s investment in his or her an- qualification requirements applicable to
(ii) * * * Paragraph (e) of this section
nuity contract. This form may be required employee contributions).
provides rules relating to use of a qualified
to be filed with the taxpayer’s returns for (2) Medical benefits for retired employ-
pension, annuity, profit-sharing, or stock
years in which such amounts are excluded ees provided under an account described
bonus plan to provide accident or health
under section 72 or 105. in section 401(h). The payment of medi-
benefits or coverage otherwise described
cal benefits described in section 401(h) un-
§1.105–4 [Removed] in section 104, 105, or 106.
der a pension or annuity plan is treated in
***** the same manner as a payment of accident
Par. 3. Section 1.105–4 is removed. (e) Medical, accident, etc., benefits or health benefits attributable to employer
paid from a qualified pension, annuity, contributions, or employer-provided cov-
§1.105–6 [Removed]
profit-sharing, or stock bonus plan—(1) erage under an accident or health plan. See
Par. 4. Section 1.105–6 is removed. Payment of premiums—(i) General rule. §1.401–14(a) for the definition of medi-
Par. 5. Section 1.106–1 is amended The payment of premiums from a quali- cal benefits described in section 401(h).
by revising the first sentence and adding fied trust for accident or health insurance, Accordingly, amounts applied for the pay-
a new sentence at the end of the paragraph including a qualified long-term care insur- ment of accident or health benefits, or for
to read as follows: ance contract under section 7702B, con- the payment of accident or health cover-
stitutes a distribution under section 402(a) age, from a section 401(h) account are not
§1.106–1 Contributions by employer to to the participant against whose benefit includible in the gross income of the par-
accident and health plans. the premium is charged. The amount of ticipant on whose behalf such contribu-
the distribution equals the amount of the tions are made to the extent they are ex-
The gross income of an employee does premium charged against the participant’s cludible from gross income under section
not include the contributions which the benefits under the plan. If a defined con- 104, 105, or 106.
employer makes to an accident or health tribution plan pays these premiums from a (3) Distributions to eligible retired pub-
plan for compensation (through insurance current year contribution or forfeiture that lic safety officers. See section 402(l) for
or otherwise) to the employee for personal has not been allocated to a participant’s a limited exclusion from gross income for
injuries or sickness incurred by the em- account, then the amount of the premium distributions used to pay for certain acci-
ployee, the employee’s spouse, or the em- for each participant will be treated as first dent or health premiums (including premi-
ployee’s dependents (as defined in section being allocated to the participant and then ums for qualified long-term care insurance
152 determined without regard to section charged against the participant’s benefits contracts). This limited exclusion applies
152(b)(1), (b)(2), or (d)(1)(B)). under the plan, so that the amount of the to eligible retired public safety officers, as
*** distribution is treated in the same manner defined in section 402(l)(4)(B).
For the treatment of the payment of as determined under the preceding sen- (4) Effect of making a distribution of in-
premiums for accident or health insurance tence. Except as described in paragraphs surance premiums on qualification. See
from a qualified trust under section 401(a), (e)(2) and (3) of this section, a distribution §1.401–1(b)(1) for rules concerning the
see §§1.72–15 and 1.402(a)–1(e). described in this paragraph (e)(1) is not types and amount of medical coverage and
Par. 6. Section 1.401–1 is amended excludable from gross income. benefits that are permitted to be provided
by adding a new sentence at the end of (ii) Treatment of amounts received under a plan that is part of a trust de-
paragraph (b)(1)(ii) to read as follows: through accident or health insurance. scribed in section 401(a). For example,
To the extent that the premium for ac- §1.401–1(b)(1)(ii) provides that a profit-
§1.401–1 Qualified pension, cident or health insurance constitutes a sharing plan is primarily a plan of de-
profit-sharing, and stock bonus plans. distribution under this paragraph (e)(1), ferred compensation, but the amounts al-
amounts received through accident or located to the account of a participant may
***** health insurance are neither attributable be used to provide incidental accident or
(b) * * * (1)(i) * * * to contributions by the employer which health insurance for the participant and
(ii) * * * See §§1.72–15, 1.72–16, and are not includible in the gross income of the participant’s family. See also, section
1.402(a)–1(e) for rules regarding the tax the employee nor are such amounts paid 401(k)(2)(B) for certain restrictions on the
treatment of incidental life or accident or by the employer. Accordingly, amounts distribution of elective contributions.
health insurance. received through the accident or health (5) Application of this paragraph (e).
Par. 7. Section 1.402(a)–1 is amended insurance for personal injuries or sickness This paragraph (e) applies to the payment
by removing the last two sentences of para- are excludable from gross income under of premiums charged against the benefits

2007–39 I.R.B. 718 September 24, 2007

of a beneficiary or an alternate payee in Par. 10. Section 1.403(b)–6 is amended SUPPLEMENTARY INFORMATION: A
the same manner as the payment of premi- by adding a sentence following the first notice of proposed rulemaking and notice
ums charged against the account of a par- sentence of paragraph (g) to read as fol- of public hearing that appeared in the Fed-
ticipant. lows: eral Register on Friday, June 1, 2007 (72
(6) Example. The provisions of this FR 30501), announced that a public hear-
paragraph (e) are illustrated by the follow- §1.403(b)–6 Timing of distributions and ing was scheduled for September 28, 2007,
ing example: benefits. at 10 a.m. in the IRS Auditorium, Internal
Example. (i) Facts. Employer sponsors a profit- Revenue Service, 1111 Constitution Av-
sharing plan qualified under section 401(a). The plan * * * * * (g) Death benefits and other enue, NW, Washington, DC. The subject of
provides solely for non-elective employer profit-shar- incidental benefits. * * * The rules of
ing contributions. The plan’s trustee enters into a
the public hearing is under section 4980G
§1.402(a)–1(e) apply for purposes of de- of the Internal Revenue Code.
contract with a third-party insurance carrier to pro-
vide health insurance for certain plan participants.
termining when incidental benefits are The public comment period for these
The insurance policy provides for the payment of treated as distributed and included in gross regulations expired on August 30, 2007.
medical expenses incurred by those participants. The income. See §§1.72–15 and 1.72–16. The notice of proposed rulemaking and no-
plan limits the amounts used to provide medical ben- ***
efits with respect to a participant to 25 percent of the
tice of public hearing instructed those in-
funds held in the participant’s account. The trustee ***** terested in testifying at the public hearing
makes monthly payments of $1,000 to pay the pre- to submit a request to speak and an out-
miums due for Participant A’s health insurance. The Linda E. Stiff, line of the topics to be addressed by August
trustee also reduces Participant A’s account balance Acting Deputy Commissioner 28, 2007. As of September 6, 2007, no
by $1,000 at the time of each premium payment. In
June of a year, Participant A is admitted to the hospi-
for Services and Enforcement. one has requested to speak and therefore,
tal for covered medical care, and in July of the same the public hearing scheduled for Septem-
(Filed by the Office of the Federal Register on August 10,
year, the health insurer pays the hospital $5,000 for 2007, 8:45 a.m., and published in the issue of the Federal ber 28, 2007, is cancelled.
the medical care provided to Participant A in June. Register for August 20, 2007, 72 F.R. 46421)
(ii) Conclusion. Under paragraph (e)(1) of this LaNita Van Dyke,
section, each of the trustee’s payments of $1,000 con- Branch Chief,
stitutes a distribution under section 402(a) to Partic-
Employer Comparable Publications and Regulations Branch,
ipant A on the date of each payment. To the extent
Legal Processing Division,
provided under section 213, the amount of these dis- Contributions to Health
tributions constitutes payments for medical care. The Associate Chief Counsel
$5,000 payment to the hospital is excludable from Savings Accounts Under (Procedure and Administration).
Participant A’s gross income under section 104(a)(3) Section 4980G; Hearing
and is not treated as a distribution from the plan. (Filed by the Office of the Federal Register on September
Cancellation 12, 2007, 8:45 a.m., and published in the issue of the Federal
Par. 8. Section 1.402(c)–2 is amended Register for September 13, 2007, 72 F.R. 52319)
by redesignating paragraphs A–4(g) and
Announcement 2007–85
A–4(h) as paragraphs A–4(h) and A–4(i)
and adding a new paragraph A–4(g) to read AGENCY: Internal Revenue Service Deletions From Cumulative
as follows: (IRS), Treasury. List of Organizations
§1.402(c)–2 Eligible rollover Contributions to Which
ACTION: Cancellation of notice of public
contributions; questions and answers. hearing on proposed rulemaking.
are Deductible Under Section
170 of the Code
***** SUMMARY: This document cancels a
A–4: * * * public hearing on proposed regulations Announcement 2007–86
(g) Distributions of premiums for (REG–143797–06, 2007–26 I.R.B. 1495)
accident or health insurance under providing guidance on employer com- The names of organizations that no
§1.402(a)–1(e). parable contributions to Health Savings longer qualify as organizations described
***** Accounts (HSAs). in section 170(c)(2) of the Internal Rev-
Par. 9. Section 1.403(a)–1 is amended enue Code of 1986 are listed below.
by revising paragraph (g) to read as fol- DATES: The public hearing, originally Generally, the Service will not disallow
lows: scheduled for September 28, 2007 at deductions for contributions made to a
10 a.m. is cancelled. listed organization on or before the date
§1.403(a)–1 Taxability of beneficiary of announcement in the Internal Revenue
under a qualified annuity plan. FOR FURTHER INFORMATION Bulletin that an organization no longer
CONTACT: Kelly Banks of the Publi- qualifies. However, the Service is not
***** cations and Regulations Branch, Legal precluded from disallowing a deduction
(g) The rules of §1.402(a)–1(e) apply Processing Division, Associate Chief for any contributions made after an or-
for purposes of determining the treatment Counsel (Procedure and Administration) ganization ceases to qualify under section
of amounts paid to provide accident and at (202) 622–0392 (not a toll-free num- 170(c)(2) if the organization has not timely
health insurance benefits. ber). filed a suit for declaratory judgment under

September 24, 2007 719 2007–39 I.R.B.

section 7428 and if the contributor (1) had ticularly set forth in section 7428(c)(1). Creativity Innovation
knowledge of the revocation of the ruling For individual contributors, the maximum Productivity Incorporated DBA
or determination letter, (2) was aware that deduction protected is $1,000, with a hus- Horizon Event Foundation
such revocation was imminent, or (3) was band and wife treated as one contributor. Highwood, MT
in part responsible for or was aware of the This benefit is not extended to any indi- Community Fellowship for Battered
activities or omissions of the organization vidual, in whole or in part, for the acts or Women of Silicon Valley, Inc.
that brought about this revocation. omissions of the organization that were the San Jose, CA
If on the other hand a suit for declara- basis for revocation. Alta Crossing, Inc.
tory judgment has been timely filed, con- Nampa, ID
tributions from individuals and organiza- Museum of American Piano Home Buyers Assistance Foundation, Inc.
tions described in section 170(c)(2) that Bangor, PA Denver, CO
are otherwise allowable will continue to Transitional Living Collaborative International Housing Solutions, Inc.
be deductible. Protection under section Moraga, CA Sacramento, CA
7428(c) would begin on September 24, Ken-Ray, Incorporated Filipino American Community
2007, and would end on the date the court Orem, UT Development Council, Inc.
first determines that the organization is not DreamHome Foundation San Jose, CA
described in section 170(c)(2) as more par- Sherwood, OR

2007–39 I.R.B. 720 September 24, 2007

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

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

September 24, 2007 i 2007–39 I.R.B.

Numerical Finding List1 Proposed Regulations— Continued: Revenue Rulings— Continued:
REG-149036-04, 2007-34 I.R.B. 411 2007-57, 2007-36 I.R.B. 531
Bulletins 2007–27 through 2007–39 REG-101001-05, 2007-36 I.R.B. 548 2007-58, 2007-37 I.R.B. 562
REG-119097-05, 2007-28 I.R.B. 74 2007-59, 2007-37 I.R.B. 582
Announcements:
REG-128843-05, 2007-37 I.R.B. 587 2007-60, 2007-38 I.R.B. 606
2007-61, 2007-28 I.R.B. 84 REG-142695-05, 2007-39 I.R.B. 681
Tax Conventions:
2007-62, 2007-29 I.R.B. 115 REG-147171-05, 2007-32 I.R.B. 334
2007-63, 2007-30 I.R.B. 236 REG-148951-05, 2007-36 I.R.B. 550 2007-75, 2007-36 I.R.B. 540
2007-64, 2007-29 I.R.B. 125 REG-163195-05, 2007-33 I.R.B. 366
Treasury Decisions:
2007-65, 2007-30 I.R.B. 236 REG-118886-06, 2007-37 I.R.B. 591
2007-66, 2007-31 I.R.B. 296 REG-128224-06, 2007-36 I.R.B. 551 9326, 2007-31 I.R.B. 242
2007-67, 2007-32 I.R.B. 345 REG-138707-06, 2007-32 I.R.B. 342 9327, 2007-28 I.R.B. 50
2007-68, 2007-32 I.R.B. 348 REG-139268-06, 2007-34 I.R.B. 415 9328, 2007-27 I.R.B. 1
2007-69, 2007-33 I.R.B. 371 REG-142039-06, 2007-34 I.R.B. 415 9329, 2007-32 I.R.B. 312
2007-70, 2007-33 I.R.B. 371 REG-144540-06, 2007-31 I.R.B. 296 9330, 2007-31 I.R.B. 239
2007-71, 2007-33 I.R.B. 372 REG-148393-06, 2007-39 I.R.B. 714 9331, 2007-32 I.R.B. 298
2007-72, 2007-33 I.R.B. 373 REG-103842-07, 2007-28 I.R.B. 79 9332, 2007-32 I.R.B. 300
2007-73, 2007-34 I.R.B. 435 REG-116215-07, 2007-38 I.R.B. 659 9333, 2007-33 I.R.B. 350
2007-74, 2007-35 I.R.B. 483 REG-118719-07, 2007-37 I.R.B. 593 9334, 2007-34 I.R.B. 382
2007-75, 2007-36 I.R.B. 540 9335, 2007-34 I.R.B. 380
Revenue Procedures:
2007-76, 2007-36 I.R.B. 560 9336, 2007-35 I.R.B. 461
2007-77, 2007-38 I.R.B. 662 2007-42, 2007-27 I.R.B. 15 9337, 2007-35 I.R.B. 455
2007-78, 2007-38 I.R.B. 663 2007-43, 2007-27 I.R.B. 26 9338, 2007-35 I.R.B. 463
2007-80, 2007-38 I.R.B. 667 2007-44, 2007-28 I.R.B. 54 9339, 2007-35 I.R.B. 437
2007-81, 2007-38 I.R.B. 667 2007-45, 2007-29 I.R.B. 89 9340, 2007-36 I.R.B. 487
2007-85, 2007-39 I.R.B. 719 2007-46, 2007-29 I.R.B. 102 9341, 2007-35 I.R.B. 449
2007-86, 2007-39 I.R.B. 719 2007-47, 2007-29 I.R.B. 108 9342, 2007-35 I.R.B. 451
Notices: 2007-48, 2007-29 I.R.B. 110 9343, 2007-36 I.R.B. 533
2007-49, 2007-30 I.R.B. 141 9344, 2007-36 I.R.B. 535
2007-54, 2007-27 I.R.B. 12 2007-50, 2007-31 I.R.B. 244 9345, 2007-36 I.R.B. 523
2007-55, 2007-27 I.R.B. 13 2007-51, 2007-30 I.R.B. 143 9346, 2007-37 I.R.B. 570
2007-56, 2007-27 I.R.B. 15 2007-52, 2007-30 I.R.B. 222 9347, 2007-38 I.R.B. 624
2007-57, 2007-29 I.R.B. 87 2007-53, 2007-30 I.R.B. 233 9348, 2007-37 I.R.B. 563
2007-58, 2007-29 I.R.B. 88 2007-54, 2007-31 I.R.B. 293 9349, 2007-39 I.R.B. 668
2007-59, 2007-30 I.R.B. 135 2007-55, 2007-33 I.R.B. 354 9350, 2007-38 I.R.B. 607
2007-60, 2007-35 I.R.B. 466 2007-56, 2007-34 I.R.B. 388 9351, 2007-38 I.R.B. 616
2007-61, 2007-30 I.R.B. 140 2007-57, 2007-36 I.R.B. 547 9352, 2007-38 I.R.B. 621
2007-62, 2007-32 I.R.B. 331 2007-58, 2007-37 I.R.B. 585 9355, 2007-37 I.R.B. 577
2007-63, 2007-33 I.R.B. 353 2007-60, 2007-39 I.R.B. 679 9356, 2007-39 I.R.B. 675
2007-64, 2007-34 I.R.B. 385
Revenue Rulings:
2007-65, 2007-34 I.R.B. 386
2007-66, 2007-34 I.R.B. 387 2007-42, 2007-28 I.R.B. 44
2007-67, 2007-35 I.R.B. 467 2007-43, 2007-28 I.R.B. 45
2007-68, 2007-35 I.R.B. 468 2007-44, 2007-28 I.R.B. 47
2007-69, 2007-35 I.R.B. 468 2007-45, 2007-28 I.R.B. 49
2007-71, 2007-35 I.R.B. 472 2007-46, 2007-30 I.R.B. 126
2007-72, 2007-36 I.R.B. 544 2007-47, 2007-30 I.R.B. 127
2007-73, 2007-36 I.R.B. 545 2007-48, 2007-30 I.R.B. 129
2007-74, 2007-37 I.R.B. 585 2007-49, 2007-31 I.R.B. 237
2007-75, 2007-39 I.R.B. 679 2007-50, 2007-32 I.R.B. 311
2007-51, 2007-37 I.R.B. 573
Proposed Regulations:
2007-52, 2007-37 I.R.B. 575
REG-121475-03, 2007-35 I.R.B. 474 2007-53, 2007-37 I.R.B. 577
REG-128274-03, 2007-33 I.R.B. 356 2007-54, 2007-38 I.R.B. 604
REG-114084-04, 2007-33 I.R.B. 359 2007-55, 2007-38 I.R.B. 604
REG-149036-04, 2007-33 I.R.B. 365 2007-56, 2007-39 I.R.B. 668

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2007–1 through 2007–26 is in Internal Revenue Bulletin
2007–26, dated June 25, 2007.

2007–39 I.R.B. ii September 24, 2007

Finding List of Current Actions on Proposed Regulations— Continued: Revenue Procedures— Continued:
Previously Published Items1 REG-117162-99 2006-27
Withdrawn by Modified by
Bulletins 2007–27 through 2007–39
REG-142695-05, 2007-39 I.R.B. 681 Rev. Proc. 2007-49, 2007-30 I.R.B. 141
Announcements:
REG-157711-02 2006-33
84-26 Corrected by Superseded by
Obsoleted by Ann. 2007-74, 2007-35 I.R.B. 483 Rev. Proc. 2007-51, 2007-30 I.R.B. 143
T.D. 9336, 2007-35 I.R.B. 461 REG-119097-05 2006-53
84-37 Hearing location change by Modified by
Obsoleted by Ann. 2007-81, 2007-38 I.R.B. 667 Rev. Proc. 2007-60, 2007-39 I.R.B. 679
T.D. 9336, 2007-35 I.R.B. 461 REG-109367-06 2006-55
Notices: Hearing scheduled by Superseded by
Ann. 2007-66, 2007-31 I.R.B. 296 Rev. Proc. 2007-43, 2007-27 I.R.B. 26
89-110
REG-143601-06 2007-4
Modified by
Corrected by Modified by
REG-142695-05, 2007-39 I.R.B. 681
Ann. 2007-71, 2007-33 I.R.B. 372 Notice 2007-69, 2007-35 I.R.B. 468
99-6
REG-143797-06 2007-15
Obsoleted as of January 1, 2009 by
Cancellation of hearing by Superseded by
T.D. 9356, 2007-39 I.R.B. 675
Ann. 2007-85, 2007-39 I.R.B. 719 Rev. Proc. 2007-50, 2007-31 I.R.B. 244
2002-45
REG-103842-07 Revenue Rulings:
Modified by
Corrected by
REG-142695-05, 2007-39 I.R.B. 681 54-378
Ann. 2007-77, 2007-38 I.R.B. 662
2003-81 Clarified by
Revenue Procedures: Rev. Rul. 2007-51, 2007-37 I.R.B. 573
Modified and supplemented by
Notice 2007-71, 2007-35 I.R.B. 472 90-27 67-93
2006-43 Superseded by Obsoleted by
Modified by Rev. Proc. 2007-52, 2007-30 I.R.B. 222 T.D. 9347, 2007-38 I.R.B. 624
T.D. 9332, 2007-32 I.R.B. 300 95-28 69-141
2006-56 Superseded by Modified by
Clarified by Rev. Proc. 2007-54, 2007-31 I.R.B. 293 REG-142695-05, 2007-39 I.R.B. 681
Notice 2007-74, 2007-37 I.R.B. 585 97-14 74-299
2006-89 Modified and superseded by Amplified by
Modified by Rev. Proc. 2007-47, 2007-29 I.R.B. 108 Rev. Rul. 2007-48, 2007-30 I.R.B. 129
Notice 2007-67, 2007-35 I.R.B. 467 2002-9 75-425
2007-3 Modified and amplified by Obsoleted by
Modified by Rev. Proc. 2007-48, 2007-29 I.R.B. 110 Rev. Rul. 2007-60, 2007-38 I.R.B. 606
Notice 2007-69, 2007-35 I.R.B. 468 Rev. Proc. 2007-53, 2007-30 I.R.B. 233
76-450
2007-26 2004-42 Obsoleted by
Modified by Superseded by T.D. 9347, 2007-38 I.R.B. 624
Notice 2007-56, 2007-27 I.R.B. 15 Notice 2007-59, 2007-30 I.R.B. 135
78-257
2005-16 Obsoleted by
Proposed Regulations:
Modified by T.D. 9347, 2007-38 I.R.B. 624
EE-16-79 Rev. Proc. 2007-44, 2007-28 I.R.B. 54
78-369
Withdrawn by 2005-27 Revoked by
REG-142695-05, 2007-39 I.R.B. 681 Superseded by Rev. Rul. 2007-53, 2007-37 I.R.B. 577
EE-130-86 Rev. Proc. 2007-56, 2007-34 I.R.B. 388
89-96
Withdrawn by 2005-66 Amplified by
REG-142695-05, 2007-39 I.R.B. 681 Clarified, modified, and superseded by Rev. Rul. 2007-47, 2007-30 I.R.B. 127
REG-243025-96 Rev. Proc. 2007-44, 2007-28 I.R.B. 54
92-17
Withdrawn by 2006-25 Modified by
REG-142695-05, 2007-39 I.R.B. 681 Superseded by Rev. Rul. 2007-42, 2007-28 I.R.B. 44
Rev. Proc. 2007-42, 2007-27 I.R.B. 15

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2007–1 through 2007–26 is in Internal Revenue Bulletin 2007–26, dated June 25, 2007.

September 24, 2007 iii 2007–39 I.R.B.

Revenue Rulings— Continued:
94-62
Supplemented by
Rev. Rul. 2007-58, 2007-37 I.R.B. 562

2001-48
Modified by
T.D. 9332, 2007-32 I.R.B. 300

2002-41
Modified by
REG-142695-05, 2007-39 I.R.B. 681

2003-102
Modified by
REG-142695-05, 2007-39 I.R.B. 681

2005-24
Modified by
REG-142695-05, 2007-39 I.R.B. 681

2006-36
Modified by
REG-142695-05, 2007-39 I.R.B. 681

2007-59
Amplified by
Notice 2007-74, 2007-37 I.R.B. 585

Treasury Decisions:

8073
Removed by
T.D. 9349, 2007-39 I.R.B. 668

9321
Corrected by
Ann. 2007-68, 2007-32 I.R.B. 348
Ann. 2007-78, 2007-38 I.R.B. 663

9330
Corrected by
Ann. 2007-80, 2007-38 I.R.B. 667

2007–39 I.R.B. iv September 24, 2007

INDEX EMPLOYEE PLANS—Cont.
Internal Revenue Bulletins 2007–27 through amended; medical and accident insurance benefits under
qualified plans (REG–148393–06) 39, 714
2007–39
26 CFR 1.125–0, –1, –2, –5, –6, –7, added; employee benefits
The abbreviation and number in parenthesis following the index entry – cafeteria plans (REG–142695–05) 39, 681
refer to the specific item; numbers in roman and italic type following 26 CFR 1.430(h)(3)–2, amended; mortality tables for deter-
the parenthesis refers to the Internal Revenue Bulletin in which the item mining present value, correction to REG–143601–06 (Ann
may be found and the page number on which it appears. 71) 33, 372
26 CFR 1.6033–5, added; 53.4965–1 thru –9, added;
Key to Abbreviations: 53.6071–1, amended; 54.6011–1, amended;
Ann Announcement 301.6011(g)–1, added; 301.6033–5, added; excise
CD Court Decision taxes on prohibited tax shelter transactions and related dis-
DO Delegation Order closure requirements, disclosure requirements with respect
EO Executive Order to prohibited tax shelter transactions, requirement of return
PL Public Law and time for filing (REG–142039–06; REG–139268–06)
PTE Prohibited Transaction Exemption 34, 415
RP Revenue Procedure Qualified retirement plans:
RR Revenue Ruling Pension plans, normal retirement age (Notice 69) 35, 468
SPR Statement of Procedural Rules Pre-approved defined benefit plans, GUST amendments (Ann
TC Tax Convention 61) 28, 84
TD Treasury Decision Regulations:
TDO Treasury Department Order 26 CFR 1.402(b)–1, amended; 1.402(g)(3)–1, added;
1.402A–1, revised; 1.403(b)–0, added; 1.403(b)–1, –2,
EMPLOYEE PLANS –3, revised; 1.403(b)–4 thru –11, added; 1.403(d)–1,
removed; 1.414(c)–5 redesignated as 1.414(c)–6; new
Bona fide severance pay plan under section 457(e)(11) and sub- 1.414(c)–5, added; 602.101, amended; revised regulations
stantial risk of forfeiture under section 457(f) (Notice 62) 32, concerning section 403(b) tax-sheltered annuity contracts
331 (TD 9340) 36, 487
Cafeteria plans under section 125, guidance (REG–142695–05) 26 CFR 1.408–2(e)(8), revised; 1.408–2T, removed; deemed
39, 681 IRAs in governmental plans/qualified nonbank trustee rules
Determination letters, staggered remedial amendments (RP 44) (TD 9331) 32, 298
28, 54 26 CFR 1.409A–1, –2, –3, –6, amended; application of sec-
Disclosure requirements with respect to prohibited tax shelter tion 409A to nonqualified deferred compensation plans;
transactions (TD 9335) 34, 380 correction to TD 9321 (Ann 78) 38, 663
Employee Plans Compliance Resolution System (EPCRS), cor- 26 CFR 1.6033–5T, added; 301.6033–5T, added; disclosure
rection program (RP 49) 30, 141 requirements with respect to prohibited tax shelter transac-
Form 5500, Schedule P, elimination (Ann 63) 30, 236 tions (TD 9335) 34, 380
Full funding limitations, weighted average interest rate for: 26 CFR 53.6011–1, amended; 53.6071–1, amended;
July 2007 (Notice 61) 30, 140 53.6071–1T, added; 54.6011–1, –1T, amended; require-
August 2007 (Notice 68) 35, 468 ment of return and time for filing (TD 9334) 34, 382
September 2007 (Notice 75) 39, 679 Requirement of return and time for filing with respect to section
Indian tribal government, Pension Protection Act of 2006 (Notice 4965 taxes (TD 9334) 34, 382; (REG–142039–06) 34, 415;
67) 35, 467 (REG–139268–06) 34, 415
Individual retirement accounts (IRAs), deemed IRAs in govern- Tax-sheltered annuities, section 403(b) contracts (TD 9340) 36,
mental plans/qualified nonbank trustee rules (TD 9331) 32, 487
298 Terminations and partial terminations, turnover of employees,
Mortality tables for determining present value, correction to presumption (RR 43) 28, 45
REG–143601–06 (Ann 71) 33, 372 Use of qualified plan amounts to pay health insurance premiums
Nonexempt employees’ trusts, income and employment tax con- (REG–148393–06) 39, 714
sequences (RR 48) 30, 129
Nonqualified deferred compensation plans, application of sec- EMPLOYMENT TAX
tion 409A, correction to TD 9321 (Ann 68) 32, 348; additional
correction to TD 9321 (Ann 78) 38, 663 American Jobs Creation Act (AJCA), modifications to the sec-
Proposed Regulations: tion 6011 regulations (TD 9350) 38, 607
26 CFR 1.72–15, amended; 1.105–4, –6, removed; 1.106–1, Disregarded entities, employment and excise taxes (TD 9356)
amended; 1.401–1, amended; 1.402(a)–1, amended; 39, 675
1.402(c)–2, amended; 1.403(a)–1, amended; 1.403(b)–6,

September 24, 2007 v 2007–39 I.R.B.

EMPLOYMENT TAX—Cont. ESTATE TAX—Cont.
Liens, changes to office to which notices of nonjudicial sale and Interest rates for 2007, farm real property, special use value (RR
requests for return of wrongfully levied property must be sent 45) 28, 49
(TD 9344) 36, 535; (REG–148951–05) 36, 550 Liens, changes to office to which notices of nonjudicial sale and
Nonexempt employees’ trusts, income and employment tax con- requests for return of wrongfully levied property must be sent
sequences (RR 48) 30, 129 (TD 9344) 36, 535; (REG–148951–05) 36, 550
Penalties, transitional relief for the return preparer penalty pro- Penalties, transitional relief for the return preparer penalty pro-
visions under section 6694 (Notice 54) 27, 12 visions under section 6694 (Notice 54) 27, 12
Proposed Regulations: Proposed Regulations:
26 CFR 301.6343–2, amended; 301.7425–3, amended; 26 CFR 20.2036–1, amended; 20.2039–1, amended; grantor
changes to office to which notices of nonjudicial sale and retained interest trusts-application of sections 2036 and
requests for return of wrongfully levied property must be 2039 (REG–119097–05) 28, 74; hearing location change
sent (REG–148951–05) 36, 550 (Ann 81) 38, 667
Publications: 26 CFR 26.2600–1, amended; 26.2642–6, amended;
1141, General Rules and Specifications for Substitute Forms 26.2654–1, amended; severance of a trust for gen-
W-2 and W-3, revised (RP 43) 27, 26 eration-skipping transfer (GST) tax purposes II
4436, General Rules and Specifications for Substitute Form (REG–128843–05) 37, 587
941 and Schedule B (Form 941), revised (RP 42) 27, 15 26 CFR 301.6343–2, amended; 301.7425–3, amended;
Regulations: changes to office to which notices of nonjudicial sale and
26 CFR 1.34–1, revised; 1.34–2 thru –6, removed; 1.1361–4, requests for return of wrongfully levied property must be
–6, amended; 301.7701–2, amended; disregarded entities, sent (REG–148951–05) 36, 550
employment and excise taxes (TD 9356) 39, 675 Regulations:
26 CFR 1.6011–4, revised; 1.6011–4T, removed; 20.6011–4, 26 CFR 1.1001–1, amended; 26.2600–1, amended;
revised; 25.6011–4, revised; 31.6011–4, revised; 26.2642–6, added; 26.2654–1, amended; 602.101,
53.6011–4, revised; 54.6011–4, revised; 56.6011–4, amended; qualified severance of a trust for genera-
revised; AJCA modifications to the section 6011 regula- tion-skipping transfer (GST) tax purposes (TD 9348) 37,
tions (TD 9350) 38, 607 563
26 CFR 31.3402(f)(2)–1, (f)(5)–1, amended; 26 CFR 1.6011–4, revised; 1.6011–4T, removed; 20.6011–4,
31.3402(f)(2)–1T, (f)(5)–1T, removed; withholding revised; 25.6011–4, revised; 31.6011–4, revised;
exemptions (TD 9337) 35, 455 53.6011–4, revised; 54.6011–4, revised; 56.6011–4,
26 CFR 301.6343–2, amended; 301.6343–2T, added; revised; AJCA modifications to the section 6011 regula-
301.7425–3, amended; 301.7425–3T, added; changes tions (TD 9350) 38, 607
to office to which notices of nonjudicial sale and requests 26 CFR 301.6343–2, amended; 301.6343–2T, added;
for return of wrongfully levied property must be sent (TD 301.7425–3, amended; 301.7425–3T, added; changes
9344) 36, 535 to office to which notices of nonjudicial sale and requests
Substitute forms: for return of wrongfully levied property must be sent (TD
W-2 and W-3, general rules and specifications (RP 43) 27, 26 9344) 36, 535
941 and Schedule B (Form 941), general rules and specifica-
tions (RP 42) 27, 15
Withholding exemptions (TD 9337) 35, 455
EXCISE TAX
American Jobs Creation Act (AJCA), modifications to the sec-
ESTATE TAX tion 6011 regulations (TD 9350) 38, 607
Disclosure requirements with respect to prohibited tax shelter
American Jobs Creation Act (AJCA), modifications to the sec- transactions (TD 9335) 34, 380
tion 6011 regulations (TD 9350) 38, 607 Disregarded entities, employment and excise taxes (TD 9356)
Charitable lead annuity trust (CLAT): 39, 675
Inter vivos, sample forms (RP 45) 29, 89 Liens, changes to office to which notices of nonjudicial sale and
Testamentary, sample form (RP 46) 29, 102 requests for return of wrongfully levied property must be sent
Generation-skipping transfer (GST) tax: (TD 9344) 36, 535; (REG–148951–05) 36, 550
Qualified severance of a trust (TD 9348) 37, 563 Penalties, transitional relief for the return preparer penalty pro-
Severance of a trust for GST tax purposes II visions under section 6694 (Notice 54) 27, 12
(REG–128843–05) 37, 587 Proposed Regulations:
Grantor retained interest trusts, application of sections 2036 and 26 CFR 1.6033–5, added; 53.4965–1 thru –9, added;
2039 (REG–119097–05) 28, 74; hearing location change (Ann 53.6071–1, amended; 54.6011–1, amended;
81) 38, 667 301.6011(g)–1, added; 301.6033–5, added; excise
taxes on prohibited tax shelter transactions and related dis-

2007–39 I.R.B. vi September 24, 2007

EXCISE TAX—Cont. EXEMPT ORGANIZATIONS—Cont.
closure requirements, disclosure requirements with respect to prohibited tax shelter transactions, requirement of return
to prohibited tax shelter transactions, requirement of return and time for filing (REG–142039–06; REG–139268–06)
and time for filing (REG–142039–06; REG–139268–06) 34, 415
34, 415 26 CFR 301.6104(a)–1, amended; 301.6110–1, amended;
26 CFR 301.6343–2, amended; 301.7425–3, amended; public inspection of material relating to tax-exempt orga-
changes to office to which notices of nonjudicial sale and nizations (REG–116215–07) 38, 659
requests for return of wrongfully levied property must be Regulations:
sent (REG–148951–05) 36, 550 26 CFR 1.402(b)–1, amended; 1.402(g)(3)–1, added;
Regulations: 1.402A–1, revised; 1.403(b)–0, added; 1.403(b)–1, –2,
26 CFR 1.34–1, revised; 1.34–2 thru –6, removed; 1.1361–4, –3, revised; 1.403(b)–4 thru –11, added; 1.403(d)–1,
–6, amended; 301.7701–2, amended; disregarded entities, removed; 1.414(c)–5 redesignated as 1.414(c)–6; new
employment and excise taxes (TD 9356) 39, 675 1.414(c)–5, added; 602.101, amended; revised regulations
26 CFR 1.6011–4, revised; 1.6011–4T, removed; 20.6011–4, concerning section 403(b) tax-sheltered annuity contracts
revised; 25.6011–4, revised; 31.6011–4, revised; (TD 9340) 36, 487
53.6011–4, revised; 54.6011–4, revised; 56.6011–4, 26 CFR 1.6011–4, revised; 1.6011–4T, removed; 20.6011–4,
revised; AJCA modifications to the section 6011 regula- revised; 25.6011–4, revised; 31.6011–4, revised;
tions (TD 9350) 38, 607 53.6011–4, revised; 54.6011–4, revised; 56.6011–4,
26 CFR 1.6033–5T, added; 301.6033–5T, added; disclosure revised; AJCA modifications to the section 6011 regula-
requirements with respect to prohibited tax shelter transac- tions (TD 9350) 38, 607
tions (TD 9335) 34, 380 26 CFR 1.6033–5T, added; 301.6033–5T, added; disclosure
26 CFR 48.4081–1, –3, –5, amended; 48.4081–1T, –3T, re- requirements with respect to prohibited tax shelter transac-
moved; 602.101, amended; entry of taxable fuel (TD 9346) tions (TD 9335) 34, 380
37, 570 26 CFR 53.6011–1, amended; 53.6071–1, amended;
26 CFR 53.6011–1, amended; 53.6071–1, amended; 53.6071–1T, added; 54.6011–1, –1T, amended; require-
53.6071–1T, added; 54.6011–1, –1T, amended; require- ment of return and time for filing (TD 9334) 34, 382
ment of return and time for filing (TD 9334) 34, 382 Requirement of return and time for filing with respect to section
26 CFR 301.6343–2, amended; 301.6343–2T, added; 4965 taxes (TD 9334) 34, 382; (REG–142039–06) 34, 415;
301.7425–3, amended; 301.7425–3T, added; changes (REG–139268–06) 34, 415
to office to which notices of nonjudicial sale and requests Revocations (Ann 64) 29, 125; (Ann 65) 30, 236; (Ann 69) 33,
for return of wrongfully levied property must be sent (TD 371; (Ann 73) 34, 435; (Ann 76) 36, 560; (Ann 86) 39, 719
9344) 36, 535 Suspension of tax-exempt status of organizations identified with
Requirement of return and time for filing with respect to section terrorism (Ann 70) 33, 371
4965 taxes (TD 9334) 34, 382; (REG–142039–06) 34, 415; Tax-sheltered annuities, section 403(b) contracts (TD 9340) 36,
(REG–139268–06) 34, 415 487
Taxable fuel, entry into the United States (TD 9346) 37, 570
GIFT TAX
EXEMPT ORGANIZATIONS
American Jobs Creation Act (AJCA), modifications to the sec-
American Jobs Creation Act (AJCA), modifications to the sec- tion 6011 regulations (TD 9350) 38, 607
tion 6011 regulations (TD 9350) 38, 607 Charitable lead annuity trust (CLAT), inter vivos, sample forms
Disclosure requirements with respect to prohibited tax shelter (RP 45) 29, 89
transactions (TD 9335) 34, 380 Liens, changes to office to which notices of nonjudicial sale and
Information and materials made available for public inspection requests for return of wrongfully levied property must be sent
(REG–116215–07) 38, 659 (TD 9344) 36, 535; (REG–148951–05) 36, 550
Letter rulings and determination letters, exemption application Penalties, transitional relief for the return preparer penalty pro-
determination letter rulings under sections 501 and 521 (RP visions under section 6694 (Notice 54) 27, 12
52) 30, 222 Proposed Regulations:
List of organizations classified as private foundations (Ann 67) 26 CFR 301.6343–2, amended; 301.7425–3, amended;
32, 345 changes to office to which notices of nonjudicial sale and
Proposed Regulations: requests for return of wrongfully levied property must be
26 CFR 1.6033–5, added; 53.4965–1 thru –9, added; sent (REG–148951–05) 36, 550
53.6071–1, amended; 54.6011–1, amended; Regulations:
301.6011(g)–1, added; 301.6033–5, added; excise 26 CFR 1.6011–4, revised; 1.6011–4T, removed; 20.6011–4,
taxes on prohibited tax shelter transactions and related dis- revised; 25.6011–4, revised; 31.6011–4, revised;
closure requirements, disclosure requirements with respect 53.6011–4, revised; 54.6011–4, revised; 56.6011–4,

September 24, 2007 vii 2007–39 I.R.B.

GIFT TAX—Cont. INCOME TAX—Cont.
revised; AJCA modifications to the section 6011 regula- Credits:
tions (TD 9350) 38, 607 Clean renewable energy bonds, volume cap, change of ad-
26 CFR 301.6343–2, amended; 301.6343–2T, added; dress (Notice 56) 27, 15
301.7425–3, amended; 301.7425–3T, added; changes Enhanced oil recovery credit, 2007 inflation adjustment (No-
to office to which notices of nonjudicial sale and requests tice 64) 34, 385
for return of wrongfully levied property must be sent (TD Low-income housing credit:
9344) 36, 535 Carryovers to qualified states, 2007 National Pool (RP 55)
33, 354
INCOME TAX Guidance on application of the qualified contract provi-
sions of section 42 (REG–114084–04) 33, 359
Guidance on temporary relief of certain section 42 require-
Accounting methods:
ments as a result of major disasters declared by the Pres-
Automatic consent to change, Advance Trade Discount
ident (RP 54) 31, 293
Method (RP 53) 30, 233
Satisfactory bond, “bond factor” amounts for the period:
Safe harbor method of accounting for rotable spare parts (RP
January through September 2007 (RR 46) 30, 126
48) 29, 110
Time extension for restoration of certain low-income hous-
Accounts and notes receivable, section 1221(a)(4) capital asset
ing credit projects located within the Gulf Opportunity
exclusion, hearing (Ann 66) 31, 296
Zone damaged by Hurricane Katrina (Notice 66) 34, 387
Agent for a consolidated group with foreign common parent (TD
Utility allowances under section 42 (REG–128274–03) 33,
9343) 36, 533
356
American Jobs Creation Act (AJCA):
Overpayments, tax liabilities:
Modifications to the section 6011 regulations (TD 9350) 38,
Outstanding amounts, bankruptcy (RR 52) 37, 575
607
Unassessed amounts, notice of deficiency (RR 51) 37, 573
Modifications to the section 6111 regulations (TD 9351) 38,
Disciplinary actions involving attorneys, certified public accoun-
616
tants, enrolled agents, and enrolled actuaries (Ann 72) 33, 373
Modifications to the section 6112 regulations (TD 9352) 38,
Disclosure of returns and return information in connection with
621
written contracts or agreements for the acquisition of property
Cafeteria plans under section 125, removal of temporary regula-
or services for tax administrative purposes (TD 9327) 28, 50
tions TD 8073 (TD 9349) 39, 668
Electronic filing and burden reduction, guidance (TD 9329) 32,
Charitable contribution of real property, deduction (Notice 72)
312
36, 544
Entertainment use of business aircraft (REG–147171–05) 32,
Charitable lead annuity trust (CLAT):
334
Inter vivos, sample forms (RP 45) 29, 89
Estates or trusts, section 67 limitations (REG–128224–06) 36,
Testamentary, sample form (RP 46) 29, 102
551
Commodity Credit Corporation (CCC) loans, tax treatment and
Financial services income under section 904(d), request for com-
information reporting of repayments (Notice 63) 33, 353
ments (Notice 58) 29, 88
Corporations:
Forms:
Consolidated returns, unified rule for loss on subsidiary stock,
1096, 1098, 1099, 5498, W-2G, and 1042-S, substitute form
correction to REG–157711–02 (Ann 74) 35, 483
specifications (RP 50) 31, 244
Corporate reorganizations:
1098, 1099, 5498 and W-2G, requirements for filing electron-
Active trade or business requirement for spin offs, distri-
ically or magnetically, 2007 revision (RP 51) 30, 143
butions under section 355 (Notice 60) 35, 466
1118, Foreign Tax Credit – Corporations, comments requested
Spin offs, distributions under section 355 (RR 42) 28, 44
on proposed revisions (Ann 62) 29, 115
Estimated tax payments by corporations (TD 9347) 38, 624
Gambling winnings, reporting requirements (RP 57) 36, 547
Exclusions from gross income of foreign corporations (TD
Health Savings Accounts (HSAs), employer comparable contri-
9332) 32, 300; (REG–138707–06) 32, 342
butions to HSAs under section 4980G, cancellation of hearing
Information returns required with respect to certain foreign
on REG–143797–06 (Ann 85) 39, 719
corporations and certain foreign-owned domestic corpora-
Hurricane Katrina filers, time for filing postponed to April 15,
tions (TD 9338) 35, 463
2007, extension of time (Notice 74) 37, 585
Real estate investment trust (REIT) distributions subject to
Inflation adjusted amounts under section 179 of the Code, cor-
section 897(h)(1) (Notice 55) 27, 13
rection (RP 60) 39, 679
Section 382 treatment of prepaid income under built-in gain
provisions of section 382(h) (TD 9330) 31, 239; correction
(Ann 80) 38, 667; (REG–144540–06) 31, 296

2007–39 I.R.B. viii September 24, 2007

INCOME TAX—Cont. INCOME TAX—Cont.
Insurance companies: 26 CFR 1.67–4, added; section 67 limitations on estates or
Diversification requirements under section 817 trusts (REG–128224–06) 36, 551
(REG–118719–07) 37, 593 26 CFR 1.165–5, amended; losses for abandoned stock or
Inevitable future costs as insurance risk (RR 47) 30, 127 securities (REG–101001–05) 36, 548
Life insurance, reserves for variable life insurance contracts 26 CFR 1.199–3, –7, –8, amended; qualified films under sec-
and required interest under section 807(d)(2) (RR 54) 38, tion 199 (REG–103842–07) 28, 79; correction (Ann 77) 38,
604 662
Minimum effectively connected income, foreign insurance 26 CFR 1.382–7, added; built-in gains and losses under sec-
company, guidance regarding computation of amount (RP tion 382(h) (REG–144540–06) 31, 296
58) 37, 585 26 CFR 1.817–5, amended; diversification requirements for
Treatment of certain nondiversified contracts, qualified pen- variable annuity, endowment, and life insurance contracts
sion or retirement contracts (RR 58) 37, 562 (REG–118719–07) 37, 593
Interest: 26 CFR 1.883–0 thru –5, amended; exclusions from gross
Investment: income of foreign corporations (REG–138707–06) 32, 342
Federal short-term, mid-term, and long-term rates for: 26 CFR 1.1397E–1, amended; qualified zone academy
July 2007 (RR 44) 28, 47 bonds, obligations of states and political subdivisions
August 2007 (RR 50) 32, 311 (REG–121475–03) 35, 474
September 2007 (RR 57) 36, 531 26 CFR 1.1502–13, –32, –35, –36, revised; unified rule for
Rates: loss on subsidiary stock, correction to REG–157711–02
Underpayments and overpayments, quarter beginning: (Ann 74) 35, 483
October 1, 2007 (RR 56) 39, 668 26 CFR 1.6411–2, –3, revised; clarification to section 6411
Suspension of interest: regulations (REG–118886–06) 37, 591
General rules and exceptions (REG–149036–04) 34, 411 26 CFR 31.3406(g)–1(f), amended; 301.6724–1, amended;
Listed transactions (TD 9333) 33, 350; (REG–149036–04) information reporting and backup withholding for payment
33, 365 card transactions (REG–163195–05) 33, 366
Liens, changes to office to which notices of nonjudicial sale and 26 CFR 301.6343–2, amended; 301.7425–3, amended;
requests for return of wrongfully levied property must be sent changes to office to which notices of nonjudicial sale and
(TD 9344) 36, 535; (REG–148951–05) 36, 550 requests for return of wrongfully levied property must be
Life-nonlife tacking rule, taxable years of members of consoli- sent (REG–148951–05) 36, 550
dated groups (TD 9342) 35, 451 26 CFR 301.6404–0, amended; 301.6404–4, added; applica-
Listed transaction, loss importation transaction (Notice 57) 29, tion of section 6404(g) of the Code suspension provisions
87 (REG–149036–04) 33, 365; (REG–149036–04) 34, 411
Losses, deductions for abandoned stock or securities Publications:
(REG–101001–05) 36, 548 1141, General Rules and Specifications for Substitute Forms
Marginal production rates, 2007 (Notice 65) 34, 386 W-2 and W-3, revised (RP 43) 27, 26
Nonexempt employees’ trusts, income and employment tax con- 1179, General Rules and Specifications for Substitute Forms
sequences (RR 48) 30, 129 1096, 1098, 1099, 5498, W-2G, and 1042-S, update (RP
Partnerships, subpart F income (TD 9326) 31, 242 50) 31, 244
Payment card transactions, procedure for payment card organi- 1220, Specifications for Filing Forms 1098, 1099, 5498 and
zation to obtain Qualified Payment Card Agent (QPCA) deter- W-2G Electronically or Magnetically, 2007 revision (RP
mination (Notice 59) 30, 135 51) 30, 143
Penalties, transitional relief for the return preparer penalty pro- 4436, General Rules and Specifications for Substitute Form
visions under section 6694 (Notice 54) 27, 12 941 and Schedule B (Form 941), revised (RP 42) 27, 15
Presidentially declared disaster: Qualified films under section 199 (REG–103842–07) 28, 79; cor-
Or combat zone, postponement of certain acts (RP 56) 34, 388 rection (Ann 77) 38, 662
Time for filing return (RR 59) 37, 582 Qualified Payment Card Agent (QPCA), payment card transac-
Private foundations, organizations now classified as (Ann 67) 32, tions (REG–163195–05) 33, 366
345 Qualified zone academy bonds, obligations of states and political
Proposed Regulations: subdivisions (TD 9339) 35, 437; (REG–121475–03) 35, 474
26 CFR 1.42–10, –12, amended; section 42 utility allowance Regulations:
regulations update (REG–128274–03) 33, 356 26 CFR 1.56–0, amended; 1.56–1(e)(4), revised; 1.6154–1
26 CFR 1.42–18, added; section 42 qualified contract provi- thru –5, removed; 1.6425–2(a), revised; 1.6425–3,
sions (REG–114084–04) 33, 359 amended; 1.6655–0, –4, –5, –6, added; 1.6655–1, –2,
26 CFR 1.61–21, amended; 1.274–9, –10, added; de- –3, revised; 1.6655–7, removed; 1.6655–5 redesignated as
ductions for entertainment use of business aircraft 1.6655–7; new 1.6655–7, revised; 301.6154–1, removed;
(REG–147171–05) 32, 334

September 24, 2007 ix 2007–39 I.R.B.

INCOME TAX—Cont. INCOME TAX—Cont.
301.6655–1, revised; 602.101, amended; corporate esti- revised; AJCA modifications to the section 6011 regula-
mated tax (TD 9347) 38, 624 tions (TD 9350) 38, 607
26 CFR 1.125–2T, removed; employee benefits – cafeteria 26 CFR 1.6012–2, amended; return required by subchapter T
plans (TD 9349) 39, 668 cooperatives under section 6012 (TD 9336) 35, 461
26 CFR 1.302–2, –4, amended; 1.302–2T, –4T, removed; 26 CFR 1.6038–2, amended; 1.6038–2T, revised; 1.6038A–2,
1.331–1, amended; 1.331–1T, removed; 1.332–6, added; amended; information returns required with respect to cer-
1.322–6T, removed; 1.338–0, –10, amended; 1.338–10T, tain foreign corporations and certain foreign-owned domes-
removed; 1.351–3, added; 1.351–3T, removed; 1.355–0, tic corporations (TD 9338) 35, 463
amended; 1.355–5, added; 1.355–5T, removed; 1.368–3, 26 CFR 1.6411–2, –3, amended; 1.6411–2T, –3T, added; clar-
added; 1.368–3T, removed; 1.381(b)–1, amended; ification of section 6411 regulations (TD 9355) 37, 577
1.381(b)–1T, removed; 1.382–1, –8, amended; 1.382–8T, 26 CFR 301.6103(n)–1, revised; disclosure of returns and re-
–11T, removed; 1.382–11, added; 1.1081–11, added; turn information in connection with written contracts or
1.1081–11T, removed; 1.1221–2, amended; 1.1221–2T, agreements for the acquisition of property or services for
removed; 1.1502–13, –31, –32, –33, –90, –95, amended; tax administration purposes (TD 9327) 28, 50
1.1502–13T, –31T, –32T, –33T, –95T, removed; 1.1563–3, 26 CFR 301.6111–3, added; 301.6111–3T, removed; AJCA
amended; 1.1563–3T, removed; 1.6012–2, amended; modifications to the section 6111 regulations (TD 9351) 38,
1.6012–2T, removed; guidance necessary to facilitate busi- 616
ness electronic filing and burden reduction (TD 9329) 32, 26 CFR 301.6112–1, revised; AJCA modifications to the sec-
312 tion 6112 regulations (TD 9352) 38, 621
26 CFR 1.367(b)–2, amended; 1.367(b)–4(d), revised; 26 CFR 301.6343–2, amended; 301.6343–2T, added;
1.1248–1, –2, –3, –7, revised; 1.1248–8, added; section 301.7425–3, amended; 301.7425–3T, added; changes
1248 attribution principles (TD 9345) 36, 523 to office to which notices of nonjudicial sale and requests
26 CFR 1.382–7T, added; built-in gains and losses under sec- for return of wrongfully levied property must be sent (TD
tion 382(h) (TD 9330) 31, 239; correction (Ann 80) 38, 667 9344) 36, 535
26 CFR 1.402(b)–1, amended; 1.402(g)(3)–1, added; 26 CFR 301.6404–0T, –4T, added; application of section
1.402A–1, revised; 1.403(b)–0, added; 1.403(b)–1, –2, 6404(g) of the Code suspension provisions (TD 9333) 33,
–3, revised; 1.403(b)–4 thru –11, added; 1.403(d)–1, 350
removed; 1.414(c)–5 redesignated as 1.414(c)–6; new Research agreements, private business use (RP 47) 29, 108
1.414(c)–5, added; 602.101, amended; revised regulations Revenue rulings, RR 75–425 obsolete (RR 60) 38, 606
concerning section 403(b) tax-sheltered annuity contracts Revocations, exempt organizations (Ann 64) 29, 125; (Ann 65)
(TD 9340) 36, 487 30, 236; (Ann 69) 33, 371; (Ann 73) 34, 435; (Ann 76) 36,
26 CFR 1.475–0, amended; 1.475(a)–4, added; 1.475(e)–1, 560; (Ann 86) 39, 719
redesignated as 1.475(g)–1; 1.475(g)–1, amended; Safe harbor for valuation under section 475 for dealers in secu-
602.101, amended; safe harbor for valuation under section rities and commodities (TD 9328) 27, 1
475 (TD 9328) 27, 1 Stocks:
26 CFR 1.883–0, thru –5, amended; 1.883–0T thru –5T, Attribution of earnings and profits to stock of controlled for-
added; 602.101, amended; exclusions from gross income eign corporations (TD 9345) 36, 523
of foreign corporations (TD 9332) 32, 300 Post-grant restrictions added to previously vested stock (RR
26 CFR 1.954–2, amended; 1.954–2T, removed; guidance un- 49) 31, 237
der subpart F relating to partnerships (TD 9326) 31, 242 Standard Industry Fare Level (SIFL) formula (RR 55) 38, 604
26 CFR 1.1397E–1, amended; 1.1397E–1T, added; 602.101, Subchapter T cooperatives, return required under section 6012
amended; qualified zone academy bonds, obligations of (TD 9336) 35, 461
states and political subdivisions (TD 9339) 35, 437 Substitute forms:
26 CFR 1.1502–19, –80, amended; 1.1502–19T, –80T, re- W-2 and W-3, general rules and specifications (RP 43) 27, 26
moved; treatment of excess loss accounts (TD 9341) 35, 941 and Schedule B (Form 941), general rules and specifica-
449 tions (RP 42) 27, 15
26 CFR 1.1502–47, –76, amended; 1.1502–47T, –76T, re- 1096, 1098, 1099, 5498, W-2G, and 1042-S, rules and speci-
moved; amendment of tacking rule requirements of life- fications (RP 50) 31, 244
nonlife consolidated regulations (TD 9342) 35, 451 Suspension of tax-exempt status of organizations identified with
26 CFR 1.1502–77, amended; 1.1502–77T, removed; agent terrorism (Ann 70) 33, 371
for a consolidated group with foreign common parent (TD Of tax-exempt status of organizations identified with terror-
9343) 36, 533 ism (Ann 70) 33, 371
26 CFR 1.6011–4, revised; 1.6011–4T, removed; 20.6011–4, Tax avoidance transaction involving foreign currency options
revised; 25.6011–4, revised; 31.6011–4, revised; (Notice 71) 35, 472
53.6011–4, revised; 54.6011–4, revised; 56.6011–4,

2007–39 I.R.B. x September 24, 2007

INCOME TAX—Cont.
Tax conventions, U.S.-Netherlands, qualification of certain pen-
sion and other employee benefit arrangements (Ann 75) 36,
540
Tax-sheltered annuities, section 403(b) contracts (TD 9340) 36,
487
Tentative allowance of refund (RR 53) 37, 577
Tentative carryback adjustment under section 6411, clarification
relating to the computation and allowance (TD 9355) 37, 577;
(REG–118886–06) 37, 591
Transaction of interest:
Contribution of successor member interest (Notice 72) 36,
544
Identification of toggling grantor trust (Notice 73) 36, 545
Treatment of excess loss accounts (TD 9341) 35, 449

SELF-EMPLOYMENT TAX
Liens, changes to office to which notices of nonjudicial sale and
requests for return of wrongfully levied property must be sent
(TD 9344) 36, 535; (REG–148951–05) 36, 550
Proposed Regulations:
26 CFR 301.6343–2, amended; 301.7425–3, amended;
changes to office to which notices of nonjudicial sale and
requests for return of wrongfully levied property must be
sent (REG–148951–05) 36, 550
Regulations:
26 CFR 301.6343–2, amended; 301.6343–2T, added;
301.7425–3, amended; 301.7425–3T, added; changes
to office to which notices of nonjudicial sale and requests
for return of wrongfully levied property must be sent (TD
9344) 36, 535

September 24, 2007 xi 2007–39 I.R.B.

2007–39 I.R.B. September 24, 2007
September 24, 2007 2007–39 I.R.B.
 INTERNAL REVENUE BULLETIN
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