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These final regulations are issued under the express delegation of authority under section 7805 of the Internal Revenue Code (Code). Section 7805(a) directs the Secretary of the Treasury or her delegate to prescribe all needful rules and regulations for the enforcement of that section and others in the Code, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.

On August 14, 2019, the Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) published proposed regulations (REG-130700-14) under section 861 of the Code in the Federal Register (84 FR 40317) (the proposed regulations). The Treasury Department and the IRS received written comments on the proposed regulations, and a public hearing was held on February 11, 2020. All written comments received in response to the proposed regulations are available at www.regulations.gov or upon request. Terms used but not defined in this preamble have the meaning provided in these final regulations.

These regulations (the final regulations) extend the classification rules in existing ¡ì1.861-18 to transfers of digital content other than computer programs and clarify the source of income for certain transfers of digital content. The final regulations also clarify the classification of transactions involving on-demand network access to computing and other similar resources.

The final regulations retain the overall approach of the proposed regulations, with certain revisions discussed in the preamble. The preamble also discusses comments received in response to the solicitation of comments in the notice of proposed rulemaking.

The principal authors of these final regulations are Christopher E. Fulle and Michelle L. Ng of the Office of the Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, the Treasury Department and the IRS amend 26 CFR part 1 as follows:

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

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

Par. 2. Section 1.861-7 is amended by revising paragraph (c) to read as follows:

* * * * *

(c) Country in which sold. For purposes of part I (section 861 and following), subchapter N, chapter 1 of the Code, and the regulations thereunder, a sale of personal property is consummated at the time when, and the place where, the rights, title, and interest of the seller in the property are transferred to the buyer. Where bare legal title is retained by the seller, the sale shall be deemed to have occurred at the time and place of passage to the buyer of beneficial ownership and the risk of loss. However, in any case in which the sales transaction is arranged in a particular manner for the primary purpose of tax avoidance, the foregoing rules will not be applied. In such cases, all factors of the transaction, such as negotiations, the execution of the agreement, the location of the property, and the place of payment, will be considered, and the sale will be treated as having been consummated at the place where the substance of the sale occurred. For determining the place of sale of copyrighted articles transferred through an electronic medium, see ¡ì1.861-18(f)(2)(ii).

* * * * *

Par. 3. Section 1.861-18 is amended by:

a. Revising the section heading;

b. Revising paragraphs (a), (b), (c)(1), (c)(2)(i) through (iv), (c)(3), (d), (e), (f)(1) through (3), (g)(2), (g)(3)(i) and (ii), and (h) through (j); and

c. Removing paragraph (k).

The revisions read as follows:

(a) General¡ª(1) Scope. This section provides rules for classifying digital content transactions (as defined in paragraph (b)(1) of this section) for purposes of subchapter N of chapter 1 of the Internal Revenue Code, sections 59A, 245A, 250, 267A, 367, 404A, 482, 679, 1059A, chapters 3 and 4, sections 842 and 845 (to the extent involving a foreign person), and transfers to foreign trusts not covered by section 679.

(2) Digital content¡ª(¾±) Digital content defined. For purposes of this section, digital content means a computer program or any other content, such as books, movies, and music, in digital format that is¡ª

(A) Protected by copyright law; or

(B) Not protected by copyright law solely¡ª

(1) Due to the passage of time; or

(2) Because the creator dedicated the content to the public domain.

(ii) Computer program defined. For purposes of this section, a computer program is a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result and includes any media, user manuals, documentation, data base, or similar item if the media, user manuals, documentation, data base, or other similar item is incidental to the operation of the computer program.

(b) Categories of transactions¡ª(1) General. A transaction that constitutes a transfer of digital content, or the provision of services or of know-how with respect to digital content (each a digital content transaction), is treated as being solely one of the following¡ª

(i) A transfer of a copyright right in the digital content;

(ii) A transfer of a copy of the digital content (a copyrighted article);

(iii) The provision of services for the development or modification of the digital content; or

(iv) The provision of know-how relating to development of digital content.

(2) Transaction with multiple elements. Taking into account the overall transaction and the surrounding facts and circumstances, a transaction that has multiple elements, one or more of which would be a digital content transaction if considered separately, is classified in its entirety as a digital content transaction under one of the categories described in paragraph (b)(1) of this section if the predominant character of the transaction is described in one of the categories in that paragraph.

(3) Determination of predominant character¡ª(¾±) General rule. For purposes of paragraph (b)(2) of this section and ¡ì1.861-19(c)(2), the predominant character of a transaction is determined by ascertaining the primary benefit or value received by the customer in the transaction.

(ii) Special rule. If the primary benefit or value received by the customer in the transaction is not reasonably ascertainable, the predominant character of a transaction is instead determined by ascertaining the primary benefit or value received by a typical customer in a substantially similar transaction as determined under paragraphs (b)(3)(ii)(A) and (B) of this section.

(A) The primary benefit or value received by a typical customer is determined by data on how a typical customer uses or accesses the digital content. See paragraph (h)(17) of this section (Example 17).

(B) If data described in paragraph (b)(3)(ii)(A) of this section is not available, then the predominant character of a transaction subject to the special rule in paragraph (b)(3)(ii) of this section is determined by examining other factors that are indicative of the primary benefit or value received by a typical customer, including the following¡ª

(1) How the transferor or provider markets the transaction;

(2) The relative development costs to the transferor or provider of each element of the transaction; and

(3) The relative price paid in an uncontrolled transaction for one or more elements compared to the total contract price of the transaction in question.

(iii) Identification and development of data. A transferor or provider must use reasonable efforts to identify the data specified in paragraphs (b)(3)(i) and (ii)(A) of this section, or if necessary, to apply the factors relevant to paragraph (b)(3)(ii)(B) of this section. However, a transferor or provider is not required to develop any of the data specified in those paragraphs that it does not develop in the course of business.

(c) * * *

(1) Transfers involving transfers of copyright rights. A digital content transaction involves a transfer of a copyright right if, as a result of the transaction, a person acquires one or more of the rights described in paragraphs (c)(2)(i) through (iv) of this section.

(2) * * *

(i) The right to make copies of the digital content for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending;

(ii) The right to prepare derivative digital content based upon the digital content;

(iii) The right to make a public performance of digital content, other than a right to publicly perform digital content for the purpose of advertising the sale of the digital content performed; or

(iv) The right to publicly display digital content, other than a right to publicly display digital content for the purpose of advertising the sale of the digital content displayed.

(3) Copyrighted articles. A copyrighted article includes a copy of digital content from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the digital content may be fixed in any medium.

(d) Provision of services. The determination of whether a transaction involving newly developed or modified digital content involves the provision of services described in paragraph (b)(1) of this section is based on all the facts and circumstances of the transaction, including, as appropriate, the intent of the parties (as evidenced by their agreement and conduct) as to which party is to own the copyright rights in the digital content and how the risks of loss are allocated between the parties. See paragraph (h)(15) of this section (Example 15).

(e) Provision of know-how. The provision of information with respect to digital content involves the provision of know-how for purposes of this section only if the information is¡ª

(1) Information relating to the development of digital content;

(2) Furnished under conditions preventing unauthorized disclosure, specifically contracted for between the parties; and

(3) Considered property subject to trade secret protection.

(f) * * *

(1) Transfers of copyright rights. The determination of whether a transfer of a copyright right is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transfer of a copyright right that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license. For this purpose, the principles of sections 1222 and 1235 apply. Income derived from the sale or exchange of a copyright right will be sourced under section 865(a), (c), (d), (e), or (h), as appropriate. Income derived from the licensing of a copyright right will be sourced under section 861(a)(4) or 862(a)(4), as appropriate.

(2) Transfers of copyrighted articles¡ª(¾±) Classification. The determination of whether a transfer of a copyrighted article is a sale or exchange is made on the basis of whether, taking into account all facts and circumstances, the benefits and burdens of ownership have been transferred. A transfer of a copyrighted article that does not constitute a sale or exchange because insufficient benefits and burdens of ownership of the copyrighted article have been transferred, such that a person other than the transferee is properly treated as the owner of the copyrighted article, will be classified as a lease.

(ii) Source. Income from transactions that are classified as sales or exchanges of copyrighted articles will be sourced under section 861(a)(6), 862(a)(6), 863, or 865(a), (b), (c), or (e), as appropriate. When a copyrighted article is sold and transferred through an electronic medium, the sale is deemed to have occurred at the location of the billing address of the purchaser for purposes of ¡ì1.861-7(c). However, in any case in which the sales transaction is arranged in a particular manner for a principal purpose of tax avoidance, the foregoing rules will not be applied. In such a case, all of the facts and circumstances relevant to the transaction, such as the place where the copyrighted article will be used, the place where negotiations and the execution of the agreement occurred, and the terms of the agreement, will be considered, and the sale will be treated as having occurred where the substance of the sale occurred. Income derived from leasing a copyrighted article will be sourced under section 861(a)(4) or 862(a)(4), as appropriate.

(3) Special circumstances of digital content. In connection with determinations under this paragraph (f), consideration must be given as appropriate to the special characteristics of digital content in transactions that take advantage of these characteristics (such as the ability to make perfect copies at minimal cost). For example, a transaction in which a person acquires a copy of digital content on a disk subject to a requirement that the disk be destroyed after a specified period is generally the equivalent of a transaction subject to a requirement that the disk be returned after such period. Similarly, a transaction in which the digital content deactivates itself after a specified period is generally the equivalent of a transaction subject to a requirement that the disk be returned after a specified period.

(g) * * *

(2) Means of transfer not to be taken into account. The rules of this section shall be applied irrespective of the physical or electronic or other medium used to effectuate a digital content transaction.

(3) * * *

(i) In general. For purposes of paragraph (c)(2)(i) of this section, a transferee of digital content shall not be considered to have the right to distribute copies of the digital content to the public if it is permitted to distribute copies of the digital content to only either a related person, or to identified persons who may be identified by either name or by legal relationship to the original transferee. For purposes of this subparagraph, a related person is a person who bears a relationship to the transferee specified in section 267(b)(3), (10), (11), or (12), or section 707(b)(1)(B). In applying section 267(b), 267(f), 707(b)(1)(B), or 1563(a), ¡°10 percent¡± shall be substituted for ¡°50 percent.¡±

(ii) Use by individuals. The number of employees of a transferee of digital content who are permitted to use the digital content in connection with their employment is not relevant for purposes of this paragraph (g)(3). In addition, the number of individuals with a contractual agreement to provide services to the transferee of digital content who are permitted to use the digital content in connection with the performance of those services is not relevant for purposes of this paragraph (g)(3).

(h) Examples. The examples in this paragraph (h) illustrate the provisions of this section. Unless otherwise specified, assume that Corp A is a domestic corporation, the digital content described in each example does not contain any online functionality, and all facts in each example occur as part of a single transaction.

(1) Example 1: Sale of a computer program on a disk¡ª(¾±) Facts. Corp A owns the copyright in a computer program, Program X. It copies Program X onto disks. The disks are placed in boxes covered with a wrapper on which is printed what is generally referred to as a shrink-wrap license. The license is stated to be perpetual. Under the license no reverse engineering, decompilation, or disassembly of the computer program is permitted. The transferee receives, first, the right to use the program on two of its own computers (for example, a laptop and a desktop) provided that only one copy is in use at any one time, and second, the right to make one copy of the program on each machine as an essential step in the utilization of the program. The transferee is permitted by the shrink-wrap license to sell the copy so long as it destroys any other copies it has made and imposes the same terms and conditions of the license on the purchaser of its copy. These disks are made available for sale to the general public in Country Z. In return for valuable consideration, P, a Country Z resident, receives one such disk.

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the transfer of a disk containing a copy of Program X from Corp A to P is a digital content transaction with one element, which is the transfer of a copy of Program X. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Under paragraph (g)(1) of this section, the label license is not determinative.

(B) Taking into account all of the facts and circumstances, P is properly treated as the owner of a copyrighted article. Therefore, under paragraph (f)(2) of this section, there has been a sale of a copyrighted article rather than the grant of a lease.

(2) Example 2: Sale of a computer program via download from the Internet¡ª(¾±) Facts. The facts are the same as those in paragraph (h)(1) of this section (Example 1), except that instead of selling disks, Corp A decides to make Program X available, for a fee, on a World Wide Web home page on the Internet. P, the Country Z resident, in return for payment made to Corp A, downloads Program X (via modem) onto the hard drive of his computer. As part of the electronic communication, P signifies his assent to a license agreement with terms identical to those in Example 1, except that in this case P may make a back-up copy of the program on to a disk.

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the digital transfer of a copy of Program X from Corp A to P is a digital content transaction with one element, which is the transfer of a copy of Program X. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Although P did not buy a physical copy of the disk with the program on it, paragraph (g)(2) of this section provides that the means of transferring the program is irrelevant.

(B) As in paragraph (h)(1) of this section (Example 1), P is properly treated as the owner of a copyrighted article. Therefore, under paragraph (f)(2) of this section, there has been a sale of a copyrighted article rather than the grant of a lease.

(3) Example 3: Lease of a computer program with requirement to return disk¡ª(i) Facts. The facts are the same as those in paragraph (h)(1) of this section (Example 1), except that Corp A only allows P, the Country Z resident, to use Program X for one week. At the end of that week, P must return the disk with Program X on it to Corp A. P must also destroy any copies made of Program X. If P wishes to use Program X for a further period he must enter into a new agreement to use the program for an additional charge.

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the transfer of a disk with a copy of Program X from Corp A to P is a digital content transaction with one element, which is the transfer of a copy of Program X. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section.

(B) Taking into account all of the facts and circumstances, P is not properly treated as the owner of a copyrighted article. Therefore, under paragraph (f)(2) of this section, there has been a lease of a copyrighted article rather than a sale. Taking into account the special characteristics of digital content as provided in paragraph (f)(3) of this section, the result would be the same if P were required to destroy the disk at the end of the one-week period instead of returning it since Corp A can make additional copies of the program at minimal cost.

(4) Example 4: Lease of a computer program with electronic lock¡ª(¾±) Facts. The facts are the same as those in paragraph (h)(2) of this section (Example 2), where P, the Country Z resident, receives Program X from Corp A¡¯s home page on the Internet, except that P may only use Program X for a period of one week at the end of which an electronic lock is activated and the program can no longer be accessed. Thereafter, if P wishes to use Program X, it must return to the home page and pay Corp A to send an electronic key to reactivate the program for another week.

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the digital transfer of a copy of Program X from Corp A to P is a digital content transaction with one element, which is the transfer of a copy of Program X. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section.

(B) As in paragraph (h)(3) of this section (Example 3), P is not properly treated as the owner of a copyrighted article. Therefore, under paragraph (f)(2) of this section, there has been a lease of a copyrighted article rather than a sale. While P does retain Program X on its computer at the end of the one-week period, as a legal matter P no longer has the right to use the program (without further payment) and, indeed, cannot use the program without the electronic key. Functionally, Program X is no longer on the hard drive of P¡¯s computer. Instead, the hard drive contains only a series of numbers which no longer perform the function of Program X. Although in Example 3, P was required to physically return the disk, taking into account the special characteristics of digital content as provided in paragraph (f)(3) of this section, the result in this paragraph (h)(4) (Example 4) is the same as in Example 3.

(5) Example 5: Sale of copyright rights to a computer program¡ª(¾±) Facts. Corp A transfers a disk containing Program X to Corp B, a Country Z corporation, and grants Corp B an exclusive license for the remaining term of the copyright to copy and distribute an unlimited number of copies of Program X in the geographic area of Country Z, prepare derivative works based upon Program X, make public performances of Program X, and publicly display Program X. Corp B will pay Corp A a royalty of $y a year for three years, which is the expected period during which Program X will have commercially exploitable value (a period shorter than the copyright term). Corp A has ascertained that the primary benefit or value from the transaction to Corp B is derived from the four legal rights obtained in Program X from Corp A and not from the receipt of a copy of Program X. The transfer of a copy of Program X is merely the means by which Corp A provides Corp B access to Program X in order to exercise its copyright rights.

(ii) Analysis. (A) The transaction between Corp A and Corp B has multiple elements. One element is the transfer of a disk with a copy of Program X, which would be a digital content transaction described under paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant of the right to make an unlimited number of copies of Program X and distribute those copies to the public, the right to prepare derivative works based upon Program X, the right to make public performances of Program X, and the right to publicly display Program X, which would be described under paragraphs (b)(1)(i) and (c)(2) of this section (transfer of a copyright right) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3)(i) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore the transfer of copyright rights because the primary benefit or value received by Corp B from the transaction is the ability to exercise the copyright rights described in paragraph (c)(2) of this section. Therefore, this transaction is classified solely as a transfer of copyright rights described in paragraph (b)(1)(i) of this section.

(C) Applying the all substantial rights test under paragraph (f)(1) of this section, Corp A will be treated as having sold copyright rights to Corp B. Corp B has acquired all of the copyright rights in Program X, has received the right to use them exclusively within Country Z, and has received the rights for the remaining life of the copyright in Program X. The fact that the payments cease before the copyright term expires is not controlling. Under paragraph (g)(1) of this section, the fact that the agreement is labelled a license is not controlling nor is the fact that Corp A receives a sum labelled a royalty. (The result in this case would be the same if the copy of Program X to be used for the purposes of reproduction were transmitted electronically to Corp B, as a result of the application of the rule of paragraph (g)(2) of this section.)

(6) Example 6: License of copyright right to make copies of a computer program and distribute to the public¡ª(¾±) Facts. Corp A transfers a disk containing Program X to Corp B, a Country Z corporation, and grants Corp B the non-exclusive right to reproduce and distribute for sale to the public an unlimited number of disks containing Program X at its factory in Country Z in return for a payment related to the number of disks copied and sold. The term of the agreement is two years, which is less than the remaining life of the copyright. Corp A has ascertained that the primary benefit or value from the transaction to Corp B is derived from the right to reproduce and distribute Program X and not from the receipt of a copy of Program X. The transfer of a copy of Program X is merely the means by which Corp A provides Corp B access to Program X in order to exercise its copyright rights.

(ii) Analysis. (A) The transaction between Corp A and Corp B has multiple elements. One element is the transfer of a disk with a copy of Program X, which would be described under paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant of the right to reproduce and distribute for sale to the public an unlimited number of disks containing Program X, which would be described under paragraphs (b)(1)(i) and (c)(2)(i) of this section (transfer of a copyright right) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore the transfer of a copyright right because the primary benefit or value received by Corp B is the right to reproduce and distribute for sale to the public copies of Program X. Therefore, this transaction is classified solely as a transfer of copyright rights described in paragraph (b)(1)(i) of this section.

(C) Taking into account all of the facts and circumstances, there has been a license of Program X to Corp B. Under paragraph (f)(1) of this section, there has not been a transfer of all substantial rights in the copyright to Program X because Corp A has the right to enter into other licenses with respect to the copyright of Program X, including licenses in Country Z (or even to sell that copyright, subject to Corp B¡¯s interest). Corp B has acquired no right itself to license the copyright rights in Program X. Finally, the term of the license is for less than the remaining life of the copyright in Program X.

(7) Example 7: Sale of disks containing copies of a computer program to a distributor¡ª(¾±) Facts. Corp C, a distributor, enters into an agreement with Corp A to purchase as many copies of Program X on disk as it may from time-to-time request. Corp C will then sell these disks to retailers. The disks are shipped in boxes covered by shrink-wrap licenses (identical to the license described in paragraph (h)(1) of this section (Example 1)).

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the transfers of disks with copies of Program X from Corp A to Corp C are digital content transactions with one element, which is the transfer of copies of Program X. Therefore, the transactions are classified solely as the transfer of copyrighted articles under paragraph (b)(1)(ii) of this section. The use of the term license is not dispositive under paragraph (g)(1) of this section.

(B) Taking into account all of the facts and circumstances, Corp C is properly treated as the owner of copyrighted articles. Therefore, under paragraph (f)(2) of this section, there has been a sale of copyrighted articles.

(8) Example 8: License to a computer manufacturer of copyright rights to make and load copies of a computer program onto the hard drive of computers¡ª(¾±) Facts. Corp A transfers a disk containing Program X to Corp D, a foreign corporation engaged in the manufacture and sale of personal computers in Country Z. Corp A grants Corp D the non-exclusive right to copy Program X onto the hard drive of an unlimited number of computers, which Corp D manufactures, and to distribute those copies (on the hard drive) to the public. The term of the agreement is two years, which is less than the remaining life of the copyright in Program X. Corp D pays Corp A an amount based on the number of copies of Program X it loads on to computers. Corp A has ascertained that the primary benefit or value from the transaction to Corp D is the ability to copy and distribute Program X onto computers manufactured by Corp D, not from the receipt of a copy of Program X. The transfer of a copy of Program X is merely the means by which Corp A provides Corp D access to Program X in order to exercise its right to make and distribute copies.

(ii) Analysis. (A) The transaction between Corp A and Corp D has multiple elements. One element is the transfer of a disk with a copy of Program X, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant of the non-exclusive right to copy Program X onto the hard drive of an unlimited number of computers and distribute those copies (on the hard drive) to the public, which would be described in paragraphs (b)(1)(i) and (c)(2)(i) of this section (transfer of a copyright right) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore the transfer of copyright rights because the primary benefit or value received by Corp D is the right to copy Program X onto the hard drive of an unlimited number of computers and sell those copies (on the hard drive) to the public. Therefore, this transaction is classified solely as a transfer of copyright rights described in paragraph (b)(1)(i) of this section.

(C) Taking into account all of the facts and circumstances, there has been a license of Program X to Corp D. Under paragraph (f)(1) of this section, there has not been a transfer of all substantial rights in the copyright to Program X because Corp A has the right to enter into other licenses with respect to the copyright of Program X, including licenses in Country Z (or even to sell that copyright, subject to Corp D¡¯s interest). Corp D has acquired no right itself to license the copyright rights in Program X. Finally, the term of the license is for less than the remaining life of the copyright in Program X. The result would be the same if Corp D included with the computers it sells a copy of Program X on a disk.

(9) Example 9: Sale of disks containing a copy of computer program to a computer manufacturer¡ª(¾±) Facts. The facts are the same as those in paragraph (h)(8) of this section (Example 8), except that Corp D, the Country Z corporation, receives physical disks. The disks are shipped in boxes covered by shrink-wrap licenses (identical to the licenses described in paragraph (h)(1) of this section (Example 1)). The terms of these licenses do not permit Corp D to make additional copies of Program X. Corp D uses each individual disk only once to load a single copy of Program X onto each separate computer. Corp D transfers the disk with the computer when it is sold.

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the transfers of disks with copies of Program X from Corp A to Corp D are digital content transactions with one element, which is the transfer of copies of Program X. Therefore, the transaction is classified solely as the transfer of copyrighted articles under paragraph (b)(1)(ii) of this section. Corp D acquires the disks without the right to reproduce and distribute publicly further copies of Program X.

(B) Taking into account all of the facts and circumstances, Corp D is properly treated as the owner of copyrighted articles. Therefore, under paragraph (f)(2) of this section, the transaction is classified as the sale of a copyrighted article. The result would be the same if Corp D used a single physical disk to copy Program X onto each computer, and transferred an unopened box containing Program X with each computer, if Corp D were not permitted to copy Program X onto more computers than the number of individual copies purchased.

(10) Example 10: Sale of a computer program with right to load onto multiple employee workstations¡ª(¾±) Facts. Corp A transfers a disk containing Program X to Corp E and grants Corp E the right to load Program X onto 50 individual workstations for use only by Corp E employees at one location in return for a one-time per-user fee (generally referred to as a site license or enterprise license). If additional workstations are subsequently introduced, Program X may be loaded onto those machines for additional one-time per-user fees. The license which grants the rights to operate Program X on 50 workstations also prohibits Corp E from selling the disk (or any of the 50 copies) or reverse engineering the program. The term of the license is stated to be perpetual.

(ii) Analysis. (A) It must be determined whether the transfer from Corp A to Corp E of a disk containing a copy of Program X and the right to load Program X onto 50 individual workstations is a transaction with multiple elements. There is at least one element, which is the transfer of a disk containing a copy of Program X, which either is a digital content transaction under paragraph (b)(1) of this section or would be a digital content transaction if considered separately. If there is no additional element, then the transaction is classified as a transfer of a copyrighted article pursuant to paragraph (b)(1)(ii) of this section. If there is a second element, then paragraph (b)(2) of this section applies and the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. The grant of a right to copy, unaccompanied by the right to distribute those copies to the public, is not the transfer of a copyright right described in paragraph (c)(2) of this section. Therefore, there is no second element in this transaction and it is classified solely as the transfer of copyrighted articles (50 copies of Program X).

(B) Taking into account all of the facts and circumstances, Corp E is properly treated as the owner of copyrighted articles. Therefore, under paragraph (f)(2) of this section, there has been a sale of copyrighted articles rather than the grant of a lease. Notwithstanding the restriction on sale, other factors such as, for example, the risk of loss and the right to use the copies in perpetuity outweigh, in this case, the restrictions placed on the right of alienation.

(C) The result would be the same if Corp E were permitted to copy Program X onto an unlimited number of workstations used by employees of either Corp E or other persons that had a relationship to Corp E specified in paragraph (g)(3) of this section.

(11) Example 11: Sale of a computer program with right to make available to multiple employees via local area network¡ª(¾±) Facts. The facts are the same as those in paragraph (h)(10) of this section (Example 10), except that Corp E, the Country Z corporation, acquires the right to make Program X available to workstation users who are Corp E employees by way of a local area network (LAN). The number of users that can use Program X on the LAN at any one time is limited to 50. Corp E pays a one-time fee for the right to have up to 50 employees use the program at the same time.

(ii) Analysis. Under paragraph (g)(2) of this section the mode of utilization is irrelevant. Therefore, as in paragraph (h)(10) of this section (Example 10), this is a digital content transaction with a single element that is classified as the transfer of a copyrighted article pursuant to paragraph (b)(1)(ii) of this section. Under the benefits and burdens test of paragraph (f)(2) of this section, this transaction is a sale of copyrighted articles. The result would be the same if an unlimited number of Corp E employees were permitted to use Program X on the LAN or if Corp E were permitted to copy Program X onto LANs maintained by persons that had a relationship to Corp E specified in paragraph (g)(3) of this section.

(12) Example 12: Lease of a computer program with right to receive upgrades and technical support services¡ª(¾±) Facts. The facts are the same as in paragraph (h)(11) of this section (Example 11), except that instead of paying a one-time fee, Corp E pays a monthly fee to Corp A calculated with reference to the permitted maximum number of users (which can be changed) and the computing power of Corp E¡¯s server. In return for this monthly fee, Corp E receives the right to receive upgrades of Program X when they become available. The agreement may be terminated by either party at the end of any month. When the disk containing the upgrade is received, Corp E must return the disk containing the earlier version of Program X to Corp A. If the contract is terminated, Corp E must delete (or otherwise destroy) all copies made of the current version of Program X. The agreement also requires Corp A to provide technical support in the form of troubleshooting and configuration assistance to Corp E, but the agreement does not allocate the monthly fee between the right to use Program X, the right to receive upgrades of Program X, and the technical support services. The amount of technical support that Corp A will provide to Corp E is not foreseeable when the contract is entered into but is expected to be minimal. Corp A has ascertained that the primary benefit or value to Corp E from the transaction is the right to use Program X on the LAN (without the ability to exercise any of the rights described in paragraphs (c)(2)(i) through (iv) of this section), not the receipt of technical support services with respect to Program X.

(ii) Analysis. (A) The transaction between Corp A and Corp E has multiple elements. One element is the transfer of a disk with a copy of Program X, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the provision of technical support services, which are not services for the development or modification of Program X described in paragraph (d) of this section because Corp E has received no copyright rights with respect to Program X. Thus, the technical support services would not be described in any of the categories in paragraph (b)(1) of this section if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer. The predominant character of this transaction is therefore the transfer of a copyrighted article because the primary benefit or value received by Corp E is the right to use Program X. Accordingly, this transaction is classified solely as a transfer of a copyrighted article described in paragraph (b)(1)(ii) of this section.

(C) Taking into account all facts and circumstances, under the benefits and burdens test Corp E is not properly treated as the owner of the copyrighted article. Corp E does not receive the right to use Program X in perpetuity, but only for so long as it continues to make payments. Corp E does not have the right to purchase Program X on advantageous (or, indeed, any) terms once a certain amount of money has been paid to Corp A or a certain period has elapsed (which might indicate a sale). Once the agreement is terminated, Corp E will no longer possess any copies of Program X, current or superseded. Therefore, under paragraph (f)(2) of this section there has been a lease of a copyrighted article.

(13) Example 13: Sale of a computer program along with right to receive upgrades¡ª(¾±) Facts. The facts are the same as those in paragraph (h)(12) of this section (Example 12), except that, while Corp E must return copies of Program X as new upgrades are received, if the agreement terminates, Corp E may keep the latest version of Program X (although Corp E is still prohibited from selling or otherwise transferring any copy of Program X).

(ii) Analysis. For the reasons stated in paragraph (h)(10)(ii)(B) of this section (Example 10), the transfer of the program will be treated as a sale of a copyrighted article rather than as a lease.

(14) Example 14: Sale of a modified computer program¡ª(¾±) Facts. Corp G enters into a contract with Corp A for Corp A to modify Program X so that it can be used at Corp G¡¯s facility in Country Z. Under the contract, Corp G is to acquire one copy of the program on a disk and the right to use the program on 5,000 workstations. The contract requires Corp A to rewrite elements of Program X so that it will conform to Country Z accounting standards and states that Corp A retains all copyright rights in the modified Program X. The agreement between Corp A and Corp G is otherwise identical as to rights and payment terms as the agreement described in paragraph (h)(10) of this section (Example 10).

(ii) Analysis. (A) It must be determined whether the transfer of disks with modified copies of Program X from Corp A to Corp G is a transaction with multiple elements. There is at least one element, the transfer of copies of Program X, which either is a digital content transaction under paragraph (b)(1) of this section or would be a digital content transaction if considered separately. If there is no additional element, then the transaction is classified as a transfer of a copyrighted article pursuant to paragraph (b)(1)(ii) of this section. If there is a second element, then paragraph (b)(2) of this section applies and the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (d) of this section, the modifications made by Corp A before transferring Program X to Corp G do not constitute the provision of services for the development or modification of digital content because Corp A retains all copyright rights with respect to the modified software. Therefore, there is no second element in this transaction and it is classified solely as the transfer of copyrighted articles.

(B) Taking into account all facts and circumstances, Corp G is properly treated as the owner of copyrighted articles. Therefore, under paragraph (f)(2) of this section, there has been the sale of a copyrighted article rather than the grant of a lease.

(15) Example 15: Provision of services for development of a computer program¡ª(¾±) Facts. Corp H enters into a license agreement for a new computer program. Program Q is to be written by Corp A. Corp A and Corp H agree that Corp A is writing Program Q for Corp H and that, when Program Q is completed, the copyright in Program Q will belong to Corp H. Corp H gives instructions to Corp A programmers regarding program specifications. Corp H agrees to pay Corp A a fixed monthly sum during development of the program. If Corp H is dissatisfied with the development of the program, it may cancel the contract at the end of any month. In the event of termination, Corp A will retain all payments, while any procedures, techniques or copyrightable interests will be the property of Corp H. All of the payments are labelled royalties. There is no provision in the agreement for any continuing relationship between Corp A and Corp H, such as the furnishing of updates of the program, after completion of the modification work.

(ii) Analysis. Under paragraph (b)(1) of this section, the provision of computer program development services by Corp A to Corp H is a digital content transaction with one element, which is the provision of services for the development or modification of digital content. Under paragraph (d) of this section, the transaction between Corp A and Corp H involves the provision of services for the development of a computer program because Corp H bears all of the risks of loss associated with the development of Program Q and is the owner of all copyright rights in Program Q. Taking into account all of the facts and circumstances, Corp A is treated as providing services to Corp H described in paragraph (b)(1)(iii) of this section. Under paragraph (g)(1) of this section, the fact that the agreement is labelled a license is not controlling (nor is the fact that Corp A receives a sum labelled a royalty).

(16) Example 16: Provision of know-how by computer programmers¡ª(¾±) Facts. Corp A and Corp I, a Country Z corporation, agree that a development engineer employed by Corp A will travel to Country Z to provide know-how relating to certain techniques not generally known to computer programmers, which will enable Corp I to more efficiently create computer programs. These techniques represent the product of experience gained by Corp A from working on many computer programming projects, and are furnished to Corp I under nondisclosure conditions. Such information is property subject to trade secret protection.

(ii) Analysis. The provision of know-how with respect to computer programming techniques by Corp A¡¯s development engineer to Corp I is described in paragraph (e) of this section. Therefore, the transaction is a digital content transaction with one element, which is the provision of know-how. The transaction is classified solely as the provision of know-how pursuant to paragraph (b)(1)(iv) of this section.

(17) Example 17: Sale of development program in transaction with multiple elements¡ª(¾±) Facts. Corp A transfers a disk containing Program Y to Corp E in exchange for a single fixed payment. Program Y is a computer program development program, which is used to create other computer programs, consisting of several components, including libraries of reusable software components that serve as general building blocks in new software applications. Because a computer program created with the use of Program Y will not operate unless the libraries are also present, the license agreement between Corp A and Corp E grants Corp E the right to distribute copies of the libraries with any program developed using Program Y. The license agreement is otherwise identical to the license agreement in paragraph (h)(1) of this section (Example 1). Corp A cannot reasonably ascertain the primary benefit or value of the transaction to Corp E. A customer like Corp E derives two benefits from this or a substantially similar transaction, the first of which is the ability to use Program Y to develop new software and the second of which is the right to utilize the libraries and reusable software components in Program Y in distributed programs. Corp A possesses data arising from market research and customer surveys indicating that customers utilize Program Y primarily for its computer program development features and do not make significant use of the libraries of reusable software components. The libraries and reusable software components are not significant components of any overall new program created by using Program Y.

(ii) Analysis. (A) The transaction between Corp A and Corp E has multiple elements. One element is the transfer of a disk with a copy of Program Y, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant of the right to distribute copies of the libraries of reusable software components with any program developed using Program Y, which would be described in paragraphs (b)(1)(i) and (c)(2)(i) of this section (transfer of a copyright right) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3)(i) of this section, the predominant character of a transaction is generally based on the primary benefit or value of the transaction to the customer. If the primary benefit or value is not reasonably ascertainable, paragraph (b)(3)(ii) of this section provides that the predominant character of a transaction may be determined based on the primary benefit or value to a typical customer of a substantially similar transaction. This primary benefit or value to a typical customer can be identified through actual data about use or access pursuant to paragraph (b)(3)(ii)(A) of this section, or if that data is not available, by other evidence indicative of the primary benefit or value to a typical customer pursuant to paragraph (b)(3)(ii)(B) of this section. Although there are two benefits in this type of transaction, Corp A possesses data indicating that a typical customer primarily uses Program Y because of its computer program development features, rather than the right to distribute reusable components. This is reinforced by the fact that programs created using Program Y do not contain libraries of reusable software components as significant components. These facts indicate that the primary benefit or value to a typical customer arises from the ability to use Program Y, rather than the right to distribute reusable components. Therefore, the predominant character of this transaction is the transfer of a copy of Program Y, and this transaction is thus classified solely as the transfer of a copyrighted article described in paragraph (b)(1)(ii) of this section.

(C) Taking into account all the facts and circumstances, Corp E is properly treated as the owner of a copyrighted article. Therefore, under paragraph (f)(2) of this section, there has been the sale of a copyrighted article rather than the grant of a lease.

(18) Example 18: Sale of a computer program with right to make modifications¡ª(¾±) Facts. Corp A transfers a disk containing Program X to Corp E. The disk contains both the object code and the source code to Program X, and the license agreement grants Corp E the right to modify the source code to correct minor errors and make minor adaptations to Program X so it will function on Corp E¡¯s computer; as well as the right to recompile the modified source code. The license does not grant Corp E the right to distribute the modified Program X to the public. The license is otherwise identical to the license agreement in paragraph (h)(1) of this section (Example 1). Corp A has ascertained that the primary benefit or value received by Corp E from the transaction is the core functionality of Program X rather than the limited rights to modify the source code.

(ii) Analysis. (A) The transaction between Corp A and Corp E has multiple elements. One element is the transfer of a disk with a copy of Program X, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant of the right to modify the source code to Program X and recompile the modified source code to create new code to correct minor errors, and to make minor adaptations to Program X, which would be described in paragraphs (b)(1)(i) and (c)(2)(ii) of this section (transfer of a copyright right) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under the categories described under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. Since the primary benefit or value received by Corp E is the core functionality of Program X, rather than the limited rights to modify the source code, the predominant character of this transaction is the transfer of a copyrighted article. Therefore, this transaction is classified solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section.

(C) Taking into account all the facts and circumstances, Corp E is properly treated as the owner of a copyrighted article. Therefore, under paragraph (f)(2) of this section, there has been the sale of a copyrighted article rather than the grant of a lease.

(19) Example 19: License to website operator to make and sell copies of electronic books via download¡ª(¾±) Facts. Corp A operates a website that offers electronic books for download onto customers¡¯ computers or other electronic devices. The books offered are protected by copyright law. In a transaction between Corp A and a content owner, Corp A receives from the content owner a digital master copy of a book, which Corp A downloads onto its server. Corp A receives the non-exclusive right to reproduce an unlimited number of copies of the book for purposes of distribution and sale to the public. Corp A pays the content owner a specified amount for each copy sold to a customer. Corp A may not transfer any of the rights it receives from the content owner. The term of the agreement Corp A has with the content owner is shorter than the remaining life of the copyright. The content owner has ascertained that the primary benefit or value Corp A receives in the transaction is the right to reproduce and distribute an unlimited number of copies of the book and not the transfer of a copy of the book. In a separate transaction, Corp A charges a customer a fixed fee for each book purchased. When purchasing a book from Corp A on Corp A¡¯s website, the customer must acknowledge the terms of a license agreement with the content owner that states that the customer may download and view the electronic book in perpetuity but may not reproduce, distribute, or sell copies of it. Once the customer downloads the book from Corp A¡¯s server onto a device, the customer may access and view the book from that device, which does not need to be connected to the Internet for the customer to view the book. The customer owes no additional payment to Corp A for the ability to view the book in the future.

(ii) Analysis. (A) Notwithstanding the license agreement between each customer and the content owner granting the customer rights to use the book, the relevant transactions are the transfer of a master copy of the book along with the grant from the content owners to Corp A of the right to reproduce and sell to the public copies of the books, and the transfers of copies of the books by Corp A to customers. Although the content owner is identified as a party to the license agreement memorializing the customer¡¯s rights with respect to the book, each customer obtains those rights directly from Corp A, not from the content owner. Under paragraph (b)(1) of this section, the download of a copy of a book by a customer is a digital content transaction with one element, which is the transfer of a digital copy of a book. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Under the benefits and burdens test of paragraph (f)(2) of this section, the transaction is classified as a sale and not a lease, because the customer receives the right to view the book in perpetuity on its device.

(B) The transaction between the content owner and Corp A has multiple elements. One element is the transfer of a master copy of the book, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant of the right to reproduce and sell an unlimited number of copies to customers, which would be described in paragraphs (b)(1)(i) and (c)(2)(i) of this section (transfer of a copyright right) if considered separately. Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under the categories described under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. Since the primary benefit or value Corp A receives in the transaction is the right to reproduce and distribute an unlimited number of copies, the predominant character of this transaction is the transfer of a copyright right. Therefore, this transaction is classified solely as a transfer of copyright rights described in paragraph (b)(1)(i) of this section.

(C) Taking into account all of the facts and circumstances, there has been a license of books to Corp A. Under paragraph (f)(1) of this section, there has not been a transfer of all substantial rights in the copyright rights to the books because each content owner has the right to enter into other licenses with respect to the copyright of their book. Corp A has acquired no right itself to license the copyrights in the books. Finally, the terms of the licenses are for less than the remaining lives of the copyrights in the books.

(20) Example 20: Internet platform operator as agent for application developers¡ª(¾±) Facts. Corp A operates a platform on the Internet that offers applications for download onto a customer¡¯s mobile phone. Under general tax principles, Corp A and an application developer establish an agency relationship whereby Corp A acts as the agent to offer the application for sale to customers on behalf of the application developer. The applications are protected by copyright law. Under the agreement between Corp A and the application developer, Corp A agrees to provide the application developer with platform and agency services to facilitate the sale of the application to customers. Corp A also provides the application developer with hosting services to host the application on Corp A¡¯s servers for download by the customers. Corp A receives a digital master copy of the application along with a non-exclusive right to make copies of the application and allow customers to download copies of the application from Corp A¡¯s platform. Corp A has ascertained that the primary benefit or value from the transaction received by the application developer is the platform and agency services that Corp A provides. Corp A receives the right to make copies of the application merely to perform its activities as an agent on behalf of the application developer. When purchasing an application on Corp A¡¯s platform, the customer must acknowledge the terms of a license agreement with the application developer that states that the customer may use the application but may not reproduce or distribute copies of it. In addition, the agreement provides that the customer may download the application onto only one mobile phone at a time. A customer does not need to be connected to the Internet to access the application. The customer owes no additional payment to Corp A or the application developer for the ability to use the application in perpetuity. Corp A retains a fixed percentage of each purchase price of the application and remits the remaining balance to the application developer.

(ii) Analysis. (A) The transaction between Corp A and the application developer has multiple elements. One element is the transfer of a master copy of an application by the application developer to Corp A, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the transfer of the right to make and distribute copies of the application by the application developer to Corp A, which would be described in paragraphs (b)(1)(i) and (c)(2) of this section (transfer of a copyright right) if considered separately. A third element is the platform and agency services provided by Corp A to the application developer, which would not be described in this section if considered separately. A fourth element is the hosting services provided by Corp A to the application developer, which would be described in ¡ì1.861-19 if considered separately. Under the facts and circumstances, although Corp A receives a copy of the application and the right to make and distribute copies of the application, Corp A receives this copy and right merely to facilitate the sale of applications on behalf of the application developer.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under the categories described under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. Since the primary benefit or value the application developer receives in the transaction is the platform and agency services, the predominant character of this transaction is the platform and agency services and not a digital content transaction nor a cloud transaction.

(C) The transfer of a copy of an application from the application developer to a customer is a digital content transaction with one element, which is the transfer of a copy of a digital program. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Under the benefits and burdens test of paragraph (f)(2) of this section, this transaction is a sale of a copyrighted article because a customer has the right to use the application in perpetuity.

(21) Example 21: Movies and TV shows available for stream, rent, or purchase¡ª(¾±) Facts. Corp A offers a catalog of movies and TV shows, all of which are subject to copyright protection. Corp A gives customers several options for viewing the content, each of which has a separate price. A ¡°streaming¡± option allows a customer to view the video, which is hosted on Corp A¡¯s servers, while connected to the Internet for as many times as the customer wants during a limited period. A ¡°rent¡± option allows a customer to download the video to its computer or other electronic device (which does not need to be connected to the Internet for viewing) and watch the video as many times as the customer wants for a limited period, after which an electronic lock is activated and the customer may no longer view the content. A ¡°purchase¡± option allows a customer to download the video and view it as many times as the customer chooses with no end date. Under all three options, the customer may view the video but may not reproduce or distribute copies of it, prepare derivative works based on it, or publicly display it.

(ii) Analysis. (A) With respect to the ¡°rent¡± option, under paragraph (b)(1) of this section the download of a video by a customer is a digital content transaction with one element, which is the transfer of a copy of the video. Therefore, the transaction is treated solely as the transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Although a customer will retain a copy of the content at the end of the payment term, the customer cannot access the content after the electronic lock is activated. The activation of the electronic lock is the equivalent of having to return the copy. Therefore, the transaction is classified as a lease of a copyrighted article under paragraph (f)(2) of this section because the customer¡¯s right to view the videos is for a limited period.

(B) With respect to the ¡°purchase¡± option, under paragraph (b)(1) of this section the download of a video by a customer is a digital content transaction with one element, which is the transfer of a copy of the video. Therefore, the transaction is treated solely as the transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. The transaction is classified as a sale of a copyrighted article under paragraph (f)(2) of this section because the customer receives the right to view the videos in perpetuity.

(C) With respect to the ¡°streaming¡± option, the transaction is Corp A¡¯s grant of the right to its customers to view the movies or shows while connected to the Internet for a limited period. There is no transfer of any copyright rights described in paragraph (c)(2) of this section. There is also no transfer of a copyrighted article because the content is not downloaded by a customer, but rather, is accessed through an on-demand network. The transaction also does not constitute the provision of services for the development of digital content or the provision of know-how under paragraph (b)(1) of this section. Therefore, the transaction is not a digital content transaction described in paragraph (b)(1) of this section. Instead, the transaction is a cloud transaction that is classified under ¡ì1.861-19. See ¡ì1.861-19(b).

(22) Example 22: Website offering third-party videos via stream¡ª(¾±) Facts. Corp A operates a website that allows customers to stream videos that third-party content creators upload to Corp A¡¯s website. Corp A has advertising contracts with third-party advertisers pursuant to which Corp A earns advertising revenue when a customer views a video. Customers can either stream videos for free with advertisements or can pay a subscription fee to stream videos without advertisements. Under the contract between Corp A and content creators, content creators retain all ownership rights in their videos and must own or have the necessary rights to publish their videos. The contract also states that content creators grant Corp A a non-exclusive license to use, reproduce, distribute, and display their videos in connection with Corp A¡¯s website, and grant customers a non-exclusive license to view the videos. These licenses terminate within a commercially reasonable time after a content creator removes or deletes a video from Corp A¡¯s website. Content creators have ascertained that the primary benefit or value Corp A receives from transactions with content creators is the right to use, reproduce, distribute, and display their videos. Corp A pays content creators a percentage of advertising revenue generated from the videos and a percentage of subscription fees.

(ii) Analysis. (A) The transaction between Corp A and the content creators has multiple elements. One element is the uploading of a video by a content creator, which would be described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the grant by content creators to Corp A of the right to use, reproduce, distribute, and display their videos, which would be described in paragraph (b)(1)(i) of this section (transfer of a copyright right) if considered separately. Content creators are not providing content development services to Corp A under paragraph (d) of this section because content creators own the copyright rights in the videos.

(B) Because the transaction has multiple elements, one or more of which would be a digital content transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under the categories described under paragraph (b)(1) of this section if its predominant character is described in that paragraph. Pursuant to paragraph (b)(3) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer. The predominant character of the transaction is therefore the transfer of copyright rights because the primary benefit or value received by Corp A is the right to use, reproduce, distribute, and display videos. Accordingly, this transaction is characterized solely as a transfer of a copyright right as described in paragraphs (b)(1)(i) of this section.

(C) Taking into account all of the facts and circumstances, there has been a license of videos to Corp A. Under paragraph (f)(1) of this section, there has not been a transfer of all substantial rights in the copyright rights to the videos because each content owner has the right to enter into other licenses with respect to the copyright of their videos. Corp A has acquired no right itself to license the copyrights in the videos. Finally, the terms of the licenses are for less than the remaining lives of the copyrights in the videos.

(D) For both the free streaming and subscription streaming transactions between Corp A and customers, there is no transfer of any copyright rights described in paragraph (c)(2) of this section. There is also no transfer of a copyrighted article, because the content is not downloaded by a customer, but rather is accessed through an on-demand network. The transactions also do not constitute the provision of services for the development of digital content or the provision of know-how under paragraph (b)(1) of this section. Therefore, paragraph (b)(1) of this section does not apply to such transactions. Instead, both transactions are cloud transactions that are classified under ¡ì1.861-19. See ¡ì1.861-19(b).

(23) Example 23: Sale of computer programs electronically through a reseller¡ª(¾±) Facts. Corp A owns the copyright to software (Program S). Corp A hosts Program S on its servers. Corp A grants Corp B, a foreign corporation wholly owned by Corp A, the right to distribute copies of Program S (without the right to reproduce copies of Program S) to Corp B¡¯s customers that are located in Corp B¡¯s country. Under the agreement between Corp A and Corp B, Corp B pays Corp A a fixed fee for each copy of Program S that Corp A delivers to a customer. In separate transactions, customers pay Corp B for the right to receive digital copies of Program S that they may then use in perpetuity without further payment. Corp B is responsible for managing the purchase/sale interaction with Corp B¡¯s customers, including invoicing and collections. Corp A is responsible for creating and delivering the digital copies of Program S to Corp B¡¯s customers from Corp A¡¯s servers. Corp B does not perform any functions to provide access to Program S.

(ii) Analysis. (A) Although there is a single contract between Corp A and Corp B that grants a legal right to Corp B with respect to Program S, that right (the right to distribute) is not a copyright right described in paragraphs (b)(1)(i) and (c)(2) of this section. Instead, the transactions between Corp A and Corp B and then Corp B and its customers are functionally and economically equivalent to back-to-back transfers of copyrighted articles. The transfers are only superficially different from those described in paragraph (h)(24) of this section (Example 24) where the reseller acquires product keys and sells them on to customers. Therefore, each sale of a copy of Program S by Corp B to a customer should be viewed as a transfer of a copyrighted article from Corp A to Corp B and then from Corp B to the customer.

(B) The transaction between Corp A and Corp B is a digital content transaction with a single element that is classified as a transfer of a copyrighted article described in paragraph (b)(1)(ii) of this section. There are no additional elements because Corp B¡¯s receipt of the right to distribute copies of Program S (without the right to make copies) is not a copyright right described in paragraph (c)(2) of this section. Under the benefits and burdens test of paragraph (f)(2) of this section, the transfer is classified as the sale of a copyrighted article.

(C) The transaction between Corp B and a customer is a digital content transaction with a single element that is classified as a transfer of a copyrighted article described in paragraph (b)(1)(ii) of this section. Under the benefits and burdens test of paragraph (f)(2) of this section, this transaction is a sale of a copyrighted article because the customer has the right to use the application in perpetuity.

(24) Example 24: Sale of video games with online and offline functionality through retailers using digital keys¡ª(¾±) Facts. Corp A owns the copyright in a computer program (Program Y). Corp A creates digital keys that allow for the download of one copy of Program Y from Corp A¡¯s website. Corp A sells these digital keys to retailers for a one-time fee per key, and the retailers do not use Program Y, but instead sell them in separate transactions to customers for a one-time fee per key. Corp A ascertains that the primary benefit or value to retailers from the purchase of digital keys from Corp A is the right to further transfer the digital keys to customers. The retailers cannot reasonably ascertain the primary benefit or value that their specific customers derive from Program Y, nor is there data available to the retailers about how their customers typically use Program Y. Program Y is a video game that contains online and offline features, both of which can be played without paying an additional game-specific cost after paying the one-time fee to purchase a key. The offline feature is comprised of a single-player story that does not require any Internet connection to play. The online feature is comprised of the ability to play competitive matches against other players that are hosted on servers owned by Corp A. The competitive matches require an ongoing connection to the Internet to play. Neither the customers nor the retailer receives any copyright rights described in paragraph (c)(2) of this section with respect to Program Y. Customers can use Program Y in perpetuity. Program Y is primarily marketed as a single-player game in television and online advertising, with only brief mentions of the multiplayer mode in print advertising. The development cost for Program Y was allocated 40% to developing the single-player content, 20% to developing the multiplayer content, and 40% to developing content that is used by both types of content (e.g., cost of developing the game engine).

(ii) Analysis. (A) The transaction between Corp A and a retailer has multiple elements. One element is the transfer of a key with the right to download a copy of Program Y for use to play the offline story, which would be a digital content transaction described in paragraph (b)(1)(ii) of this section (transfer of a copyrighted article) if considered separately. Another element is the transfer of the same key with a copy of Program Y providing on-demand network access to digital content in the form of competitive multiplayer functionality, which would be a cloud transaction described in ¡ì1.861-19(b) if considered separately.

(B) Because the transaction has multiple elements, one of which would be a digital content transaction if considered separately and one of which would be a cloud transaction if considered separately, paragraph (b)(2) of this section provides that the transaction is classified within a single category under paragraph (b)(1) of this section if its predominant character is described in that paragraph, or the transaction is classified solely as a cloud transaction if its predominant character is a cloud transaction pursuant to ¡ì1.861-19(c)(2). Pursuant to paragraph (b)(3)(i) of this section, the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore the transfer of copyrighted articles because the primary benefit or value received by a retailer is the right to further transfer the same copyrighted articles to customers in the form of digital keys. The retailers do not have any intent to utilize the cloud functionality of the digital keys, although they do have the right to do so. Therefore, this transaction is classified solely as a transfer of copyrighted articles described in paragraph (b)(1)(ii) of this section.

(C) Under the benefits and burdens test of paragraph (f)(2) of this section, the transfer between Corp A and a retailer is classified as the sale of a copyrighted article because the retailer has the right to use, or sell, Program Y in perpetuity without further payment.

(D) The transfer of a key (with the right to download a copy of Program Y) by a retailer to a customer also contains the same two elements as each transaction between Corp A and a retailer. However, a retailer cannot reasonably ascertain the primary benefit or value derived by a specific customer from Program Y. In such situations, paragraph (b)(3)(ii) of this section provides that the predominant character of a transaction may be determined based on the primary benefit or value to a typical customer of a substantially similar transaction. This primary benefit or value to a typical customer can be identified through actual data about use or access pursuant to paragraph (b)(3)(ii)(A) of this section, or if that data is not available, by using other evidence indicative of the primary benefit or value to a typical customer pursuant to paragraph (b)(3)(ii)(B) of this section. Because the retailers do not have available data about how customers use Program Y, they may use the marketing with respect to Program Y to determine that its predominant character is that of a transfer of a copyrighted article described in paragraph (b)(1)(ii) of this section. The relative development costs of the offline and online components of the game could also be used if they are known to a retailer. Therefore, the transfer between a retailer and a customer of a digital key containing the right to download a copy of Program Y is classified solely as a transfer of a copyrighted article.

(E) Under the benefits and burdens test of paragraph (f)(2) of this section, the transfer between a retailer and a customer is classified as the sale of a copyrighted article because the customer has the right to use Program Y in perpetuity without further payment.

(25) Example 25: Source of income from the sale of a copyrighted article transferred through an electronic medium¡ª(¾±) Facts. Corp A is the parent company of a world-wide group of affiliated companies. Corp B is a foreign corporation wholly owned by Corp A. In the ordinary course of business, Corp B acts as a procurement hub for Corp A¡¯s affiliated companies. In this role, Corp B regularly purchases products that will be distributed amongst Corp A¡¯s affiliated companies to be used by them in their respective businesses. Corp B purchases digital copies of a computer program (Program Y) from Corp C, an unrelated company. Corp B may use Program Y in perpetuity without further payment. Corp B receives no copyright rights in Program Y. Corp B does not use Program Y, and instead distributes all of its copies of Program Y to various affiliates. Corp C sources income from the sale of Program Y using sections 861(a)(6) and 862(a)(6).

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the transfer of Program Y from Corp C to Corp B is a digital content transaction with one element, which is the transfer of a copy of Program Y. Therefore, the transaction is treated solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Taking into account all of the facts and circumstances, there have been sales of copies of Program Y to Corp B under paragraph (f)(2) of this section.

(B) Income from the sale of Program Y by Corp C is sourced pursuant to sections 861(a)(6) and 862(a)(6) to the place where the sale occurred. Pursuant to paragraph (f)(2)(ii) of this section, a transfer of a copyrighted article through an electronic medium is treated as occurring at the billing address of the purchaser, in this case Corp B, unless the sales transaction is arranged for a principal purpose of tax avoidance. In this case, the sale is treated as occurring at the billing address of Corp B, and Corp C¡¯s income is foreign source, even though Corp B will not use Program Y, because Corp B regularly purchases products that will be distributed amongst its affiliates to be used in their respective businesses, and therefore there is no evidence that Corp B was used by Corp A to purchase Program Y with a principal purpose of tax avoidance.

(26) Example 26: Application of anti-abuse rule for sale of a copyrighted article transferred through an electronic medium¡ª(¾±) Facts. Corp A is the parent company of a world-wide group of affiliated companies. Corp B is a foreign affiliate of Corp A. In the ordinary course of business, Corp B does not act as a procurement hub regularly purchasing products for use by Corp A¡¯s affiliated companies. Corp A negotiates an agreement with Corp C, an unrelated company, to purchase digital copies of a computer program (Program Y) for use in Corp A¡¯s business. The agreement grants Corp A the right to use Program Y in perpetuity for a one-time payment. Corp C requests that Corp B be the purchaser of the copies of Program Y even though Corp B will not use Program Y and is not otherwise involved in the transaction between Corp A and Corp C for a principal purpose of tax avoidance. Corp A agrees, and Corp B purchases the copies of Program Y and subsequently distributes them to Corp A. Corp C sources income from the sale of Program Y using sections 861(a)(6) and 862(a)(6).

(ii) Analysis. (A) Under paragraph (b)(1) of this section, the transfer of Program Y from Corp C to Corp B is a digital content transaction with one element, which is the transfer of a copy of Program Y. Therefore, the transaction is classified solely as a transfer of a copyrighted article under paragraph (b)(1)(ii) of this section. Taking into account all of the facts and circumstances, there have been sales of copies of Program Y to Corp B under paragraph (f)(2) of this section.

(B) Income from the sale of Program Y by Corp C is sourced pursuant to sections 861(a)(6) and 862(a)(6) to the place where the sale occurred. Pursuant to paragraph (f)(2)(ii) of this section, a transfer of a copyrighted article through an electronic medium is treated as occurring at the billing address of the purchaser, in this case Corp B, unless the sales transaction is arranged for a principal purpose of tax avoidance. In this case, Corp B does not regularly purchase products that will be used by other companies within Corp A¡¯s group of affiliated companies, and Corp B was instead used as the purchaser of Program Y on behalf of Corp A with a principal purpose of tax avoidance. Therefore, the place where the sale occurred must be determined based on all relevant facts and circumstances. Corp A negotiated the purchase, and the software will be used by Corp A in its business. As a result, under paragraph (f)(2)(ii) of this section, the sale is treated as occurring at the location of Corp A and the income derived by Corp C from the sale is U.S. source.

(C) The same result would apply if, instead of using Corp B for the purchase, Corp A made the purchase but rented a P.O. Box outside the United States to serve as the billing address for the transaction with a principal purpose of tax avoidance.

(i) Applicability date¡ª(1) In general. This section applies to taxable years beginning on or after January 14, 2025.

(2) Early application. A taxpayer can apply this section to taxable years beginning on or after August 14, 2019 and all subsequent taxable years not described in paragraph (i)(1) of this section (early application years) if¡ª

(i) The taxpayer also applies ¡ì1.861-19 to the early application years;

(ii) This section and ¡ì1.861-19 are applied to the early application years by all persons related to the taxpayer (within the meaning of sections 267(b) and 707(b));

(iii) The period of limitations on assessment for each early application year of the taxpayer and all related parties (within the meaning of sections 267(b) and 707(b)) is open under section 6501; and

(iv) The taxpayer would not be required under this section to change its method of accounting as a result of such election.

(j) Change in method of accounting required by this section. In order to comply with this section, a taxpayer may be required to change its method of accounting. If so required, the taxpayer must secure the consent of the Commissioner in accordance with the requirements of ¡ì1.446-1(e) and the applicable administrative procedures for obtaining the Commissioner¡¯s consent under section 446(e) for voluntary changes in methods of accounting.

Par. 4. Section 1.861-19 is added to read as follows:

(a) In general. This section provides rules for classifying cloud transactions (as defined in paragraph (b) of this section). The rules of this section apply for purposes of Internal Revenue Code sections 59A, 245A, 250, 267A, 367, 404A, 482, 679, and 1059A; subchapter N of chapter 1; chapters 3 and 4; and sections 842 and 845 (to the extent involving a foreign person), and apply with respect to transfers to foreign trusts not covered by section 679.

(b) Cloud transaction defined. A cloud transaction is a transaction through which a person obtains on-demand network access to computer hardware, digital content (as defined in ¡ì1.861-18(a)(2)), or other similar resources. A cloud transaction does not include network access to download digital content for storage and use on a person¡¯s computer or other electronic device.

(c) Classification of cloud transactions¡ª(1) In general. A cloud transaction is classified as the provision of services.

(2) Transaction with multiple elements. Taking into account the overall transaction and the surrounding facts and circumstances, a transaction that has multiple elements, one or more of which would be a cloud transaction if considered separately, is classified in its entirety as a cloud transaction if the predominant character of the transaction as determined under ¡ì1.861-18(b)(3) is a cloud transaction.

(d) Examples. The examples in this paragraph (d) illustrate the provisions of this section. Unless otherwise specified, assume that Corp A is a domestic corporation, no rights described in ¡ì1.861-18(c)(2) (copyright rights) are transferred as part of the transactions described, and all facts in each example occur as part of a single transaction.

(1) Example 1: Computing capacity¡ª(¾±) Facts. Corp A operates data centers on its premises in various locations. Corp A provides Corp B computing capacity on Corp A¡¯s servers in exchange for a monthly fee based on the amount of computing power made available to Corp B. Corp B provides its own software to run on Corp A¡¯s servers.

(ii) Analysis. The provision of on-demand network computing capacity by Corp A to Corp B is a cloud transaction with one element. Therefore, the transaction is treated solely as a cloud transaction under paragraph (b) of this section and is classified as the provision of services under paragraph (c)(1) of this section.

(2) Example 2: Computing capacity on dedicated on-premises servers¡ª(¾±) Facts. The facts are the same as in paragraph (d)(1)(i) of this section (the facts in Example 1), except that, in order to offer more security to Corp B, Corp A provides Corp B computing capacity exclusively through designated servers, which are owned and operated by Corp A and located at Corp B¡¯s facilities. Corp A agrees not to use the designated server for any other customer for the duration of its arrangement with Corp B. Although the server is located at Corp B¡¯s facilities, Corp B accesses the server through Corp A¡¯s network and the monthly fee is based on the amount of computing power made available to Corp B.

(ii) Analysis. As in paragraph (d)(1) of this section (Example 1), the transaction between Corp A and Corp B is the provision of on-demand network computing capacity and is therefore a cloud transaction with one element. Therefore, the transaction is treated solely as a cloud transaction under paragraph (b) of this section and is classified as the provision of services under paragraph (c)(1) of this section. If the transaction between Corp A and Corp B involved only the provision of a server by Corp A for use by Corp B, and not on-demand network access to computing capacity, the transaction would not be a cloud transaction and this section would not apply.

(3) Example 3: Access to software development platform and website hosting¡ª(¾±) Facts. Corp A provides Corp B a software platform that Corp B uses to develop and deploy websites with a range of features, including blogs, message boards, and other collaborative knowledge bases. The software development platform consists of an operating system, web server software, scripting languages, libraries, tools, and back-end relational database software and allows Corp B to use in its websites certain visual elements subject to copyrights held by Corp A. The software development platform is hosted on servers owned by Corp A and located at Corp A¡¯s facilities. Corp B¡¯s finished websites are also hosted on Corp A¡¯s servers. Corp B accesses the software development platform via a standard web browser. Corp B has no ability to alter the software code. A small amount of copyrighted scripting code is downloaded onto Corp B¡¯s computers to facilitate secure logins and access to the software development platform. All other functions of the software development platform execute on Corp A¡¯s servers, and no portion of the core software code is ever downloaded by Corp B or Corp B¡¯s customers. Corp A has ascertained that the primary benefit or value to Corp B from the transaction is the right to use the software development platform. Corp B pays Corp A a monthly fee for the platform and website hosting.

(ii) Analysis. (A) There is one transaction with multiple elements between Corp A and Corp B. One element is Corp A¡¯s provision to Corp B of on-demand network access to the software platform, which would be a cloud transaction described in paragraph (b) of this section if considered separately. Another element is Corp A¡¯s hosting of Corp B¡¯s finished websites, which would be a cloud transaction described in paragraph (b) of this section if considered separately. A third element is the grant by Corp A to Corp B of the right to use in Corp B¡¯s websites certain visual elements subject to copyrights held by Corp A, which would be a transfer of copyright rights under ¡ì1.861-18(b)(1)(i) if considered separately. A fourth element is the download of scripting code by Corp B, which would be a transfer of a copyrighted article under ¡ì1.861-18(b)(1)(ii) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a cloud transaction if considered separately, paragraph (c)(2) of this section provides that the transaction is classified as a cloud transaction if its predominant character is a cloud transaction. Pursuant to ¡ì1.861-18(b)(3), the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore a cloud transaction because the primary benefit or value received by Corp B is the right to use the software development platform. Accordingly, this transaction is classified solely as a cloud transaction described in paragraph (b) of this section and is classified as the provision of services under paragraph (c)(1) of this section.

(4) Example 4: Access to online software via an application¡ª(¾±) Facts. Corp A provides Corp B word processing, spreadsheet, and presentation software and allows employees of Corp B to access the software over the Internet through a web browser or an application (¡°app¡±) that can be downloaded from Corp A¡¯s servers onto a computer or mobile device. Corp B¡¯s employees usually download Corp A¡¯s app onto their mobile devices. To access the full functionality of the app, the device must be connected to the Internet. Only a limited number of features on the app are available without an Internet connection. Corp B has no ability to alter the software code. The software is hosted on servers owned by Corp A and located at Corp A¡¯s facilities and is used concurrently by other Corp A customers in addition to Corp B. Corp B pays a monthly fee based on the number of employees with access to the software. Users have the option to save files either online using the storage provided by Corp B, or offline on their own hard drives. Corp B¡¯s employees can also download updates to the app as part of the monthly fee arrangement. Upon termination of the arrangement, Corp A activates an electronic lock preventing Corp B¡¯s employees from further utilizing the app, and Corp B¡¯s employees are no longer able to access the software via a web browser. Corp A has ascertained that the primary benefit or value to Corp B from the transaction is the right to access Corp A¡¯s software over the Internet, whether via web browser or after downloading the app.

(ii) Analysis. (A) There is one transaction with multiple elements between Corp A and Corp B. One element is Corp A¡¯s provision to Corp B of on-demand network access to Corp A¡¯s computer hardware and software resources for the purpose of fully utilizing Corp A¡¯s software, which would be a cloud transaction described in paragraph (b) of this section if considered separately. Another element is the download of Corp A¡¯s app by Corp B employees, which would be a transfer of a copyrighted article under ¡ì1.861-18(b)(1)(ii) if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a cloud transaction if considered separately, paragraph (c)(2) of this section provides that the transaction is classified as a cloud transaction if its predominant character is a cloud transaction. Pursuant to ¡ì1.861-18(b)(3), the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore a cloud transaction because the primary benefit or value received by Corp B is the right to access Corp A¡¯s software over the Internet. Accordingly, this transaction is classified solely as a cloud transaction described in paragraph (b) of this section and is classified as the provision of services under paragraph (c)(1) of this section.

(5) Example 5: Access to offline software with limited online functions¡ª(¾±) Facts. Corp A provides Corp B word processing, spreadsheet, and presentation software that is functionally similar to the software in paragraph (d)(4) of this section (Example 4). The software is made available for access over the Internet but only to download the software from servers owned by Corp A onto a computer or mobile device in the form of an app. The downloaded software contains all the core functions of the software. Employees of Corp B can use the software on their computers or mobile devices regardless of whether their computer or mobile device is online. When online, the software provides a few ancillary functions that are not available offline, such as access to document templates and data collection for diagnosing problems with the software. Whether working online or offline, Corp B employees can store their files only on their own computer or mobile device, and not on Corp A¡¯s data storage servers. Corp B¡¯s employees can also download updates to the software as part of the monthly fee arrangement. Upon termination of the arrangement, an electronic lock is activated so that the software can no longer be accessed. Corp A has ascertained that the primary benefit or value to Corp B from the transaction is the right to download and use Corp A¡¯s software offline.

(ii) Analysis. (A) The transaction between Corp A and Corp B contains multiple elements. One element is the transfer of a copy of Corp A¡¯s software via download, which would be a transfer of a copyrighted article described under ¡ì1.861-18(b)(1)(ii) if considered separately. Another element is the provision of online ancillary functionality of the software, which would be a cloud transaction described in paragraph (b) of this section if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a cloud transaction if considered separately, paragraph (c)(2) of this section provides that the transaction is classified as a cloud transaction if its predominant character is a cloud transaction. Pursuant to ¡ì1.861-18(b)(3), the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. The predominant character of this transaction is therefore the transfer of a copyrighted article because the primary benefit or value received by Corp B is the right to download and use Corp A¡¯s software offline. Accordingly, this transaction is classified solely as a transfer of a copyrighted article described in ¡ì1.861-18(b)(1)(ii). The provision of the software constitutes a lease of a copyrighted article under ¡ì1.861-18 because access to the app is terminated when the monthly fee is no longer paid, even though Corp B employees retain the locked files on their devices. See ¡ì1.861-18(h)(4).

(6) Example 6: Data storage, separate from access to offline software¡ª(¾±) Facts. The facts are the same as in paragraph (d)(5)(i) of this section (the facts in Example 5), except that Corp A also provides on-demand network data storage to Corp B on Corp A¡¯s servers in exchange for a monthly fee based on the amount of data storage used by Corp B. Under the data storage terms, Corp B employees may store files created by Corp B employees using Corp A¡¯s software or other software. Although Corp A¡¯s word processing software is compatible with Corp A¡¯s data storage systems, the core functionality of Corp A¡¯s software is not dependent on Corp B¡¯s purchase of the storage plan. Corp A¡¯s provision of software and data storage capacity constitute separate transactions.

(ii) Analysis. (A) As explained in paragraph (d)(5)(ii) of this section, Corp B¡¯s download of fully functional software, along with on-demand network access to certain limited online features, does not constitute a cloud transaction, but rather constitutes a lease of a copyrighted article under ¡ì1.861-18.

(B) The provision of on-demand network data storage by Corp A to Corp B is a cloud transaction with one element. Therefore, the transaction is treated solely as a cloud transaction under paragraph (b) of this section and is classified as the provision of services under paragraph (c)(1) of this section.

(7) Example 7: Streaming and temporary download of digital content using third-party servers¡ª(¾±) Facts. Corp A offers via stream or temporary download digital content in the form of videos and music to customers from servers located in data centers owned and operated by Data Center Operator. Each customer uses a computer or other electronic device to access unlimited streaming or temporary downloads of video and music in exchange for payment of a flat monthly fee to Corp A. The customer may select from among the available content the particular video or song to be streamed or downloaded. Corp A continually updates its content catalog, replacing content with higher quality versions and adding new content at no additional charge to the customer. It also provides additional functionality such as various methods of filtering and sorting the library, a watchlist, and recommendations based on a customer¡¯s preferences. Content that is streamed to the customer is not stored locally on the customer¡¯s computer or other electronic device and therefore can be played only while the customer¡¯s computer or other electronic device is connected to the Internet. Content that is temporarily downloaded is stored on the customer¡¯s computer or other electronic device for 1 week and therefore can be played while the customer¡¯s computer or other electronic device is not connected to the Internet. Corp A cannot reasonably ascertain the primary benefit or value that its specific customers derive from accessing Corp A¡¯s catalog of digital content. Data collected by Corp A indicates that the vast majority of customers stream digital content rather than temporarily download the content. Corp A pays Data Center Operator a fee based on the amount of data storage used and computing power made available in connection with Corp A¡¯s content offerings.

(ii) Analysis. (A) The provision of data storage and computing power by Data Center Operator to Corp A is a cloud transaction with one element. Therefore, the transaction is treated solely as a cloud transaction under paragraph (b) of this section, and is classified as the provision of services under paragraph (c)(1) of this section.

(B) A transaction between Corp A and a customer has two elements. One element is streaming access to a curated and routinely updated library of digital content, which would be a cloud transaction described in paragraph (b) of this section if considered separately. Another element is the transfer of a copy of digital content via temporary download, which would be a transfer of a copyrighted article under ¡ì1.861-18(b)(1)(ii) if considered separately.

(C) Because the transaction has multiple elements, one or more of which would be a cloud transaction if considered separately, paragraph (c)(2) of this section provides that the transaction is classified as a cloud transaction if its predominant character is a cloud transaction. Pursuant to ¡ì1.861-18(b)(3), the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer if it is reasonably ascertainable. However, Corp A cannot reasonably ascertain the primary benefit or value derived by a specific customer from Corp A¡¯s offering. In such situations, ¡ì1.861-18(b)(3)(ii) provides that the predominant character of a transaction may be determined based on the primary benefit or value to a typical customer of a substantially similar transaction. This primary benefit or value to a typical customer can be identified through actual data about use or access pursuant to ¡ì1.861-18(b)(3)(ii)(A), or if that data is not available, by using other evidence indicative of the primary benefit or value to a typical customer pursuant to ¡ì1.861-18(b)(3)(ii)(B). Because Corp A has data that shows the typical customer streams digital content rather than temporarily downloading it, the primary benefit or value received by a typical customer is streaming access to digital content. Therefore, the predominant character of the transaction is a cloud transaction. Under paragraph (c)(1) of this section, the cloud transaction is classified as the provision of services.

(8) Example 8: Access to online database¡ª(¾±) Facts. Corp A offers an online database of industry-specific materials. Customers access the materials through Corp A¡¯s website, which aggregates and organizes information topically and hosts a proprietary search engine. Corp A hosts the website and database on its own servers and provides multiple customers access to the website and database concurrently. Most materials in Corp A¡¯s database are publicly available by other means, but Corp A¡¯s website offers an efficient way to locate and obtain the information on demand. Certain materials in Corp A¡¯s database constitute digital content within the meaning of ¡ì1.861-18(a)(2), and Corp A pays the copyright owners a license fee for using them. Each customer may download any of the materials to its own computer and keep such materials without further payment. The customer pays Corp A a fee based on the number of searches or the amount of time spent on the website, and such fee is not dependent on the amount of materials the customer downloads. The fee that the customer pays is substantially higher than the stand-alone charge for accessing the same digital content outside of Corp A¡¯s system. Corp A cannot reasonably ascertain the primary benefit or value that a specific customer derives from accessing Corp A¡¯s database. Corp A does not have data indicating whether the typical customer downloads materials from the database. Corp A markets its website and online database as user-friendly and an efficient way to find relevant materials because of its proprietary search engine. Developing the proprietary search engine was the largest cost Corp A incurred in creating its website and online database.

(ii) Analysis. (A) The transaction between Corp A and a customer has multiple elements. One element is Corp A¡¯s provision to a customer of access to Corp A¡¯s website and online database, which is a cloud transaction described in paragraph (b) of this section if considered separately. Another element is the transfer of digital content via download, which is the transfer of a copyrighted article under ¡ì1.861-18 if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a cloud transaction if considered separately, paragraph (c)(2) of this section provides that the transaction is classified as a cloud transaction if its predominant character is a cloud transaction. Pursuant to ¡ì1.861-18(b)(3), the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. However, Corp A cannot reasonably ascertain the primary benefit or value derived by a specific customer from access to Corp A¡¯s database. In such situations, ¡ì1.861-18(b)(3)(ii) provides that the predominant character of a transaction may be determined based on the primary benefit or value to a typical customer of a substantially similar transaction. This primary benefit or value to a typical customer can be identified through actual data about use or access pursuant to ¡ì1.861-18(b)(3)(ii)(A), or if that data is not available, by using other evidence indicative of the primary benefit or value to a typical customer pursuant to ¡ì1.861-18(b)(3)(ii)(B). That Corp A focuses on its proprietary search engine when marketing its website and database, as well as the facts that the search engine was the most expensive cost incurred by Corp A in creating its website and database, and that customers pay a substantially higher fee to access Corp A¡¯s system than they would otherwise pay to access the content outside of Corp A¡¯s system, indicates that the primary benefit or value received by a typical customer is the right to use the search engine. Therefore, under paragraph (c)(2) of this section, the predominant character of the transaction between Corp A and a customer is a cloud transaction. Under paragraph (c)(1) of this section the cloud transaction is classified as the provision of services.

(9) Example 9: Temporary or perpetual access to a single movie via stream or download¡ª(¾±) Facts. Corp A hosts movies on its website and allows customers to view a single movie for a limited period or perpetually for a one-time fee, with perpetual viewing rights costing a higher fee. Corp A does not charge customers a separate fee for access to the website. In addition, Corp A¡¯s website provides recommendations for movies based on a customer¡¯s search for a particular title and/or the customer¡¯s purchase history. Customers have no ability to alter the servers, website, or movies available on the website. The movies in Corp A¡¯s database constitute digital content within the meaning of ¡ì1.861-18(a)(2), and Corp A pays the copyright owners a license fee for using them. Corp A allows customers to view the movies by either streaming the movies from Corp A¡¯s servers, or by downloading the movies onto the customer¡¯s computer or other electronic device. The file size of movies offered by Corp A is generally large and so customers may be expected to download movies only in certain situations such as when traveling without Internet access. Upon the expiration of the rental period, customers will no longer have access to stream the movies, and any movie that was downloaded onto a customer¡¯s computer or other electronic device will auto-delete from the customer¡¯s computer or other electronic device. Whether a customer chooses to view the movie via stream or download, Corp A charges the same one-time fee. Corp A cannot reasonably ascertain the primary benefit or value that a specific customer derives from accessing Corp A¡¯s website. Corp A maintains aggregate data on whether a given movie is viewed via stream or download, and this data shows that most movies are viewed by streaming, even in the case where a customer pays for the right to view a movie in perpetuity.

(ii) Analysis. (A) A transaction between Corp A and a customer contains multiple elements. One element is Corp A¡¯s provision to a customer of access to Corp A¡¯s website in order to view a movie via stream, which is a cloud transaction described in paragraph (b) of this section if considered separately. Another element is Corp A¡¯s provision to a customer of access to Corp A¡¯s website in order to download a movie, which is the transfer of a copyrighted article under ¡ì1.861-18 if considered separately.

(B) Because the transaction has multiple elements, one or more of which would be a cloud transaction if considered separately, paragraph (c)(2) of this section provides that the transaction is classified as a cloud transaction if its predominant character is a cloud transaction. Pursuant to ¡ì1.861-18(b)(3), the predominant character of the transaction is based on the primary benefit or value of the transaction to the customer, if it is reasonably ascertainable. However, Corp A cannot reasonably ascertain the primary benefit or value derived by a specific customer from access to Corp A¡¯s database. In such situations, ¡ì1.861-18(b)(3)(ii) provides that the predominant character of a transaction may be determined based on the primary benefit or value to a typical customer of a substantially similar transaction. This primary benefit or value to a typical customer can be identified through actual data about use or access pursuant to ¡ì1.861-18(b)(3)(ii)(A), or if that data is not available, by using other evidence indicative of the primary benefit or value to a typical customer pursuant to ¡ì1.861-18(b)(3)(ii)(B). Corp A has data that shows that the typical customer views movies by streaming rather than download. Accordingly, under paragraph (c)(2) of this section, the predominant character of the transaction is a cloud transaction because the primary benefit or value a typical customer receives is access to stream movies on Corp A¡¯s website. Under paragraph (c)(1) of this section, the cloud transaction is classified as the provision of services.

(10) Example 10: Reseller of software as a service¡ª(¾±) Facts. Corp A owns the copyright to software (Program S). Corp A hosts Program S on its servers. Customers access Program S only through an Internet connection. Corp A grants Corp B, a foreign corporation wholly owned by Corp A, the right to sell access to Program S to Corp B¡¯s customers that are located in Corp B¡¯s country. Corp B is responsible for managing the purchase/sale interaction with Corp B¡¯s customers, including invoicing and collections. Corp A is responsible for providing customers with access to Program S. Corp B does not perform any functions to provide access to Program S.

(ii) Analysis. (A) The transaction between Corp A and Corp B is treated as Corp A providing on-demand access to Program S to Corp B even though Corp B resells that access. This transaction is a cloud transaction with one element. Under paragraph (c)(1) of this section, the cloud transaction is classified as the provision of services. The transaction does not involve the transfer of any copyright rights described in ¡ì1.861-18(c)(2), and therefore is governed solely by this section.

(B) The transaction between Corp B and its customers is the provision of on-demand access to Program S by Corp B, which is a cloud transaction with one element. Under paragraph (c)(1) of this section, the cloud transaction is classified as the provision of services. The transaction does not involve the transfer of any copyright rights described in ¡ì1.861-18(c)(2), and therefore is governed solely by this section.

(11) Example 11: Computer game with online functionality and in-game purchases¡ª(¾±) Facts. Corp A owns the copyright to a computer game (Game X). Customers can purchase Game X for a one-time fee and download it onto their computers. A customer may play certain aspects of Game X while not connected to the Internet, but most of the core functionality of Game X is available only when the customer is connected to the Internet, including the ability to play with other customers. In order to access the additional online functionality specific to Game X, customers must pay a monthly fee to Corp A. The additional functionality of Game X is hosted on servers owned by Corp A. Customers may also pay a one-time fee to access an in-game item that can be utilized only when playing Game X online.

(ii) Analysis. (A) There are three transactions between Corp A and a customer. The first transaction is the transfer of a copy of Game X, which is a digital content transaction with one element because a customer receives from Corp A access only to offline content in exchange for purchasing a copy of the game. Therefore, this transaction is treated solely as a transfer of a copyrighted article under ¡ì1.861-18.

(B) The second transaction between Corp A and a customer is the payment of a monthly fee to play Game X online on Corp A¡¯s servers, which is a cloud transaction with one element. Therefore, this transaction is treated solely as a cloud transaction, and is classified as the provision of services under paragraph (c)(1) of this section.

(C) The third transaction between Corp A and a customer is the payment of a one-time fee in exchange for an in-game item. Because a customer can utilize the item only when playing Game X through an Internet connection, the transaction is a cloud transaction with one element. Therefore, this transaction is treated solely as a cloud transaction, and is classified as the provision of services under paragraph (c)(1) of this section.

(e) Applicability date¡ª(1) In general. This section applies to taxable years beginning on or after January 14, 2025.

(2) Early application. A taxpayer can apply this section to taxable years beginning on or after August 14, 2019 and all subsequent taxable years not described in paragraph (e)(1) (early application years) if¡ª

(i) The taxpayer also applies ¡ì1.861-18 to the early application years;

(ii) This section and ¡ì1.861-18 are applied to the early application years by all persons related to the taxpayer (within the meaning of sections 267(b) and 707(b));

(iii) The period of limitations on assessment for each early application year of the taxpayer and all related parties (within the meaning of sections 267(b) and 707(b)) is open under section 6501; and

(iv) The taxpayer would not be required under this section to change its method of accounting as a result of such election.

(f) Change in method of accounting required by this section. In order to comply with this section, a taxpayer may be required to change its method of accounting. If so required, the taxpayer must secure the consent of the Commissioner in accordance with the requirements of ¡ì1.446-1(e) and the applicable administrative procedures for obtaining the Commissioner¡¯s consent under section 446(e) for voluntary changes in methods of accounting.

¡ì1.937-3 [Amended]

Par. 5. Section 1.937-3 is amended by removing Examples 4 and 5 from paragraph (e).

Douglas W. O¡¯Donnell, Deputy Commissioner.

Approved: December 18, 2024.

Aviva R. Aron-Dine, Deputy Assistant Secretary of the Treasury (Tax Policy).

(obÌåÓýd by the Office of the Federal Register January 10, 2025, 8:45 a.m., and published in the issue of the Federal Register for January 14, 2025, 90 FR 2977)

These proposed regulations are promulgated under section 7805(a) of the Internal Revenue Code (Code), which provides that ¡°the Secretary shall prescribe all needful rules and regulations for the enforcement of [the Code], including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.¡± In addition, section 341 of the SECURE 2.0 Act of 2022 (SECURE 2.0 Act), enacted on December 29, 2022, as Division T of the Consolidated Appropriations Act, 2023, Public Law 117-328, 136 Stat. 4459 (2022), instructs the Secretaries of the Treasury and Labor (or their delegates) to adopt regulations related to the consolidation of notices required for defined contribution plans under the Code and the Employee Retirement Income Security Act of 1974, Public Law 93-406, 88 Stat. 829, as amended (ERISA).

This notice of proposed rulemaking sets forth a proposed regulation under section 414A of the Code that would be added to the Income Tax Regulations (26 CFR part 1). Section 414A, which was added to the Code by section 101 of the SECURE 2.0 Act, provides that certain retirement plans must automatically enroll employees.

In addition to adding a new regulation under section 414A of the Code, this notice of proposed rulemaking sets forth proposed amendments to the regulations under section 414(w). These amendments to ¡ì1.414(w)-1 would reflect the application of section 414A and the exception to the notice requirements for unenrolled participants set forth in section 414(bb), as added to the Code by section 320 of the SECURE 2.0 Act. The proposed amendments to ¡ì1.414(w)-1 also would address section 402A(e)(5)(C) of the Code, which was added to the Code by section 127 of the SECURE 2.0 Act, as well as section 341 of the SECURE 2.0 Act. Section 402A(e)(5)(C) of the Code and section 341 of the SECURE 2.0 Act permit the consolidation of certain notices required under the Code and ERISA.

Section 1.414A-1 and the amendments to ¡ì1.414(w)-1 are proposed to apply to plan years that begin more than 6 months after the date that final regulations under section 414A are issued. For a plan year beginning after December 31, 2024, but before the applicability date of those final regulations, a plan is treated as having complied with section 414A if the plan complies with a reasonable, good faith interpretation of section 414A.

Before final regulations are adopted to implement section 414A of the Code, or to revise the regulations under section 414(w) to reflect changes made by sections 101, 320, and 341 of the SECURE 2.0 Act, consideration will be given to comments regarding the notice of proposed rulemaking that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES section. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. Comments specifically are requested on whether guidance is needed to define the term ¡°predecessor employer¡± as used in section 414A(c)(4)(A) of the Code and on the criteria that should apply for an individual to be an unenrolled participant under section 414(bb)(2). All comments will be made available at www.regulations.gov. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn.

A public hearing has been scheduled for April 8, 2025, beginning at 10 a.m. ET in the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. Participants may alternatively attend the public hearing by telephone.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments must submit an outline of the topics to be addressed and the time to be devoted to each topic by March 17, 2025, as prescribed in the preamble under the DATES section. A period of 10 minutes will be allocated to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing. If no outline of the topics to be discussed at the hearing is received by March 17, 2025, the public hearing will be cancelled. If the public hearing is cancelled, a notice of cancellation of the public hearing will be published in the Federal Register.

Individuals who want to testify in person at the public hearing must send an email to [email protected] to have their names added to the building access list. The subject line of the email must contain the regulation number REG-100669-24 and the language TESTIFY In Person. For example, the subject line may say: Request to TESTIFY In Person at Hearing for REG-100669-24.

Individuals who want to testify by telephone at the public hearing must send an email to [email protected] to receive the telephone number and access code for the hearing. The subject line of the email must contain the regulation number REG-100669-24 and the language TESTIFY Telephonically. For example, the subject line may say: Request to TESTIFY Telephonically at Hearing for REG-100669-24.

Individuals who want to attend the public hearing in person without testifying must also send an email to [email protected] to have their names added to the building access list. The subject line of the email must contain the regulation number REG-100669-24 and the language ATTEND In Person. For example, the subject line may say: Request to ATTEND Hearing In Person for REG-100669-24. Requests to attend the public hearing must be received by 5 p.m. ET on April 4, 2025.

Individuals who want to attend the public hearing by telephone without testifying must also send an email to [email protected] to receive the telephone number and access code for the hearing. The subject line of the email must contain the regulation number REG-100669-24 and the language ATTEND Hearing Telephonically. For example, the subject line may say: Request to ATTEND Hearing Telephonically for REG-100669-24. Requests to attend the public hearing must be received by 5 p.m. ET on April 4, 2025.

Hearings will be made accessible to people with disabilities. To request special assistance during the hearing, please contact the Publications and Regulations Branch of the Office of Associate Chief Counsel (Procedure and Administration) by sending an email to [email protected] (preferred) or by telephone at (202) 317-6901 (not a toll-free number) by April 3, 2025.

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

The principal authors of these proposed regulations are Christina M. Cerasale and Kara M. Soderstrom, of the Office of the Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes (EEE)). However, other personnel from the Treasury Department and the IRS participated in the development of the proposed regulations.

Income taxes, Reporting and recordkeeping requirements.

Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows:

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

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

* * * * *

Par. 2. Section 1.414(w)-1 is amended by:

a. Revising the second sentence of paragraph (b)(1); and

b. Adding paragraph (b)(4).

The revision and addition read as follows:

* * * * *

(b) Eligible automatic contribution arrangement¡ª(1) In general. * * * Except to the extent required under section 414A (which applies to plan years beginning after December 31, 2024), an eligible automatic contribution arrangement need not cover all employees who are eligible to elect to have contributions made on their behalf under the applicable employer plan.

* * * * *

(4) Special rules¡ª(¾±) No requirement to provide notice to unenrolled participant. If the requirements of section 414(bb)(1) are satisfied with respect to an unenrolled participant described in section 414(bb)(2), then the requirement to give the notice of an employee¡¯s rights and obligations set forth in paragraph (b)(3) of this section does not apply to the participant.

(ii) Consolidation of notices. The notice described in paragraph (b)(3) of this section may be combined with one or more of the notices required under section 404(c)(5)(B), 514(e)(3), or 801(d)(3)(A) of the Employee Retirement Income Security Act of 1974 (Public Law 93-406, 88 Stat. 829), as amended, and any notice required under section 401(k)(12)(D) or (13)(E), provided that the combined notice¡ª

(A) Includes the required content,

(B) Clearly identifies the issues addressed therein,

(C) Is furnished at the time and with the frequency required for each notice,

(D) Is presented in a manner that is reasonably calculated to be understood by the average plan participant, and

(E) Does not obscure or fail to highlight the primary information required for each notice.

* * * * *

Par. 3. Section 1.414A-1 is added to read as follows:

(a) Overview. This section provides rules regarding the automatic enrollment requirements under section 414A. Paragraph (b) of this section provides that a plan that includes a qualified cash or deferred arrangement under section 401(k) or a salary reduction agreement under section 403(b) is required to satisfy the automatic enrollment requirements of paragraph (c) of this section unless an exception described in paragraph (d) of this section (for certain types of plans and businesses) or paragraph (e) of this section (for a cash or deferred arrangement or section 403(b) plan established before December 29, 2022) applies to the plan. The applicability date of section 414A and the applicability date of this section are set forth in paragraph (f) of this section.

(b) General rule¡ª(1) Qualified cash or deferred arrangements. Except as provided in paragraph (d) or (e) of this section, a cash or deferred arrangement will not be treated as a qualified cash or deferred arrangement described in ¡ì1.401(k)-1(a)(4)(i) for a plan year unless the plan that includes the arrangement provides that any cash or deferred election under the arrangement must satisfy the automatic enrollment requirements of paragraph (c) of this section.

(2) Section 403(b) plans with salary reduction agreements. Except as provided in paragraph (d) or (e) of this section, an annuity contract described in section 403(b) that is purchased pursuant to a salary reduction agreement described in ¡ì31.3121(a)(5)-2(a)(1) (that is, an election to reduce compensation pursuant to a cash or deferred election as defined in ¡ì1.401(k)-1(a)(3)) will not be treated as purchased under a section 403(b) plan for a plan year unless the plan provides that any salary reduction agreement under the plan must satisfy the automatic enrollment requirements of paragraph (c) of this section.

(c) Automatic enrollment requirements¡ª(1) In general¡ª(¾±) Arrangement must be an eligible automatic contribution arrangement. A cash or deferred arrangement or salary reduction agreement under a plan satisfies the automatic enrollment requirements of this paragraph (c) only if the plan provides for an eligible automatic contribution arrangement (as defined in section 414(w)(3)) that¡ª

(A) Covers the employees described in paragraph (c)(1)(ii) of this section, and

(B) Satisfies the additional requirements of paragraphs (c)(2) through (4) of this section.

(ii) Employees covered under the eligible automatic contribution arrangement. The employees who must be covered by the eligible automatic contribution arrangement are all employees in the plan who are eligible to elect to have contributions made on their behalf under a cash or deferred arrangement or pursuant to a salary reduction agreement.

(iii) Exception to default election for employees with an affirmative election. An eligible automatic contribution arrangement will not fail to satisfy the requirements of this paragraph (c) merely because the default election under the arrangement does not apply to an employee who, on the date paragraph (b) of this section first applies to the plan that includes the cash or deferred arrangement or salary reduction agreement, had an affirmative election in effect (that remains in effect) to¡ª

(A) Have contributions made on the employee¡¯s behalf under a cash or deferred election or a salary reduction agreement (in a specified amount or percentage of compensation); or

(B) Not have contributions made on the employee¡¯s behalf under a cash or deferred election or a salary reduction agreement.

(2) Arrangement must permit permissive withdrawals. An eligible automatic contribution arrangement satisfies the requirements of this paragraph (c)(2) only if the plan that includes the arrangement provides that any employee who has default elective contributions made under the arrangement may elect to make a permissible withdrawal (as defined in section 414(w)(2) and described in ¡ì1.414(w)-1(c)).

(3) Contribution requirements¡ª(¾±) Default election. An eligible automatic contribution arrangement under a plan satisfies the requirements of this paragraph (c)(3) only if, under the arrangement, the default election made on behalf of an employee is equal to a uniform percentage, as described in paragraph (c)(3)(ii) of this section, of the employee¡¯s compensation that is subject to a cash or deferred election or salary reduction arrangement under the plan, unless the employee affirmatively elects to¡ª

(A) Have contributions made in a different amount on the employee¡¯s behalf under a cash or deferred election or a salary reduction agreement (in a specified amount or percentage of compensation); or

(B) Not have contributions made on the employee¡¯s behalf under a cash or deferred election or a salary reduction agreement.

(ii) Uniform percentage¡ª(´¡) Initial period¡ª(1) Initial percentage. The contribution percentage under the default election for each employee¡¯s initial period must be a uniform percentage that is not less than 3 percent and not more than 10 percent.

(2) Beginning of initial period. An employee¡¯s initial period begins when the employee is first eligible to elect to have contributions made on the employee¡¯s behalf under the plan (or if later, when section 414A first applies to the plan).

(3) End of initial period. The employee¡¯s initial period ends on the last day of the plan year that follows the plan year that includes the date the initial period begins.

(B) Subsequent plan years. For each plan year beginning after an employee¡¯s initial period under the arrangement, the percentage contribution under the default election must be increased by 1 percentage point until the percentage is at least 10 percent. However, the percentage may not exceed 15 percent (or the lower percentage specified in section 414A(b)(3)(B), if applicable).

(iii) Exception to uniform percentage requirement. An eligible automatic contribution arrangement does not fail to satisfy the uniform percentage requirement of paragraph (c)(3)(ii) of this section merely because¡ª

(A) The percentage used for the default election varies based on the number of years (or portions of years) since the beginning of the initial period for an employee;

(B) The rate of contributions under a cash or deferred election or salary reduction agreement that is in effect for an employee immediately prior to the date that the default election under paragraph (c) of this section first applies to the employee is not reduced;

(C) The rate of contributions under a cash or deferred election or salary reduction agreement is limited so as not to exceed the applicable limits of sections 401(a)(17), 401(k)(16), 402(g) (determined with or without catch-up contributions), 403(b)(16), and 415; or

(D) The default election provided under paragraph (c)(3)(i) of this section is not applied during the period an employee is not permitted to have contributions made on the employee¡¯s behalf under a cash or deferred election or salary reduction agreement in order for the plan to satisfy the requirements of section 414(u)(12)(B)(ii).

(iv) Treatment of periods without default contributions¡ª(´¡) Permissive redetermination of initial period in certain situations. The uniform percentages described in paragraph (c)(3)(ii) of this section are based on the date an employee¡¯s initial period begins. However, if, after the employee¡¯s initial period began, the employee did not have default elective contributions made for an entire plan year, then the plan is permitted to provide that the employee¡¯s initial period is redetermined as described in paragraph (c)(3)(iv)(B) or (C) of this section.

(B) Redetermination for employee who became ineligible. If, for an entire plan year, no default elective contributions were made solely because the employee was not eligible to elect to have contributions made on the employee¡¯s behalf under a cash or deferred election or salary reduction agreement for that plan year, then the plan is permitted to provide that the employee¡¯s initial period is redetermined so that it begins on the date the employee is again eligible to elect to have contributions made on the employee¡¯s behalf under the plan.

(C) Redetermination for employee who remained eligible and made an affirmative election. If, for an entire plan year, no default elective contributions were made solely because the employee made an affirmative election to have contributions made on the employee¡¯s behalf under a cash or deferred election or salary reduction agreement in a different amount (including an election not to have contributions made), then the plan is permitted to provide that the initial period is redetermined so that it begins on any date specified under the plan that is later than the date specified in paragraph (c)(3)(ii)(A)(3) of this section.

(4) Investment requirements. An eligible automatic contribution arrangement satisfies the requirements of this paragraph (c)(4) only if amounts contributed pursuant to the arrangement, and for which no investment is elected by the employee, are invested in accordance with the requirements of 29 CFR 2550.404c-5 (or any successor regulations).

(d) Exceptions for certain types of plans and businesses¡ª(1) SIMPLE 401(k) plans. Paragraph (b) of this section does not apply to any SIMPLE 401(k) plan (as described in section 401(k)(11) and ¡ì1.401(k)-4).

(2) Governmental plans. Paragraph (b) of this section does not apply to any governmental plan (within the meaning of section 414(d)).

(3) Church plans. Paragraph (b) of this section does not apply to any church plan (within the meaning of section 414(e)).

(4) New and small businesses¡ª(¾±) New businesses. Paragraph (b) of this section does not apply to any qualified cash or deferred arrangement, or any annuity contract purchased under a section 403(b) plan, for a plan year if, as of the beginning of the plan year, the employer maintaining the plan (aggregated with any predecessor employer) has been in existence for less than 3 years.

(ii) Small businesses. Paragraph (b) of this section does not apply to any qualified cash or deferred arrangement, or any annuity contract purchased under a section 403(b) plan, before the first plan year that begins at least 12 months after the close of the first taxable year of the employer maintaining the plan with respect to which that employer normally employed more than 10 employees. For this purpose, the number of employees that the employer normally employs for a taxable year is determined using the rules of Q&A-5 of ¡ì54.4980B-2 of this chapter.

(iii) Applicability to multiple employer plans. In the case of a multiple employer plan, the exceptions provided in paragraphs (d)(4)(i) and (ii) of this section apply on an employer-by-employer basis.

(iv) Example¡ª(´¡) Facts. Employer Q has been in existence since July 1, 2026, and does not have a predecessor employer. Employer Q maintains Plan X, which has a plan year that is the calendar year and includes a cash or deferred arrangement. Plan X was effective on January 1, 2027, and provides that a cash or deferred election must be an affirmative election. Employee M, who became eligible to elect to have contributions made on Employee M¡¯s behalf under Plan X on January 1, 2027, made an affirmative election not to have elective contributions made on Employee M¡¯s behalf and that affirmative election is in effect on January 1, 2030. Employee N, who also became eligible to elect to have contributions made on Employee N¡¯s behalf under Plan X on January 1, 2027, has not made any election to have (or not have) contributions made on Employee N¡¯s behalf under Plan X. Effective January 1, 2030, Plan X is amended to include an eligible automatic contribution arrangement that satisfies the requirements of paragraphs (c)(2) through (4) of this section. The amendment provides that an employee who has a cash or deferred election that is an affirmative election and is in effect on January 1, 2030, is not subject to the default election under the eligible automatic contribution arrangement that is included in Plan X.

(B) Analysis and Conclusion. Because the exception for new businesses set forth in paragraph (d)(4)(i) of this section ceases to apply to Plan X for plan years beginning on or after January 1, 2030, paragraph (b) of this section first applies to Plan X as of that date. Pursuant to paragraph (c)(1)(iii) of this section, the eligible automatic contribution arrangement required to be included in Plan X for plan years beginning on January 1, 2030, does not fail to satisfy the requirements of paragraph (c) of this section merely because the default election under the arrangement does not apply to Employee M as a result of Employee M¡¯s affirmative election. However, Plan X does not satisfy the requirements of section 414A unless the default election in paragraph (c)(3) of this section applies to Employee N because of the absence of an affirmative election made by Employee N to have elective contributions made on Employee N¡¯s behalf in a different amount (or to not have elective contributions made on Employee N¡¯s behalf).

(e) Exception for plans established before the enactment of section 414A¡ª(1) In general. Subject to the rules of application in paragraphs (e)(2) through (6) of this section, paragraph (b) of this section does not apply to¡ª

(i) Any plan that includes a qualified cash or deferred arrangement if the plan terms providing for the qualified cash or deferred arrangement were adopted initially before December 29, 2022 (the date of the enactment of section 414A), even if the plan terms providing for the cash or deferred arrangement are effective after that date, or

(ii) Any section 403(b) plan adopted initially before December 29, 2022, without regard to the date of adoption of plan terms providing for salary reduction agreements.

(2) Merger of plans established before the enactment of section 414A¡ª(¾±) General rule. If two plans described in paragraph (e)(1)(i) of this section are merged, then the merged plan will be treated as a plan described in paragraph (e)(1)(i) of this section. Similarly, if two section 403(b) plans described in paragraph (e)(1)(ii) of this section are merged, then the merged plan will be treated as a section 403(b) plan described in paragraph (e)(1)(ii) of this section.

(ii) Effect of merger of multiple employer plans on participating employers. If either of the plans described in paragraph (e)(2)(i) of this section are multiple employer plans, then the merger will not affect whether the merged plan is treated as a plan described in paragraph (e)(1) of this section with respect to any employer that maintained the multiple employer plan prior to the merger.

(3) Merger of a plan established on or after the enactment of section 414A with a plan established before the enactment of section 414A¡ª(¾±) General rule¡ª(´¡) Section 401(k) plans. Except as provided in paragraphs (e)(3)(ii), (iii), and (4)(ii) of this section, if a plan that includes a cash or deferred arrangement and that is not described in paragraph (e)(1)(i) of this section is merged with a plan described in paragraph (e)(1)(i) of this section, then the merged plan will not be treated as a plan described in paragraph (e)(1)(i) of this section.

(B) Section 403(b) plans. Except as provided in paragraphs (e)(3)(ii), (iii), and (4)(ii) of this section, if a section 403(b) plan that is not described in paragraph (e)(1)(ii) of this section is merged with a plan described in paragraph (e)(1)(ii) of this section, then the merged plan will not be treated as a plan described in paragraph (e)(1)(ii) of this section.

(ii) Exception for certain transactions. A plan that is maintained by a single employer and described in paragraph (e)(1) of this section will continue to be treated as described in paragraph (e)(1) of this section after a merger described in paragraph (e)(3)(i) of this section, if¡ª

(A) There is a transaction described in ¡ì1.410(b)-2(f),

(B) The plan described in paragraph (e)(1) of this section is designated as the ongoing plan, and

(C) The plan merger occurs within the transition period described in section 410(b)(6)(C)(ii).

(iii) Applicability to multiple employer plans¡ª(A) Applicability of exception for certain transactions involving a merger into a multiple employer plan. In the case of a merger of a plan that is not a multiple employer plan and not described in paragraph (e)(1) of this section into a multiple employer plan that is designated as the ongoing plan, paragraph (e)(3)(ii) of this section applies even though the ongoing plan is a multiple employer plan and without regard to whether that plan is a plan described in paragraph (e)(1) of this section, provided that prior to the transaction described in paragraph (e)(3)(ii)(A) of this section, the multiple employer plan was treated as a plan described in paragraph (e)(1) of this section with respect to the employer that maintained the multiple employer plan and engaged in the transaction.

(B) Merger of multiple employer plans. If both of the plans described in paragraph (e)(3)(i) of this section are multiple employer plans, then the exception in paragraph (e)(3)(ii) of this section does not apply. In such a case, the merger will not affect whether the merged plan is treated as a plan described in paragraph (e)(1) of this section with respect to any employer that maintained either multiple employer plan prior to the merger.

(4) Treatment of adoption of, or merger with, a multiple employer plan¡ª(¾±) In general. If, after December 29, 2022, an employer adopts a multiple employer plan, then, with respect to that employer, the multiple employer plan will not be treated as a plan described in paragraph (e)(1) of this section. The same treatment will apply if the employer maintains a plan other than a multiple employer plan that is merged with a multiple employer plan after December 29, 2022, unless the merger is described in paragraph (e)(3)(iii) of this section.

(ii) Exception for mergers involving plans established before the enactment of section 414A. Paragraph (e)(4)(i) of this section does not apply if the plan that is merged into the multiple employer plan is a plan described in paragraph (e)(1) of this section. Thus, if the employer maintains a plan described in paragraph (e)(1) of this section that is merged into the multiple employer plan after December 29, 2022, then the multiple employer plan will be treated as a plan described in paragraph (e)(1) of this section with respect to that employer.

(iii) Effect on other participating employers. Neither an adoption nor a merger described in paragraph (e)(4)(i) or (ii) of this section affects whether the multiple employer plan is treated as a plan described in paragraph (e)(1) of this section with respect to any other employer maintaining the plan.

(5) Plan spin-off. If a portion of a plan described in paragraph (e)(1) of this section is spun off from that plan, the resulting spun-off plan will be treated as a plan described in paragraph (e)(1) of this section if either¡ª

(i) The plan from which the spin-off occurred was not a multiple employer plan, or

(ii) The plan from which the spin-off occurred was a multiple employer plan that was treated as described in paragraph (e)(1) of this section with respect to the employer maintaining the spun-off plan.

(6) Other plan amendments¡ª(i) Treatment of amendments to a plan established before the enactment of section 414A. A plan described in paragraph (e)(1) of this section will not fail to be described in paragraph (e)(1) of this section merely because the plan is amended, provided that the amendment is not an amendment relating to an action described in paragraph (e)(2), (3), or (4) of this section. The preceding sentence applies even if the amendment expands eligibility to participate in the cash or deferred arrangement, or to enter into a salary reduction agreement, to other employees of the employer that maintains the plan or to employees of another employer that is aggregated with the employer that maintains the plan under section 414(b), (c), or (m).

(ii) Mergers with plans that do not include cash or deferred arrangements or salary reduction agreements. If an employer maintains a plan that is described in paragraph (e)(1) of this section and that plan is merged with a plan that does not include a cash or deferred arrangement or permit a salary reduction agreement, then the merged plan will continue to be a plan described in paragraph (e)(1) of this section after the merger.

(7) Examples. The following examples illustrate the application of this paragraph (e). For purposes of the examples, each plan is maintained on a calendar-year basis, includes a cash or deferred arrangement that was adopted on the same date that the plan was adopted, and is not a SIMPLE 401(k) plan, governmental plan, or church plan. These examples assume that this section applies for plan years beginning on or after January 1, 2026, and, unless otherwise specifically provided, any plan merger does not occur in connection with a transaction described in ¡ì1.410(b)-2(f).

(i) Example 1¡ª(A) Facts. Plan A, which is maintained by a single employer, Employer R, was adopted on January 1, 2021. Plan B, which is maintained by a single employer, Employer S, was adopted on January 1, 2025. On July 1, 2026, Plan A is merged with Plan B, and Plan A is the surviving plan in the merger.

(B) Analysis and Conclusion. The merger is a merger of a plan described in paragraph (e)(1)(i) of this section with a plan that is not described in paragraph (e)(1)(i) of this section and is not a merger described in paragraph (e)(3)(ii) or (4) of this section. Under paragraph (e)(3)(i)(A) of this section, Plan A will no longer be a plan described in paragraph (e)(1)(i) of this section and will be subject to paragraph (b) of this section after the merger (unless an exception described in paragraph (d)(4) of this section, relating to new or small businesses, applies to Employer R).

(ii) Example 2¡ª(´¡) Facts. The facts are the same as in paragraph (e)(7)(i) of this section (Example 1), except that there is an acquisition described in ¡ì1.410(b)-2(f), and the plan merger occurs within the transition period described in section 410(b)(6)(C)(ii).

(B) Analysis and Conclusion. The merger satisfies the requirements of paragraph (e)(3)(ii) of this section. Accordingly, Plan A will continue to be excepted from paragraph (b) of this section as a plan described in paragraph (e)(1)(i) of this section after the merger.

(iii) Example 3¡ª(´¡) Facts. Plan C, a multiple employer plan, was established on January 1, 2021. Plan D, a plan maintained by Employer T that is not a multiple employer plan, was adopted on January 1, 2024. Plan D merges with Plan C on December 31, 2024.

(B) Analysis and Conclusion. The merger is described in paragraph (e)(4)(i) of this section and because Plan D is not a plan described in paragraph (e)(1)(i) of this section, the merger is not excepted under paragraph (e)(4)(ii) of this section. Similarly, because there was no transaction described in ¡ì1.410(b)-2(f), the merger is not described in paragraph (e)(3)(iii) of this section. Accordingly, with respect to Employer T, Plan C will not be a plan described in paragraph (e)(1)(i) of this section and will be subject to paragraph (b) of this section after the merger (unless an exception described in paragraph (d)(4) of this section, relating to new or small businesses, continues to apply to Employer T). However, under paragraph (e)(4)(iii) of this section, the merger does not affect whether Plan C is treated as a plan described in paragraph (e)(1)(i) of this section with respect to any other employers.

(iv) Example 4¡ª(´¡) Facts. Plan E, a plan maintained by Employer U that is not a multiple employer plan, was adopted on January 1, 2021. Plan F, a multiple employer plan, was established on January 1, 2024. Plan E merges with Plan F on December 31, 2024.

(B) Analysis and Conclusion. Under paragraph (e)(4)(ii) of this section, the portion of Plan F that applies with respect to Employer U will continue to be excepted from paragraph (b) of this section as a plan described in paragraph (e)(1)(i) of this section after the merger. However, under paragraph (e)(4)(iii) of this section, the merger does not affect whether Plan F is treated as a plan described in paragraph (e)(1)(i) of this section with respect to any other employers.

(v) Example 5¡ª(´¡) Facts. Plan G, a plan maintained by Employer V that is not a multiple employer plan, was adopted on January 1, 2021. Plan G is amended, effective January 1, 2026, to add an additional participating employer, a subsidiary that is 100 percent owned by Employer V.

(B) Analysis and Conclusion. Because the expansion of eligibility is not an amendment relating to an action described in paragraph (e)(2), (3), or (4) of this section, Plan G will continue to be excepted from paragraph (b) of this section as a plan described in paragraph (e)(1)(i) of this section after the amendment pursuant to paragraph (e)(6)(i) of this section.

(vi) Example 6¡ª(´¡) Facts. Plan J, a multiple employer plan, was established on January 1, 2021. Employer W adopts Plan J on January 1, 2022. Effective January 1, 2026, the assets and account balances attributable to the employees of Employer W are spun off to form a new plan, Plan K, maintained solely by Employer W.

(B) Analysis and Conclusion. Under paragraph (e)(5)(ii) of this section, Plan K will be excepted from paragraph (b) of this section as a plan described in paragraph (e)(1)(i) of this section.

(f) Applicability dates¡ª(1) Statutory applicability date. Section 414A applies to plan years beginning after December 31, 2024.

(2) Regulatory applicability date. This section applies to plan years beginning after [DATE SIX MONTHS AFTER DATE OF PUBLICATION OF FINAL RULE]. For earlier plan years, a plan is treated as having complied with section 414A if the plan complies with a reasonable, good faith interpretation of section 414A.

Douglas W. O¡¯Donnell, Deputy Commissioner.

(obÌåÓýd by the Office of the Federal Register January 10, 2025, 8:45 a.m., and published in the issue of the Federal Register for January 14, 2025, 90 FR 3092)

¹ Under ¡ì1.401(k)-1(a)(2)(i), a CODA generally is an arrangement providing for an election by an employee to have the employer provide either contributions to a plan described in section 401(a) or payments directly in cash.

² The ADP test in section 401(k)(3)(A)(ii) compares the average deferral percentage for highly compensated employees with the average deferral percentage for non-highly compensated employees. As an alternative to satisfying the annual ADP test, a plan may satisfy the provisions of section 401(k)(11), (12), (13), or (16).

³ Section 902 of PPA ¡¯06 also added a new section 514(e) to ERISA, which broadly provides that, notwithstanding any other provision of section 514, title I of ERISA supersedes State laws that would directly or indirectly prohibit or restrict the inclusion of an automatic contribution arrangement in a plan.

⁴ Section 414(w)(5) defines an applicable employer plan for purposes of section 414(w) as a trust described in section 401(a) that is exempt from tax under section 501(a), a plan described in section 403(b), a section 457(b) plan that is maintained by a governmental employer described in section 457(e)(1)(A), a simplified employee pension the terms of which provide for a salary reduction arrangement described in section 408(k)(6), or a SIMPLE individual retirement account described in section 408(p).

⁵ Section 414(w)(1)(A) and (B) provides that the amount of the distribution is includible in the gross income of the employee for the taxable year in which the distribution is made but is not subject to the additional income tax on early distributions under section 72(t).

⁶ Section 414A(b)(3)(B) provides a reduced maximum default contribution percentage of 10 percent for certain plans with respect to certain plan years.

⁷ The requirements of 29 CFR 2550.404c-5 relate to investments in qualified default investment alternatives.

⁸ On January 12, 2024, the Treasury Department and the IRS released Notice 2024-22, 2024-6 IRB 662, which provides initial guidance regarding anti-abuse rules under section 402A(e)(12) of the Code, as added by section 127 of the SECURE 2.0 Act, and also addresses whether Rev. Rul. 74-55, 1974-1 CB 89, and Rev. Rul. 74-56, 1974-1 CB 90, are applicable to PLESAs.

⁹ This interpretation is consistent with the heading of section 414A(c)(4)(C) (¡°Treatment of multiple employer plans¡±) and the interpretation in ¡ì1.413-2(a)(2) and (3) of the substantially identical language in section 413(c) (¡°a plan maintained by more than one employer¡±).

¹⁰ The Department of Labor published frequently asked questions online providing general compliance information under ERISA regarding PLESAs providing that, generally, the investment option designated for PLESAs cannot be the same as a plan¡¯s qualified default investment alternative under 29 CFR 2550.404c-5(e)(4)(i). However, Q&A-15 does indicate that a PLESA¡¯s investment option could meet the requirements for a qualified default investment alternative for a short period of time.

¹¹ Section 414(bb)(2) defines an unenrolled participant as an employee who: (1) is eligible to participate in a defined contribution plan, (2) has been furnished the summary plan description pursuant to section 104(b) of ERISA for the plan and any other notices related to eligibility under the plan and required to be furnished under the Code or ERISA in connection with the participant¡¯s initial eligibility to participate in the plan, (3) is not participating in the defined contribution plan, and (4) satisfies any other criteria as the Secretary of the Treasury may determine appropriate, as prescribed in guidance issued in consultation with the Secretary of Labor.

This notice of proposed rulemaking sets forth proposed amendments to the Income Tax Regulations (26 CFR part 1) under sections 401(k), 403(b), and 414(v) of the Internal Revenue Code (Code) relating to catch-up contributions. These proposed regulations are issued by the Secretary of the Treasury or the Secretary¡¯s delegate (Secretary) under the express delegations of authority in sections 401(m)(9), 414(v)(7)(D), and 7805(a) of the Code.

Section 401(m)(9) provides, in part, that ¡°[t]he Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subsection and subsection (k).¡± Section 414(v)(7)(D) provides a specific delegation of authority with respect to the requirements of section 414(v)(7)(A), stating, ¡°[t]he Secretary may provide by regulations that an eligible participant may elect to change the participant¡¯s election to make additional elective deferrals if the participant¡¯s compensation is determined to exceed the limitation under subparagraph (A) after the election is made.¡± Section 7805(a) provides that ¡°the Secretary shall prescribe all needful rules and regulations for the enforcement of [the Code], including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.¡±

This notice of proposed rulemaking sets forth proposed amendments to the Income Tax Regulations under section 414(v) of the Code. Section 414(v) permits a plan to allow catch-up eligible participants to make additional elective deferrals that are catch-up contributions and sets forth requirements relating to those contributions. These proposed regulations would amend the regulations under section 414(v) to reflect changes to the catch-up contribution requirements for certain catch-up eligible participants pursuant to sections 109, 117, and 603 of Division T of the Consolidated Appropriations Act, 2023, Public Law 117-328, 136 Stat. 4459 (2022), known as the SECURE 2.0 Act of 2022 (SECURE 2.0 Act).

This document also proposes conforming amendments to the regulations under sections 401(k) and 403(b) of the Code that reflect section 603 of the SECURE 2.0 Act.

The amendments to ¡ì1.414(v)-1 are proposed to apply with respect to contributions in taxable years that begin more than 6 months after the date that final regulations amending ¡ì1.414(v)-1 are issued. However, the proposed regulations would permit a taxpayer to elect to apply: (1) proposed ¡ì1.414(v)-1(c)(2)(ii)(C) and (c)(2)(iii)(C) (relating to the higher catch-up limit for certain newly-established SIMPLE plans) with respect to taxable years beginning after December 31, 2023, and (2) proposed ¡ì1.414(v)-1(c)(2)(i)(B), (c)(2)(ii)(B), and (c)(2)(iii)(B) (relating to the higher catch-up limit applicable during the taxable year of attainment of age 60 through 63) with respect to taxable years beginning after December 31, 2024.

For a plan that is not maintained pursuant to a collective bargaining agreement, proposed ¡ì1.414(v)-2 and the proposed amendments to ¡ì¡ì1.401(k)-1 and 1.403(b)-3 are proposed to apply with respect to contributions in taxable years beginning more than 6 months after the date that final regulations adding ¡ì1.414(v)-2 to the Code of Federal Regulations are issued. For a plan that is maintained pursuant to one or more collective bargaining agreements, proposed ¡ì1.414(v)-2 and the proposed amendments to ¡ì¡ì1.401(k)-1 and 1.403(b)-3 are proposed to apply with respect to contributions in taxable years beginning after the later of the first taxable year described in the preceding sentence, or the first taxable year that begins after the date on which the last collective bargaining agreement related to the plan that is in effect on December 31, 2025, terminates (determined without regard to any extension of those agreements). However, under the proposed regulations, a plan would be permitted to apply ¡ì1.414(v)-2 and the amendments to ¡ì¡ì1.401(k)-1 and 1.403(b)-3 with respect to contributions in taxable years beginning after December 31, 2023.

Before these proposed regulations and proposed amendments to the regulations are adopted as final regulations, consideration will be given to comments regarding the notice of proposed rulemaking that are submitted timely to the IRS as prescribed in the preamble under the ADDRESSES section. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. All comments will be made available at www.regulations.gov. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn.

A public hearing has been scheduled for April 7, 2025, beginning at 10 a.m. EST in the Auditorium of the Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. Participants may alternatively attend the public hearing by telephone.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments must submit an outline of the topics to be addressed and the time to be devoted to each topic by March 14, 2025, as prescribed in the preamble under the DATES section. A period of 10 minutes will be allocated to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing. If no outline of the topics to be discussed at the hearing is received by March 14, 2025, the public hearing will be cancelled. If the public hearing is cancelled, a notice of cancellation of the public hearing will be published in the Federal Register.

Individuals who want to testify in person at the public hearing must send an email to [email protected] to have your name added to the building access list. The subject line of the email must contain the regulation number REG-101268-24 and the language TESTIFY In Person. For example, the subject line may say: Request to TESTIFY In Person at Hearing for REG-101268-24.

Individuals who want to testify by telephone at the public hearing must send an email to [email protected] to receive the telephone number and access code for the hearing. The subject line of the email must contain the regulation number REG-101268-24 and the language TESTIFY Telephonically. For example, the subject line may say: Request to TESTIFY Telephonically at Hearing for REG-101268-24.

Individuals who want to attend the public hearing in person without testifying must also send an email to [email protected] to have your name added to the building access list. The subject line of the email must contain the regulation number REG-101268-24 and the language ATTEND In Person. For example, the subject line may say: Request to ATTEND Hearing In Person for REG-101268-24. Requests to attend the public hearing must be received by 5 p.m. EST on April 3, 2025.

Individuals who want to attend the public hearing by telephone without testifying must also send an email to [email protected] to receive the telephone number and access code for the hearing. The subject line of the email must contain the regulation number REG-101268-24 and the language ATTEND Hearing Telephonically. For example, the subject line may say: Request to ATTEND Hearing Telephonically for REG-101268-24. Requests to attend the public hearing must be received by 5 p.m. EST on April 3, 2025.

Hearings will be made accessible to people with disabilities. To request special assistance during the hearing, please contact the Publications and Regulations Branch of the Office of Associate Chief Counsel (Procedure and Administration) by sending an email to [email protected] (preferred) or by telephone at (202) 317-6901 (not a toll-free number) by April 2, 2025.

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

The principal authors of these proposed regulations are Jessica S. Weinberger and Jason E. Levine, of the Office of the Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes (EEE)). However, other personnel from the Treasury Department and the IRS participated in the development of the proposed regulations.

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows:

Paragraph 1. The authority citation for part 1 is amended by adding entries, in numerical order, for ¡ì¡ì1.401(k)-1 and 1.414(v)-2 to read in part, as follows:

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

* * * * *

Section 1.401(k)-1 also issued under 26 U.S.C. 401(m)(9).

* * * * *

Section 1.414(v)-2 also issued under 26 U.S.C. 414(v)(7)(D).

* * * * *

Par. 2. Section 1.401(k)-1 is amended by adding paragraphs (f)(5)(iii) and (iv) to read as follows:

* * * * *

(f) * * *

(5) * * *

(iii) Deemed Roth catch-up contribution elections. For taxable years beginning after December 31, 2023, a plan that satisfies the requirements of paragraph (f)(5)(iv) of this section may provide that an employee who is subject to the requirement under section 414(v)(7) to make any catch-up contributions as designated Roth contributions is deemed to have irrevocably designated any elective deferrals that are catch-up contributions as designated Roth contributions in accordance with paragraph (f)(1)(i) of this section. In such a case, the elective deferrals must be--

(A) Treated by the employer as not excludible from the employee¡¯s gross income, in accordance with paragraph (f)(2) of this section; and

(B) Maintained by the plan in a separate account, in accordance with paragraph (f)(3) of this section.

(iv) Election for employees subject to section 414(v)(7)(A). A plan satisfies the requirements of this paragraph (f)(5)(iv) only if it provides to an employee who is described in paragraph (f)(5)(iii) of this section an effective opportunity (as determined under paragraph (e)(2)(ii) of this section) to make a new election that is different than the deemed election described in paragraph (f)(5)(iii) of this section.

* * * * *

Par. 3. Section 1.403(b)-3 is amended in paragraph (c)(1) by:

a. Removing the reference ¡°¡ì1.401(k)-1(f)(1) and (2)¡± and adding, in its place, the reference ¡°¡ì1.401(k)-1(f)(1), (2), (3), and (5)¡±;

b. Adding the language ¡°(or is deemed to be so irrevocably designated in accordance with ¡ì1.401(k)-1(f)(5)(iii))¡± immediately following the language ¡°otherwise eligible to make under the plan¡±; and

c. Removing the language ¡°(within the meaning of ¡ì1.401(k)-1(f)(2))¡± and adding, in its place, the language ¡°(within the meaning of ¡ì1.401(k)-1(f)(3))¡±.

Par. 4. Section 1.414(v)-1 is amended by:

a. In the last sentence of paragraph (a)(1), removing the language ¡°this section and ¡ì1.402(g)-2¡± and adding, in its place, the language ¡°this section, and ¡ì¡ì1.414(v)-2 and 1.402(g)-2¡±;

b. Adding paragraph (a)(4);

c. Revising and republishing paragraph (c)(2);

d. Adding paragraph (e)(1)(iii); and

e. Revising and republishing paragraph (i).

The additions and revisions read as follows:

(a) * * *

(4) Catch-up contributions must be designated Roth contributions for certain participants. For provisions relating to the requirement under section 414(v)(7) that catch-up contributions made by certain catch-up eligible participants must be designated Roth contributions, see ¡ì1.414(±¹)-2.

* * * * *

(c) * * *

(2) Applicable dollar catch-up limit¡ª(¾±) Plans other than SIMPLE Plans¡ª(´¡) In general. Except as provided in paragraph (c)(2)(i)(B) of this section, the applicable dollar catch-up limit that applies under an applicable employer plan, other than a SIMPLE 401(k) plan described in section 401(k)(11) or a SIMPLE IRA plan described in section 408(p), for a taxable year is $5,000, as adjusted for changes in the cost of living under paragraph (c)(2)(iii)(A) of this section.

(B) Higher limit applicable during the taxable year of attainment of age 60 through 63. For a taxable year beginning after 2024, with respect to a catch-up eligible participant who would attain age 60, 61, 62, or 63 during the taxable year, the applicable dollar catch-up limit for the taxable year under an applicable employer plan described in paragraph (c)(2)(i)(A) of this section is $11,250 (which is 150 percent of the applicable dollar catch-up limit described in paragraph (c)(2)(i)(A) of this section for a taxable year beginning in 2024), as adjusted for changes in the cost of living under paragraph (c)(2)(iii)(B) of this section.

(ii) SIMPLE plans¡ª(´¡) In general. Except as provided in paragraph (c)(2)(ii)(B) or (C) of this section, the applicable dollar catch-up limit that applies under a SIMPLE 401(k) plan described in section 401(k)(11) or a SIMPLE IRA plan described in section 408(p) for a taxable year is $2,500, as adjusted for changes in the cost of living under paragraph (c)(2)(iii)(A) of this section.

(B) Higher limit applicable during the taxable year of attainment of age 60 through 63. For a taxable year beginning after 2024, with respect to a catch-up eligible participant who would attain age 60, 61, 62, or 63 during the taxable year, the applicable dollar catch-up limit for the taxable year under an applicable employer plan described in paragraph (c)(2)(ii)(A) of this section is $5,250 (which is 150 percent of the applicable dollar catch-up limit under paragraph (c)(2)(ii)(A) of this section for a taxable year beginning in 2025), as adjusted for changes in the cost of living under paragraph (c)(2)(iii)(B) of this section.

(C) Higher limit for certain SIMPLE plans. For a taxable year beginning after 2023, the applicable dollar catch-up limit under an applicable employer plan described in paragraph (c)(2)(ii)(A) of this section that is maintained by an eligible employer meeting the requirements in section 408(p)(2)(E)(iv) is $3,850 (which is 110 percent of the applicable dollar catch-up limit in effect under paragraph (c)(2)(ii)(A) of this section for a taxable year beginning in 2024), as adjusted for changes in the cost of living under paragraph (c)(2)(iii)(C) of this section. The preceding sentence applies with respect to a taxable year only if the taxable year begins in a calendar year for which the eligible employer is described in section 408(p)(2)(E)(i)(I) or makes the election described in section 408(p)(2)(E)(i)(II).

(iii) Cost-of-living adjustments¡ª(´¡) In general. For a taxable year beginning after 2006, the applicable dollar catch-up limit under paragraph (c)(2)(i)(A) or (c)(2)(ii)(A) of this section (whichever applies to the plan) is the initial amount ($5,000 or $2,500, respectively), increased for changes in the cost of living. The increase is made at the same time and in the same manner as adjustments under section 415(d), except that the base period is the calendar quarter beginning July 1, 2005, and any increase that is not a multiple of $500 is rounded to the next lower multiple of $500.

(B) Adjustments to higher limit applicable during the taxable year of attainment of age 60 through 63. For a taxable year beginning after 2025, the applicable dollar catch-up limit under paragraph (c)(2)(i)(B) or (c)(2)(ii)(B) of this section (whichever applies to the plan) is the initial amount ($11,250 in the case of paragraph (c)(2)(i)(B) of this section and $5,250 in the case of paragraph (c)(2)(ii)(B) of this section), increased for changes in the cost of living. The increase is made at the same time and in the same manner as adjustments under section 415(d), except that the base period is the calendar quarter beginning July 1, 2024, and any increase that is not a multiple of $500 is rounded to the next lower multiple of $500.

(C) Adjustments to higher limit for certain SIMPLE plans. For a taxable year beginning after 2024, the applicable dollar catch-up limit under paragraph (c)(2)(ii)(C) of this section is the initial amount ($3,850), increased for changes in the cost of living. The increase is made at the same time and in the same manner as adjustments under section 415(d), except that the base period is the calendar quarter beginning July 1, 2023, and any increase that is not a multiple of $500 is rounded to the next lower multiple of $500.

* * * * *

(e) * * *

(1) * * *

(iii) Plans providing the statutory maximum catch-up contributions. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because of differences among catch-up eligible participants as to the dollar amount of catch-up contributions they are permitted to make, provided that each catch-up eligible participant who participates under any applicable employer plan maintained by the employer is provided with an effective opportunity to make the maximum amount of catch-up contributions permitted for that participant under section 414(v) or, if applicable, section 1081.01(d)(7) of the Puerto Rico Internal Revenue Code of 2011 (13 L.P.R.A. section 30391(d)(7)), as amended. For example, an applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because the plan permits catch-up eligible participants who would attain age 60, 61, 62, or 63 during a taxable year to make catch-up contributions up to the increased applicable dollar catch-up limit in section 414(v)(2)(E) while only permitting other catch-up eligible participants to make catch-up contributions up to the applicable dollar catch-up limit in section 414(v)(2)(B) without regard to section 414(v)(2)(E).

* * * * *

(i) Applicability dates¡ª(1) In general. Except as described in paragraph (i)(2) of this section or ¡ì1.414(v)-2(e), section 414(v) applies to contributions in taxable years beginning on or after January 1, 2002. Except as provided in paragraph (i)(2) of this section, paragraphs (a) through (h) of this section apply to contributions in taxable years beginning on or after January 1, 2004.

(2) Increases in applicable dollar catch-up limit under section 414(v)(2)¡ª(i) Higher limit during the taxable year of attainment of age 60 through 63. The amendments to section 414(v)(2) made by section 109 of Division T of the Consolidated Appropriations Act, 2023, Public Law 117-328, 136 Stat. 4459 (2022), known as the SECURE 2.0 Act of 2022 (SECURE 2.0 Act) to provide for a higher applicable dollar catch-up limit for individuals who attain age 60, 61, 62, or 63 during the taxable year apply to contributions in taxable years beginning after December 31, 2024. Paragraphs (c)(2)(i)(B), (c)(2)(ii)(B), and (c)(2)(iii)(B) of this section apply to contributions in taxable years beginning after [DATE SIX MONTHS AFTER DATE OF PUBLICATION OF FINAL RULE] (or, at the election of the taxpayer, taxable years beginning after December 31, 2024). Except as provided in paragraph (i)(2)(ii) of this section, for taxable years beginning on or before December 31, 2024, the applicable dollar catch-up limit is determined under ¡ì1.414(v)-1(c)(2) as it appeared in the April 1, 2024, edition of 26 CFR part 1.

(ii) Higher limit for certain SIMPLE plans. The amendments to section 414(v)(2) made by section 117 of the SECURE 2.0 Act to provide for a higher applicable dollar catch-up limit for certain SIMPLE plans apply to contributions in taxable years beginning after December 31, 2023. Paragraphs (c)(2)(ii)(C) and (c)(2)(iii)(C) of this section apply to contributions in taxable years beginning after [DATE SIX MONTHS AFTER DATE OF PUBLICATION OF FINAL RULE] (or, at the election of the taxpayer, taxable years beginning after December 31, 2023). For taxable years beginning on or before December 31, 2023, the applicable dollar catch-up limit for a SIMPLE 401(k) plan described in section 401(k)(11) or a SIMPLE IRA plan described in section 408(p) is determined under ¡ì1.414(v)-1(c)(2)(ii) as it appeared in the April 1, 2024, edition of 26 CFR part 1.

Par. 5. Section 1.414(v)-2 is added to read as follows:

(a) Section 414(v)(7) Roth catch-up contribution requirement¡ª(1) Organization of this section. Paragraphs (a)(2) through (5) of this section provide general rules relating to the requirements of section 414(v)(7). Paragraph (b) of this section provides certain rules of operation for implementing the requirements of section 414(v)(7) addressed in this paragraph (a). Paragraph (c) of this section provides rules relating to the treatment of pre-tax catch-up contributions that were required to be designated Roth contributions under section 414(v)(7). Paragraph (d) of this section provides examples illustrating the application of the rules of this section. Paragraph (e) of this section sets forth the statutory and regulatory effective dates relating to the section 414(v)(7) Roth catch-up requirement.

(2) Roth catch-up contribution requirement in general. For a taxable year beginning on or after January 1, 2024, if, for the calendar year preceding the calendar year in which the taxable year begins, a catch-up eligible participant in an applicable employer plan had wages (as defined in section 3121(a) for purposes of the taxes imposed by sections 3101(a) and 3111(a), for the year the wages are required to be taken into account for purposes of chapter 21 of the Code) from the employer sponsoring the plan (as determined under paragraph (b)(3) of this section) that exceeded the applicable Roth catch-up wage threshold, then ¡ì1.414(v)-1(a)(1) applies only if that participant¡¯s catch-up contributions (as described in ¡ì1.414(v)-1(a)(1)) under the plan are designated Roth contributions (as defined in section 402A(c)(1)). The Roth catch-up wage threshold that applies for a calendar year is $145,000, as adjusted for changes in the cost of living under paragraph (a)(3) of this section.

(3) Cost-of-living adjustment. For a calendar year beginning after December 31, 2024, the applicable Roth catch-up wage threshold in paragraph (a)(2) of this section is the initial amount ($145,000), increased for changes in the cost of living. The increase is made at the same time and in the same manner as adjustments under section 415(d), except that the base period is the calendar quarter beginning July 1, 2023, and any increase that is not a multiple of $5,000 is rounded to the next lower multiple of $5,000.

(4) Certain plans not subject to section 414(v)(7). Paragraph (a)(2) of this section does not apply to a plan described in section 408(k) or (p).

(5) Availability of designated Roth catch-up contributions¡ª(¾±) In general. Except as provided in paragraph (a)(5)(ii) of this section, if, under an applicable employer plan, any catch-up eligible participant who is subject to the Roth catch-up requirement under paragraph (a)(2) of this section is permitted to make catch-up contributions as designated Roth contributions for a plan year, then all catch-up eligible participants in the plan must be permitted to make catch-up contributions as designated Roth contributions for the plan year.

(ii) Special rule for participants subject to the Puerto Rico Code. In the case of a catch-up eligible participant who is subject to the Roth catch-up requirement under paragraph (a)(2) of this section and is subject to section 1081.01 of the Puerto Rico Internal Revenue Code of 2011 (13 L.P.R.A. section 30391), as amended (Puerto Rico Code), paragraph (a)(5)(i) of this section is treated as satisfied if, under the applicable employer plan, that participant is permitted to make catch-up contributions as after-tax contributions within the meaning of section 1081.01(a)(15) of the Puerto Rico Code.

(b) Rules of operation¡ª(1) Determination of catch-up contributions subject to section 414(v)(7) Roth requirement. For a participant who is subject to the Roth catch-up requirement under paragraph (a)(2) of this section for a plan year, an elective deferral that, in accordance with ¡ì1.414(v)-1(c)(3), is treated as a catch-up contribution at the time of deferral (for example, an elective deferral that is a catch-up contribution because it exceeds the section 401(a)(30) limit on elective deferrals) is required to be a designated Roth contribution only to the extent the participant has not previously made elective deferrals that are designated Roth contributions during the calendar year or taxable year equal to the applicable dollar catch-up limit under ¡ì1.414(v)-1(c)(2). Thus, for example, if a participant who is subject to the Roth catch-up requirement under paragraph (a)(2) of this section has already made elective deferrals that are designated Roth contributions during the calendar year that equal or exceed the applicable dollar catch-up limit at the time the participant¡¯s elective deferrals reach the section 401(a)(30) limit on elective deferrals, section 414(v)(7) would not require the participant¡¯s subsequent elective deferrals for the calendar year to be designated Roth contributions even though they are treated as catch-up contributions under ¡ì1.414(v)-1(c)(3).

(2) Treatment of plans without qualified Roth contribution programs¡ª(¾±) In general. For purposes of ¡ì1.414(v)-1(e)(1)(iii), if an applicable employer plan does not include a qualified Roth contribution program (within the meaning of section 402A(b)), then, for a catch-up eligible participant who is subject to the Roth catch-up requirement under paragraph (a)(2) of this section, the maximum amount of catch-up contributions permitted under section 414(v) is $0. Such a plan does not fail to satisfy the universal availability requirement of ¡ì1.414(v)-1(e) merely because the plan (or another applicable employer plan maintained by the employer that does not include a qualified Roth contribution program) does not permit catch-up contributions for participants who are subject to the Roth catch-up requirement under paragraph (a)(2) of this section.

(ii) Application of nondiscrimination requirements. If an applicable employer plan is described in paragraph (b)(2)(i) of this section, then ¡ì1.414(v)-1(d)(4) does not apply to the plan. As a result, a plan that has one or more highly compensated employees (as defined in section 414(q)) who are not subject to the Roth catch-up requirement under paragraph (a)(2) may need to preclude one or more of those highly compensated employees from making catch-up contributions to facilitate satisfaction of ¡ì1.401(a)(4)-4 with respect to the availability of catch-up contributions. In such a case, the plan is not treated as failing to satisfy the universal availability requirement of ¡ì1.414(v)-1(e) merely because of that preclusion.

(3) Determination of employer sponsoring the plan. For purposes of determining the employer sponsoring the plan with respect to a catch-up eligible participant, the employer is the participant¡¯s common law employer. Thus, for purposes of this section, the employer sponsoring the plan does not include other entities that are treated as a single employer with a catch-up eligible participant¡¯s common law employer under section 414(b), (c), (m), or (o).

(4) Plans with more than one employer sponsoring the plan. If an applicable employer plan has more than one employer sponsoring the plan (that is, the plan is sponsored by multiple employers that are aggregated under section 414(b), (c), (m), or (o), or is a multiple employer plan or a multiemployer plan), a catch-up eligible participant¡¯s wages for the preceding calendar year from one employer sponsoring the plan are not aggregated with the wages from another employer sponsoring the plan for purposes of determining whether the participant¡¯s wages for the preceding calendar year exceeded the applicable Roth catch-up wage threshold in paragraph (a)(2) of this section. Furthermore, even if a catch-up eligible participant¡¯s wages for the preceding calendar year from one employer sponsoring the plan exceeded the applicable Roth catch-up wage threshold in paragraph (a)(2) of this section, elective deferrals made from the participant¡¯s compensation from another employer sponsoring the plan that are catch-up contributions would not be required to be designated Roth contributions unless the participant¡¯s wages for the preceding calendar year from that other employer also exceeded that wage threshold.

(c) Treatment of pre-tax catch-up contributions that are required to be designated Roth contributions¡ª(1) General rule. Subject to paragraph (c)(3) of this section, a pre-tax elective deferral in excess of an applicable limit described in ¡ì1.414(v)-1(b)(1) that, in accordance with paragraph (a)(2) of this section, is a catch-up contribution only if it is a designated Roth contribution does not cause an applicable employer plan to fail to satisfy any requirement of the Internal Revenue Code if the failure to be a designated Roth contribution is corrected in accordance with paragraph (c)(2) of this section.

(2) Correction of section 414(v)(7) failures¡ª(¾±) In general. For purposes of this paragraph (c), if an elective deferral that exceeds a statutory limit, employer-provided limit, or ADP limit (as such terms are defined in ¡ì1.414(v)-1(b)(1)) fails to be a catch-up contribution under section 414(v)(1) because the elective deferral is not a designated Roth contribution, then the failure to satisfy section 414(v)(7) is referred to as a ¡°section 414(v)(7) failure¡± and may be corrected in accordance with this paragraph (c)(2). A plan may provide for either of the correction methods described in paragraphs (c)(2)(ii) and (iii) of this section, but with respect to a plan year, the plan must apply the same correction method for all participants with elective deferrals in excess of the same applicable limit.

(ii) Permitted correction on Form W-2. A plan may correct a section 414(v)(7) failure by transferring the catch-up contribution (adjusted for earnings and losses) from the participant¡¯s pre-tax account to the participant¡¯s designated Roth account and reporting the contribution (not adjusted for earnings and losses) as an elective deferral that is a designated Roth contribution on the participant¡¯s Form W-2 (Wage and Tax Statement) for the year in which the elective deferral was originally excluded from the participant¡¯s gross income. However, this correction method may be used only if the participant¡¯s Form W-2 for that year has not been filed or furnished to the participant.

(iii) Permitted correction by in-plan Roth rollover. As an alternative to the correction method permitted under paragraph (c)(2)(ii) of this section, a plan may correct a section 414(v)(7) failure by directly rolling over the catch-up contribution (adjusted for earnings and losses) from the participant¡¯s pre-tax account to the participant¡¯s designated Roth account, in accordance with section 402A(c)(4)(E), and reporting the amount of the in-plan Roth rollover on Form 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) for the year of the rollover.

(3) General correction requirements¡ª(¾±) Practices and procedures. For a plan to be eligible to use either of the correction methods described under paragraph (c)(2) of this section with respect to an elective deferral that is a catch-up contribution because it exceeds a statutory limit described in ¡ì1.414(v)-1(b)(1)(i), the plan sponsor or plan administrator must have in place practices and procedures designed to result in compliance with section 414(v)(7) at the time the elective deferral is made. As part of these practices and procedures, the plan must provide that the elective deferrals of a participant who is subject to the Roth catch-up requirement under paragraph (a)(2) of this section, but who has not made an affirmative election to make catch-up contributions as designated Roth contributions nor made designated Roth contributions equal to the applicable dollar catch-up limit earlier in a calendar year, are automatically treated as designated Roth contributions after the participant¡¯s pre-tax elective deferrals made during the calendar year equal the section 401(a)(30) limit on elective deferrals for the taxable year that begins in the calendar year. Similarly, the elective deferrals of such a participant who has not made an affirmative election to make catch-up contributions as designated Roth contributions nor made designated Roth contributions equal to the applicable dollar catch-up limit earlier in the limitation year must be automatically treated as designated Roth contributions after the participant¡¯s pre-tax elective deferrals result in the participant¡¯s annual additions for the limitation year exceeding the section 415(c) limit for the limitation year.

(ii) Reliance on Form W-2. A plan sponsor or plan administrator does not fail to have in place practices and procedures in accordance with paragraph (c)(3)(i) of this section merely because a plan determines the applicability of the section 414(v)(7)(A) Roth catch-up requirement to a participant on the basis of a timely-filed Form W-2 with respect to the participant.

(iii) Deadlines for corrections of section 414(v)(7) failures under paragraph (c)(2) of this section¡ª(´¡) Elective deferrals in excess of a statutory limit. If the section 414(v)(7) failure arises with respect to an elective deferral that is a catch-up contribution because it exceeds the section 401(a)(30) limit on elective deferrals, the deadline to complete all corrective steps required under paragraph (c)(2) of this section in order to avoid a qualification failure is April 15 of the calendar year following the calendar year for which the elective deferral was made. If the section 414(v)(7) failure arises with respect to an elective deferral that is a catch-up contribution because it results in the participant¡¯s annual additions for the limitation year exceeding the section 415(c) limit, the deadline to complete the corrective steps required under paragraph (c)(2) of this section in order to avoid a qualification failure is the deadline that applies under ¡ì1.415(c)-1(b)(6) for allocating amounts to the limitation year for which the elective deferral was made.

(B) Elective deferrals in excess of an employer-provided limit. If the section 414(v)(7) failure arises with respect to an elective deferral that is a catch-up contribution because it exceeds an employer-provided limit as described in ¡ì1.414(v)-1(b)(1)(ii), the deadline to complete the corrective steps required under paragraph (c)(2) of this section in order to avoid a qualification failure is the date that is 2? months (6 months, in the case of an applicable employer plan that includes an eligible automatic contribution arrangement within the meaning of section 414(w)) after the close of the plan year for which the catch-up contribution was made.

(C) Elective deferrals in excess of the ADP limit. If the section 414(v)(7) failure arises with respect to an elective deferral that is a catch-up contribution because it exceeds the ADP limit, the deadline to complete the corrective steps required under paragraph (c)(2) of this section in order to avoid a qualification failure is the date that is 2? months (6 months, in the case of an applicable employer plan that includes an eligible automatic contribution arrangement within the meaning of section 414(w)) after the close of the plan year for which the excess contribution was made.

(d) Examples. The following examples illustrate the application of this section. For purposes of these examples, assume that the participant¡¯s elective deferrals under all plans of the employer do not exceed the participant¡¯s section 415(c)(3) compensation, the participant¡¯s annual additions for a limitation year do not exceed the section 415(c) limit, the taxable year of the participant is the calendar year, the plan includes a qualified Roth contribution program, and the plan year is the calendar year (except as specifically provided). Assume further that this section applies to contributions in taxable years beginning in 2026, the section 401(a)(30) limit on elective deferrals for 2026 is $24,000, the applicable dollar catch-up limit for 2026 that is applicable to each participant in the examples is $8,000, and the Roth catch-up wage threshold to be applied to 2025 FICA wages for determining applicability of the Roth catch-up requirement under section 414(v)(7)(A) for a plan year beginning in 2026 is $150,000.

(1) Example 1: Application of Roth catch-up wage threshold¡ª(´¡) Facts. In January 2025, Participant A became an employee of an accounting firm that is structured as a partnership. Through October 2025, A had $151,000 of FICA wages from the accounting firm. In November 2025, Participant A became a partner in the accounting firm, and, for 2025, Participant A had a $30,000 distributive share of partnership income from the accounting firm, all of which was self-employment income. Participant A is a partner with the accounting firm for all of 2026.

(B) Analysis. Although Participant A is a partner with the accounting firm for the last two months of 2025 and for all of 2026 (and thus has self-employment income rather than FICA wages for that period), Participant A had more than $150,000 in FICA wages from the accounting firm for 2025. Thus, Participant A is subject to section 414(v)(7)(A) for 2026, and if Participant A makes elective deferrals in excess of an applicable limit for 2026 under a plan sponsored by the accounting firm, those elective deferrals must be designated Roth contributions.

(2) Example 2: Application of Roth catch-up wage threshold¡ª(´¡) Facts. The facts are the same as in paragraph (d)(1) of this section (Example 1), except that Participant A became a partner of the accounting firm in May 2025, and had FICA wages from the firm of $60,000 before becoming partner. In addition, for 2025, Participant A had a $150,000 distributive share of partnership income from the accounting firm, all of which was self-employment income.

(B) Analysis. Although Participant A had total compensation of $210,000 for the services Participant A performed for the accounting firm in 2025, only $60,000 of that amount were FICA wages. Because Participant A did not have more than $150,000 of FICA wages from the accounting firm for 2025, any elective deferrals in excess of an applicable limit that Participant A makes for 2026 under a plan sponsored by the accounting firm are not required to be designated Roth contributions.

(3) Example 3: Application of section 414(v)(7)(B) to a plan with a plan year other than the calendar year¡ª(A) Facts. Participant B participates in an applicable employer plan sponsored by Employer E. The plan year begins on July 1 and ends on June 30. Participant B had $155,000 in wages within the meaning of section 3121(a) from Employer E for calendar year 2025, and is a catch-up eligible participant for calendar year 2026. For the plan year beginning July 1, 2026, and ending June 30, 2027, the plan allows all catch-up eligible participants to make catch-up contributions and requires that any elective deferrals in excess of an applicable limit made by catch-up eligible participants who are subject to the requirements of section 414(v)(7)(A) be designated Roth contributions.

(B) Analysis. Because Participant B¡¯s FICA wages from Employer E for calendar year 2025 exceeded $150,000, Participant B is subject to the requirements of section 414(v)(7)(A) for the first half of the plan year beginning July 1, 2026, and any catch-up contributions that Participant B makes under the plan during that period must be designated Roth contributions. Because Participant B is permitted to make catch-up contributions that are designated Roth contributions under the plan for the plan year beginning July 1, 2026 (after Participant B reaches an applicable limit (as defined in ¡ì1.414(v)-1(b)(1)), all catch-up eligible participants under the plan must be permitted to make catch-up contributions that are designated Roth contributions for the plan year.

(4) Example 4: Plans with more than one employer sponsoring the plan¡ª(´¡) Facts. Employer F and Employer G are members of a controlled group of corporations within the meaning of section 414(b). Participant C was hired by Employer F on January 1, 2025, and remained employed by Employer F through October 31, 2025. Effective November 1, 2025, Participant C transferred to Employer G and was employed by Employer G for the remainder of 2025. Participant C is employed by Employer G for all of 2026, the year in which Participant C attains age 55. Employer F reported $155,000 of FICA wages on a Form W-2 for Participant C for 2025. Employer G reported $35,000 of FICA wages on a Form W-2 for Participant C for 2025. Employers F and G are participating employers in a section 401(k) plan, Plan P. Participant C becomes eligible to participate in Plan P on January 1, 2026, and all of Participant C¡¯s elective deferrals for 2026 are made from compensation paid by Employer G.

(B) Analysis. Employers F and G are common law employers of Participant C during different portions of 2025, and, under paragraph (b)(3) of this section, they are both employers sponsoring the plan. Because Participant C¡¯s FICA wages from Employer G in 2025 did not exceed $150,000, Participant C is not subject to the requirements of section 414(v)(7)(A) with respect to elective deferrals that are made from compensation paid by Employer G in 2026. Accordingly, Participant C is not required to designate any catch-up contributions made for 2026 under Plan P as designated Roth contributions. This is the case even though Participant C had wages from Employer F (an employer sponsoring the plan) that exceeded $150,000 for 2025.

(5) Example 5: Correction of section 414(v)(7) failure¡ª(´¡) Facts. Participant D, who attains age 55 in 2026, participates in a section 401(k) plan, Plan Q, sponsored by Employer H. Plan Q does not limit elective deferrals except as necessary to comply with sections 401(a)(30) and 415(c). Plan Q does not provide catch-up eligible participants with a separate election for elective deferrals that are in excess of the section 401(a)(30) limit and provides that such a participant is permitted to defer amounts in excess of the section 401(a)(30) limit on elective deferrals up to the applicable dollar catch-up limit for the year. For 2025, Participant D had $151,000 in wages (within the meaning of section 3121(a)) from Employer H. For 2026, Participant D elects to defer $1,250 into Participant D¡¯s account in Plan Q for each of 24 pay periods. Employer H has in place practices and procedures that are designed to prevent section 414(v)(7) failures and to result in compliance with the section 414(v)(7) Roth catch-up requirement at the time an elective deferral is made, and Plan Q provides for a deemed Roth catch-up election as described in paragraph (c)(3)(i) of this section. Nonetheless, Employer H discovers that all of Participant D¡¯s elective deferrals under Plan Q during 2026 (a total of $30,000) were pre-tax elective deferrals.

(B) Analysis. Because Participant D had over $150,000 in wages from Employer H for 2025, under section 414(v)(7)(A), Participant D¡¯s catch-up contributions under Plan Q for 2026 (that is, the elective deferrals that exceed the section 401(a)(30) limit) are required to be designated Roth contributions. Thus, $6,000 of Participant D¡¯s elective deferrals for 2026 (that is, the elective deferrals in excess of the section 401(a)(30) limit of $24,000) are required to be designated Roth contributions. To keep these contributions in the plan, Employer H must correct the section 414(v)(7) failure with respect to $6,000 of Participant D¡¯s pre-tax elective deferrals for 2026, using one of the methods set forth under paragraph (c)(2) of this section, by April 15, 2027 (the deadline under paragraph (c)(3)(iii)(A) of this section).

(6) Example 6: Designated Roth contributions that can satisfy the section 414(v)(7) Roth catch-up requirement¡ª(´¡) Facts. The facts are the same as in paragraph (d)(5) of this section (Example 5), except that the first $5,000 of the $30,000 total elective deferrals Participant D makes for 2026 are designated Roth contributions. (Thus, during each of the first 4 pay periods in 2026, Participant D makes $1,250 of elective deferrals that are designated Roth contributions, and then subsequently makes $25,000 in pre-tax elective deferrals ratably over the remaining 20 pay periods.) Participant D reaches the section 401(a)(30) limit on elective deferrals during the twentieth pay period of 2026 and does not make any designated Roth contributions after reaching the section 401(a)(30) limit on elective deferrals in 2026.

(B) Analysis. In accordance with paragraph (b)(1) of this section, the $5,000 in elective deferrals that are designated Roth contributions that Participant D made at the beginning of 2026 can be taken into account for purposes of satisfying Participant D¡¯s Roth catch-up requirement under section 414(v)(7). Thus, the portion of Participant D¡¯s pre-tax elective deferrals that are required to be corrected is $1,000 ($6,000 of elective deferrals that are in excess of the section 401(a)(30) limit, minus $5,000 of elective deferrals that were made as designated Roth contributions within the taxable year), and Employer H must correct the section 414(v)(7) failure with respect to only $1,000 of Participant D¡¯s pre-tax elective deferrals. To keep the $1,000 in the plan, Employer H must correct the section 414(v)(7) failure using one of the methods set forth under paragraph (c)(2) of this section, by April 15, 2027 (the deadline under paragraph (c)(3)(iii)(A) of this section).

(e) Applicability dates¡ª(1) Statutory applicability date. Section 414(v)(7) applies to contributions in taxable years beginning after December 31, 2023.

(2) Regulatory applicability dates¡ª(¾±) General rule. Except as provided in paragraphs (e)(2)(ii) and (iii) of this section, this section applies to contributions in taxable years beginning after [DATE SIX MONTHS AFTER DATE OF PUBLICATION OF FINAL RULE].

(ii) Collectively bargained plans. In the case of an applicable employer plan maintained pursuant to one or more collective bargaining agreements, paragraphs (a) through (d) of this section shall not apply until the first taxable year described in paragraph (e)(2)(i) of this section, or, if later, the first taxable year beginning after the date on which the last collective bargaining agreement related to the plan that is in effect on December 31, 2025, terminates (determined without regard to any extension to those agreements).

(iii) Early implementation permitted. A plan is permitted to apply the rules of this section to contributions in any taxable year beginning after December 31, 2023.

Douglas W. O¡¯Donnell, Deputy Commissioner.

(obÌåÓýd by the Office of the Federal Register January 10, 2025, 8:45 a.m., and published in the issue of the Federal Register for January 13, 2025, 90 FR 2645)

¹ Section 414(v)(6)(C) provides that section 414(v) does not apply to a participant in an eligible governmental 457(b) plan for any year for which a higher limitation applies to the participant under section 457(b)(3).

² The annual limit on salary reduction contributions or elective contributions is lower for SIMPLE plans than for other types of plans. However, SIMPLE plans are not subject to nondiscrimination testing, and the employer must make certain contributions.

³ An eligible employer is described in section 408(p)(2)(E)(iv) if, during the three-taxable-year period preceding the first year that the employer maintained the SIMPLE plan, the employer (including any member of the employer¡¯s controlled group or any predecessor of the employer or member of its controlled group) has not established or maintained a qualified plan, a section 403(a) annuity plan, or a section 403(b) plan under which contributions were made or benefits were accrued for substantially the same employees as are eligible to participate in the SIMPLE plan. See Q&A E-1 in Notice 2024-2, 2024-2 IRB 316.

⁴ Under a spillover design, a participant who would attain age 50 by the end of the taxable year makes one election with respect to elective deferrals for a plan year and, after the participant¡¯s elective deferrals reach a Code or plan limitation on elective deferrals that are not catch-up contributions, additional elective deferrals automatically begin counting toward the applicable dollar catch-up limit under section 414(v)(2).

⁵ This Notice of Proposed Rulemaking (NPRM) does not propose to incorporate proposed ¡ì1.401(k)-1(f)(5)(iii) and (iv) into the regulations relating to eligible governmental 457(b) plans because those regulations do not currently provide for the inclusion of a qualified Roth contribution program in an eligible governmental 457(b) plan. On June 22, 2016, proposed regulations relating to the inclusion of a qualified Roth contribution program in an eligible governmental 457(b) plan were published in the Federal Register (81 FR 40548) and those proposed regulations have not been finalized.

⁶ The higher applicable dollar catch-up limit for participants attaining age 60 through 63 may, but is not required to be, included in an applicable employer plan. Thus, an applicable employer plan may also be designed to limit the catch-up contributions for those participants to the same applicable dollar catch-up limit that applies for all other catch-up eligible participants.

⁷ For taxable years beginning in 2024, the limit on catch-up contributions that can be made by a participant who is eligible to make catch-up contributions under the Puerto Rico Code is $1,500.

⁸ The Roth catch-up wage threshold of $145,000 would be applied to a catch-up eligible participant¡¯s 2023 FICA wages to determine whether the Roth catch-up requirement applies to the participant¡¯s catch-up contributions made for 2024. In accordance with Notice 2024-80, 2024-47 IRB 1120, the Roth catch-up wage threshold that would be applied to a catch-up eligible participant¡¯s 2024 FICA wages to determine whether the Roth catch-up requirement applies to the participant¡¯s catch-up contributions made for 2025 remains $145,000.

⁹ By contrast, if none of the participants who are subject to the Roth catch-up requirement are permitted to make catch-up contributions under a plan for a plan year (for example, if a plan does not include a qualified Roth contribution program), then section 414(v)(7)(A) would not be considered to apply to any catch-up eligible participant in the plan for the plan year (and the requirement of section 414(v)(7)(B) would not apply to the plan). This interpretation of section 414(v)(7)(B) is consistent with the Joint Committee on Taxation general explanation of the provision. See JCS-1-23 (December 2023).

¹⁰ For purposes of this NPRM, a dual-qualified plan includes a plan for which an election under section 1022(i)(2) of the Employee Retirement Income Security Act of 1974 (Public Law 93-406, 88 Stat. 829), as amended (ERISA), has been made.

¹¹ This is also the case with respect to elective deferrals that are determined to be catch-up contributions because the plan would fail the actual deferral percentage (ADP) test under section 401(k)(3) if it did not correct under section 401(k)(8). The determination of elective deferrals that are catch-up contributions because they are in excess of this ADP limit in ¡ì1.414(v)-1(b)(1)(iii) occurs in the plan year following the plan year for which the elective deferrals are made.

¹² This is particularly true if an employer makes the top-paid group election under section 414(q)(1)(B)(ii).

¹³ In general, FICA wages are determined separately by related employers. See ¡ì31.3121(a)(1)-1(a)(3) (¡°If during a calendar year the employee receives remuneration from more than one employer, the annual wage limitation does not apply to the aggregate remuneration received from all of such employers, but instead applies to the remuneration received during such calendar year from each employer.¡±). See also ¡ì31.3121(s)-1(a) (¡°For purposes of section...3121(a)(1), except as otherwise provided..., when two or more related corporations concurrently employ the same individual and compensate that individual..., each of the corporations is considered to have paid only the remuneration it actually disburses to that individual.¡±).

¹⁴ This rule applies even if responsibilities under chapter 21 of the Code are imposed on a third party, such as a section 3401(d) statutory employer, a section 3504 agent, a section 3121(s) common paymaster, a section 3511 certified PEO, or a section 3512 motion picture project employer.

¹⁵ This would not be the case with respect to an employee of the joint board of trustees who participates in the plan. In that case, the joint board of trustees would be both the ¡°sponsor¡± within the meaning of section 3(16)(B) of ERISA and the common law employer.

¹⁶ Commenters also suggested that a plan be permitted to avoid having to correct section 414(v)(7) failures by requiring that all catch-up contributions be made as designated Roth contributions. The Treasury Department and the IRS have considered that suggestion and concluded that, for a participant who is not subject to the Roth catch-up requirement, allowing a plan design that requires all participants¡¯ catch-up contributions to be designated Roth contributions would be inconsistent with the language of section 402A(b)(1), which provides that a designated Roth contribution must be elected by an employee ¡°in lieu of all or a portion of elective deferrals the employee is otherwise eligible to make.¡±

¹⁷ This method would generally not be available with respect to an elective deferral that is a catch-up contribution because it exceeds the ADP limit under a plan with a calendar year plan year. This is because a participant¡¯s Form W-2 for a year is generally filed and furnished to the participant prior to determination of any catch-up contributions made by the participant because the elective deferrals exceed the ADP limit for such a plan year.

¹⁸ A plan would not be required under proposed ¡ì1.414(v)-2(c)(3)(i) to have such practices and procedures in place in order to correct a pre-tax catch-up contribution that is a catch-up contribution because it exceeds an employer-provided limit as described in ¡ì1.414(v)-1(b)(1)(ii). A plan would also not be required to have such practices and procedures in place in order to correct a pre-tax elective deferral that is a catch-up contribution because it exceeds the ADP limit as described in ¡ì1.414(v)-1(b)(1)(iii). This is because these elective deferrals are not determined to be catch-up contributions under ¡ì1.414(v)-1(c)(3) until the last day of the plan year of deferral or in the following plan year.

¹⁹ In the case of a plan that does not provide for a deemed Roth catch-up election, if the plan provides that it will not accept an elective deferral that exceeds an applicable limit on elective deferrals unless the elective deferral is a catch-up contribution, then the plan may be designed to automatically stop elective deferrals for a catch-up eligible participant who is subject to the Roth catch-up requirement after the participant¡¯s elective deferrals reach an applicable limit (unless the participant has designated the additional elective deferrals as Roth contributions).

²⁰ The Treasury Department and the IRS invite comments on whether there are scenarios in which it would not be appropriate to require correction of pre-tax catch-up contributions that are required to be designated Roth contributions on the basis of a subsequent determination that the amount of FICA wages reported on the Form W-2 was incorrect.

²¹ If the applicable deadline for a new correction method under the proposed regulations is not satisfied, then a section 414(v)(7) failure would need to be corrected by a distribution from the plan in accordance with the correction principles set forth in section 6 of Revenue Procedure 2021-30.

The proposed regulations are issued under the express delegation of authority under section 7805 of the Internal Revenue Code (Code). Section 7805(a) directs the Secretary of the Treasury or her delegate to prescribe all needful rules and regulations for the enforcement of that section and others in the Code, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.

Proposed regulations published in the Federal Register (84 FR 40317) in 2019 (REG-130700-14) (the 2019 proposed regulations) set forth proposed rules for identifying and classifying cloud transactions, and the preamble to the 2019 proposed regulations requested comments on rules for sourcing income from cloud transactions. Comments received addressed the necessity of developing specific rules for sourcing gross income from cloud transactions and provided recommendations on the content of such rules. This notice of proposed rulemaking, which is being published with the final regulations for identifying and classifying cloud transactions (TD 10022) (the 2025 final regulations) that are being published in the Final Rules section of this same issue of the Federal Register (90 FR 2977), proposes rules for sourcing gross income from cloud transactions.

The regulations are proposed to apply to taxable years beginning on or after the date of publication of the Treasury decision adopting these regulations as final regulations in the Federal Register.

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES heading. All comments will be available at www.regulations.gov.

A public hearing will be scheduled if requested in writing by any person that timely submits comments. Requests for a public hearing are also encouraged to be made electronically. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register.

The principal authors of these proposed regulations are Christopher E. Fulle and Michelle L. Ng of the Office of the Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Accordingly, the Treasury Department and IRS propose to amend 26 CFR part 1 as follows:

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

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

Par. 2. Section 1.861-19, as added in a final rule published elsewhere in this issue of the Federal Register, effective January 14, 2025, is amended as follows:

a. Revise the section heading and paragraph (a);

b. Redesignate paragraphs (d), (e), and (f) as paragraphs (e), (f), and (g), respectively;

c. Add new paragraph (d);

d. For each paragraph listed in the following table, remove the language in the ¡°Remove¡± column and add in its place the language in the ¡°Add¡± column.

 

e. Add paragraphs (e)(12) and (13); and

f. Revise newly redesignated paragraph (f).

The revisions and additions read as follows:

(a) In general. This section provides rules for classifying and sourcing gross income from cloud transactions (as defined in paragraph (b) of this section). The rules of this section apply for purposes of Internal Revenue Code sections 59A, 245A, 250, 267A, 367, 404A, 482, 679, and 1059A; subchapter N of chapter 1; chapters 3 and 4; and sections 842 and 845 (to the extent involving a foreign person), and apply with respect to transfers to foreign trusts not covered by section 679.

* * * * *

(d) Source of income from a cloud transaction--(1) In general. Gross income from a cloud transaction is sourced as services income under section 861(a)(3) or 862(a)(3), as appropriate, according to where the service is performed. The place of performance of the cloud transaction is based on the intangible property factor described in paragraph (d)(2) of this section, the personnel factor described in paragraph (d)(3) of this section, and the tangible property factor described in paragraph (d)(4) of this section. To determine gross income from a cloud transaction from sources within the United States, gross income from the cloud transaction is multiplied by a fraction, the numerator of which is the sum of the portion of each of the intangible property factor, personnel factor, and tangible property factor that is from sources within the United States as calculated in paragraphs (d)(2)(ii), (3)(ii), and (4)(ii) of this section, and the denominator of which is the sum of the intangible property factor, personnel factor, and tangible property factor as calculated in paragraphs (d)(2)(i), (3)(i), and (4)(i) of this section. See paragraph (e)(12) of this section (Example 12). Any remaining gross income from a cloud transaction is gross income from sources without the United States.

(2) Intangible property factor--(i) Total. For purposes of paragraph (d)(1) of this section, the intangible property factor with respect to any cloud transaction performed by the taxpayer in a taxable year is equal to the sum of the taxpayer¡¯s specified research or experimental expenditures (as defined in section 174(b) and regardless of whether and when the expenses are deductible) for that taxable year that are associated with cloud transactions in the same product line as the cloud transaction performed and the taxpayer¡¯s amortization (other than amounts capitalized under section 174(a)(2)(A) and amortized under section 174(a)(2)(B)) and royalty expense for intangible property for the taxable year to the extent directly used to provide the cloud transaction. If the same cost or expense would be included by a taxpayer in the intangible property factor for more than one cloud transaction during a taxable year, such cost or expense is allocated among each such cloud transaction based on the relative gross income earned from each cloud transaction.

(ii) Portion from sources within the United States. With respect to a cloud transaction provided in a taxable year, the portion of the intangible property factor from sources within the United States is determined using a formula based on the location of all of the taxpayer¡¯s employees whose primary function is to perform research and experimentation activities associated with cloud transactions in the same product line in that taxable year (the research and experimentation personnel). The formula is as follows: applying the principles of ¡ì1.861-4(b)(2)(ii)(E) (relating to sourcing income from labor or personal services on a time basis), divide the sum of the total compensation paid to the research and experimentation personnel for services performed within the United States by the sum of the total compensation paid to the research and experimentation personnel, and multiply the resulting quotient by the intangible property factor described in paragraph (d)(2)(i) of this section.

(3) Personnel factor--(i) Total. For purposes of paragraph (d)(1) of this section, the personnel factor with respect to a cloud transaction performed in a taxable year is equal to the sum of the total compensation paid to all of the taxpayer¡¯s employees in that taxable year whose primary function is to directly contribute to the provision of the cloud transaction, excluding compensation amounts that are paid to research and experimentation personnel described in paragraph (d)(2) of this section. If, however, an employee¡¯s primary function is to directly contribute to multiple cloud transactions, then all of such employee¡¯s compensation is allocated among the cloud transactions that the employee directly contributes to as part of their primary function based on the relative amount of time the employee spends contributing to each cloud transaction. If an employee contributes to multiple cloud transactions simultaneously, then that employee¡¯s compensation is allocated among those cloud transactions based on the relative gross income earned from each cloud transaction.

(ii) Portion from sources within the United States. With respect to a cloud transaction, the portion of the personnel factor described in paragraph (d)(3)(i) of this section that is from sources within the United States is equal to the part of that factor paid for services performed in the United States, as determined using the principles of ¡ì1.861-4(b)(2)(ii)(E) (relating to sourcing income from labor or personal services on a time basis).

(iii) Personnel considered to directly contribute to the provision of the cloud transaction. Personnel are considered to directly contribute to the provision of the cloud transaction to the extent they personally perform technical or operational activities for the provision of the cloud transaction, or to the extent they are a manager who directly supports or immediately supervises such technical or operational personnel. Such technical or operational activities are the conduct of scientific, engineering, or technical activities for the configuration, delivery, or maintenance of the cloud transaction; the provision of monitoring, diagnostics, or incident response with respect to the cloud transaction¡¯s performance, reliability, efficiency, or security; the management of the cloud transaction¡¯s infrastructure; the delivery of end-user support with respect to the cloud transaction; and the conduct of any similar functions.

(iv) Personnel not considered to directly contribute to the provision of the cloud transaction. Personnel are not considered to directly contribute to the provision of the cloud transaction to the extent they conduct business strategy, leadership, legal or compliance, marketing, communications, sales, business development, finance, accounting, clerical, human resources or administrative duties, or similar functions.

(4) Tangible property factor--(i) Total. For purposes of paragraph (d)(1) of this section, the tangible property factor with respect to a cloud transaction performed in a taxable year is equal to the sum of the depreciation expense for that taxable year for tangible property owned by the taxpayer and rental expense for that taxable year for tangible property leased by the taxpayer, in each case to the extent directly used to provide the cloud transaction. If any depreciation expense or rental expense would be included in the tangible property factor for more than one cloud transaction during the taxable year, such depreciation expense or rental expense is allocated among the cloud transactions based on relative gross income earned from each cloud transaction.

(ii) Portion from sources within the United States. The portion of the tangible property factor described in paragraph (d)(4)(i) of this section from sources within the United States is equal to the part of that factor attributable to property located within the United States.

(iii) Determination of depreciation expense. For purposes of paragraph (d)(4) of this section, depreciation expense for a taxable year is determined by dividing the adjusted depreciable basis (as defined in ¡ì1.168(b)-1(a)(4)) of the tangible property by the applicable recovery period as though the alternative depreciation system set forth in section 168(g)(2) applied for the entire period that such property has been in service, without regard to the election to expense certain depreciable property under section 179 and without regard to any additional first-year depreciation provision (for example, section 168(k)).

(5) Primary function. For purposes of this section, an employee¡¯s primary function is the set of tasks to which they are assigned to spend the majority of their working time.

(6) Employee. For purposes of this section, the term employee has the meaning given to it in ¡ì31.3121(d)-1(c).

(7) Aggregation rule. For purposes of applying this paragraph (d), a taxpayer may aggregate substantially similar cloud transactions unless it knows or has reason to know that doing so would materially distort the source of gross income from any cloud transaction.

(8) Product line. For purposes of this section, a product line is defined as all products within the same Corresponding Index Entry under a North American Industry Classification System (NAICS) code number. Once a taxpayer selects a Corresponding Index Entry and NAICS code number for the first taxable year for which this section applies, it must continue to use that Corresponding Index Entry and NAICS code number in following years unless the taxpayer establishes to the satisfaction of the Commissioner that, due to changes in the relevant facts, a change in Corresponding Index Entry and NAICS code number is appropriate.

(9) Anti-Abuse Rule. The purpose of this paragraph (d) is to attribute the source of the taxpayer¡¯s gross income from a cloud transaction to the location where the cloud transaction is performed. Therefore, if the taxpayer has entered into or structured one or more transactions with a principal purpose of reducing its U.S. tax liability in a manner inconsistent with the purpose of this paragraph (d), appropriate adjustments will be made so that the source of the taxpayer¡¯s gross income reflects the location where the cloud transaction is performed.

(e) * * *

(12) Example 12: Sourcing gross income from a cloud transaction--(i) Facts. (A) Corp A provides customers on-demand network access to Program Y in exchange for a monthly fee. All of the transactions with customers are substantially similar to one another. Customers must be connected to the Internet to access the functionality of Program Y.

(B) Corp A has employees whose primary function (as determined under paragraph (d)(5) of this section) is to conduct research and experimentation associated with developing new versions of Program Y and other products in the same product line (as determined under paragraph (d)(8) of this section). Corp A paid $160x in compensation to such employees, of which $80x was paid for services performed within the United States as determined in accordance with the principles of ¡ì1.861-4(b)(2)(ii)(E). Besides employee compensation, Corp A spent an additional $200x for research and experimentation costs associated with developing new versions of Program Y and other products in the same product line. Corp A did not take any amortization deductions with respect to intellectual property used to provide Program Y.

(C) Corp A paid $400x in compensation to employees whose primary function was to directly contribute (as determined under paragraphs (d)(3)(iii) and (iv) of this section) to Corp A¡¯s provision of Program Y to customers, of which $100x was paid for services performed in the United States as determined in accordance with the principles of ¡ì1.861-4(b)(2)(ii)(E). None of these employees were research and experimentation personnel (as defined in paragraph (d)(2)(ii) of this section).

(D) Corp A hosts Program Y on servers it owns that are located both within and without the United States. These servers are used only to host Program Y. Corp A deducted $140x for depreciation expense attributable to these servers, $80x of which was attributable to the servers located within the United States, and $60x of which was attributable to the servers located without the United States. These depreciation deductions are in accordance with the rules of section 168(g)(2).

(E) Corp A earned $800x of gross income from providing customers access to Program Y. Corp A does not know or have reason to know that any of the costs, functions or assets described in this paragraph are disproportionately allocated to certain transactions or groups of transactions among all of the transactions that generated $800x of gross income.

(ii) Analysis. (A) Under paragraph (b) of this section, each transaction between Corp A and a customer is a cloud transaction because Corp A provides on-demand network access to Program Y. Under paragraph (c)(1) of this section, each cloud transaction is classified as the provision of services. Under paragraph (d)(7) of this section, because all of these transactions are substantially similar and Corp A does not know or have reason to know that there is any disproportionate allocation of costs, functions or assets among them, all of the transactions may be considered in the aggregate for purposes of applying paragraph (d) of this section.

(B) Under paragraph (d)(1) of this section, the source of Corp A¡¯s $800x of gross income from providing access to Program Y to customers is determined based on the intangible property factor described in paragraph (d)(2) of this section, the personnel factor described in paragraph (d)(3) of this section, and the tangible property factor described in paragraph (d)(4) of this section.

(C) Under paragraph (d)(2) of this section, the intangible property factor is equal to $360x because Corp A paid $160x in compensation to employees whose primary function was to conduct research and experimentation associated with developing new versions of Program Y and other products in the same product line, and incurred $200x in other research and experimentation costs associated with developing new versions of Program Y and other products in the same product line. $80x/$160x of such compensation, or 50%, is paid to employees for research and experimentation services performed with respect to Program Y and other products in the same product line in the United States. Corp A¡¯s $360x intangible property factor is multiplied by the same quotient to determine that $180x is from sources within the United States pursuant to paragraph (d)(2)(ii) of this section.

(D) Under paragraph (d)(3) of this section, the personnel factor is equal to $400x because Corp A paid $400x in compensation to employees whose primary function was to directly contribute to the provision of Program Y to customers and none of these employees were research and experimentation personnel (as defined in paragraph (d)(2)(ii) of this section). Pursuant to paragraph (d)(3)(ii) of this section, $100x of the personnel factor is from sources within the United States because Corp A paid $100x in compensation to employees for services performed in the United States that directly contributed to the provision of Program Y to customers.

(E) Under paragraph (d)(4) of this section, the tangible property factor is equal to $140x because Corp A deducted $140x in depreciation expense for tangible property directly used to provide Program Y to customers under the method described in section 168(g)(2). $80x of the tangible property factor is from sources within the United States because this amount of the $140x depreciation expense is attributable to tangible property located within the United States.

(F) The sum of the intangible property factor ($360x), the personnel factor ($400x), and the tangible property factor ($140x) is equal to $900x. The sum of these factors from sources within the United States is $360x ($180x with respect to the intangible property factor, $100x with respect to the personnel factor, and $80x with respect to the tangible property factor). Accordingly, Corp A¡¯s $800x of gross income from providing Program Y to customers for the taxable year is multiplied by the quotient of $360x/$900x pursuant to paragraph (d)(1) of this section to determine that $320x is from sources within the United States. Pursuant to paragraph (d)(1) of this section, the remaining $480x ($800x - $320x) is from sources without the United States.

(13) Example 13: Sourcing gross income from multiple cloud transactions--(i) Facts. (A) The facts are the same as in paragraph (e)(12) of this section (Example 12), except that Corp A also provides customers on-demand network access to software platform Z in exchange for a monthly fee, and Corp A hosts software platform Z on the same servers it uses to host Program Y (which generate more depreciation than in Example 12). All of the transactions for software platform Z customers are substantially similar to one another. Customers must be connected to the Internet to access the functionality of software platform Z.

(B) Corp A has employees whose primary function (as determined under paragraph (d)(5) of this section) is to conduct research and experimentation associated with developing new versions of software platform Z and other products in the same product line. The software platform Z product line is not the same as the Program Y product line under the definition in paragraph (d)(8) of this section. Corp A paid $200x in compensation to such employees, all of which was paid for services performed in the United States as determined in accordance with the principles of ¡ì1.861-4(b)(2)(ii)(E). Corp A also has employees whose primary function as determined under paragraph (d)(5) of this section is to conduct research and experimentation associated with developing functionality for new versions of both Program Y and software platform Z. Corp A paid $100x in compensation to such employees, all of which was paid for services performed in the United States as determined in accordance with the principles of ¡ì1.861-4(b)(2)(ii)(E). Corp A did not have any other research and experimentation costs associated with software platform Z.

(C) Corp A paid $100x in compensation to employees whose primary function was to directly contribute (as determined under paragraphs (d)(3)(iii) and (iv) of this section) to Corp A¡¯s provision of software platform Z to customers, and that entire amount was paid for services performed in the United States as determined in accordance with the principles of ¡ì1.861-4(b)(2)(ii)(E). None of these employees were research and experimentation personnel (as defined in paragraph (d)(2)(ii) of this section). Corp A also paid $80x in compensation to employees whose primary function was to directly contribute (as determined under paragraphs (d)(3)(iii) and (iv) of this section) to Corp A¡¯s provision of both Program Y and software platform Z to customers, and that entire amount was paid for services performed in the United States as determined in accordance with the principles of ¡ì1.861-4(b)(2)(ii)(E). These employees spent half their time contributing to software platform Z transactions and half their time contributing to Program Y transactions. None of these employees were research and experimentation personnel (as defined in paragraph (d)(2)(ii) of this section).

(D) Corp A hosts software platform Z on servers it owns that are located both within and without the United States. These servers are used to host both Program Y and software platform Z. Corp A deducted $180x for depreciation expense attributable to these servers, $120x of which was attributable to the servers located within the United States, and $60x of which was attributable to the servers located without the United States. These depreciation deductions are in accordance with the rules of section 168(g)(2).

(E) Corp A earned $800x of gross income from providing customers access to software platform Z. Corp A does not know or have reason to know that any of the costs, functions or assets described in this paragraph are disproportionately allocated to certain transactions or groups of transactions among all of the transactions that generated $800x of gross income.

(ii) Analysis. (A) Under paragraph (b) of this section, each transaction between Corp A and a customer for software platform Z is a cloud transaction because Corp A provides on-demand network access to software platform Z. Under paragraph (c)(1) of this section, each cloud transaction is classified as the provision of services. Under paragraph (d)(7) of this section, because all of these software platform Z transactions are substantially similar and Corp A does not know or have reason to know that there is any disproportionate allocation of costs, functions or assets among them, all of the software platform Z transactions may be considered in the aggregate for purposes of applying paragraph (d) of this section.

(B) Under paragraph (d)(1) of this section, the source of Corp A¡¯s $800x of gross income from providing access to software platform Z to customers is determined based on the intangible property factor described in paragraph (d)(2) of this section, the personnel factor described in paragraph (d)(3) of this section, and the tangible property factor described in paragraph (d)(4) of this section.

(C) Under paragraph (d)(2) of this section, the intangible property factor is equal to $250x. Corp A paid $200x in compensation to employees whose primary function was to conduct research and experimentation associated with developing new versions of software Platform Z and other products in the same product line. Corp A also paid $100x in compensation to employees whose primary function was to conduct research and experimentation developing functionality for new versions of both Program Y and software platform Z, of which Corp A allocates $50x to software Platform Z and $50x to Program Y based on Corp A¡¯s relative gross income from Program Y and software platform Z transactions in the taxable year. $250x/$250x of such compensation, or 100%, is paid to employees for research and experimentation services performed in the United States with respect to software Platform Z and other products in the same product line. Corp A¡¯s $250x intangible property factor is multiplied by the same quotient to determine that $250x is from sources within the United States pursuant to paragraph (d)(2)(ii) of this section.

(D) Under paragraph (d)(3) of this section, the personnel factor is equal to $140x. Corp A paid $100x in compensation to employees whose primary function was to directly contribute to the provision of software platform Z to customers and none of these employees were research and experimentation personnel (as defined in paragraph (d)(2)(ii) of this section). Corp A also paid $80x in compensation to employees whose primary function was to directly contribute to the provision of both Program Y and software platform Z (and none of these employees were research and experimentation personnel (as defined in paragraph (d)(2)(ii) of this section)), and Corp A allocated $40x to software platform Z and $40x to Program Y based on the relative amount of time these employees spent contributing to Program Y and software platform Z transactions in the taxable year. $140x/$140x of such compensation, or 100%, is paid to employees for services performed in the United States that directly contributed to the provision of software platform Z to customers.

(E) Under paragraph (d)(4) of this section, the tangible property factor is equal to $90x. Corp A deducted $180x in depreciation expense for tangible property directly used to provide both Program Y and software platform Z transactions under the method described in section 168(g)(2), of which $120x is from sources within the United States because this amount is attributable to tangible property located within the United States. Based on Corp A¡¯s relative gross income from Program Y and software platform Z transactions in the taxable year, Corp A reasonably allocates $90x to software platform Z, of which $60x is from sources within the United States and $90x to Program Y, of which $60x is from sources within the United States.

(F) The sum of the intangible property factor ($250x), the personnel factor ($140x), and the tangible property factor ($90x) is equal to $480x. The sum of these factors from sources within the United States is $450x ($250x with respect to the intangible property factor, $140x with respect to the personnel factor, and $60x with respect to the tangible property factor). Accordingly, Corp A¡¯s $800x of gross income from providing software platform Z to customers for the taxable year is multiplied by the quotient of $450x/$480x pursuant to paragraph (d)(1) of this section to determine that $750x is from sources within the United States. Pursuant to paragraph (d)(1) of this section, the remaining $50x ($800x - $750x) is from sources without the United States.

(f) Applicability date--(1) In general. Except as otherwise provided in this paragraph (f), this section applies to taxable years beginning on or after January 14, 2025. Paragraphs (d), (e)(12) and (13) of this section apply to taxable years beginning on or after the date of publication of the Treasury decision adopting those paragraphs as final regulations in the Federal Register.

(2) Early application. Except for paragraphs (d), (e)(12) and (13) of this section, a taxpayer can apply this section to taxable years beginning on or after August 14, 2019 and all subsequent taxable years not described in paragraph (f)(1) (early application years) if--

(i) The taxpayer also applies ¡ì1.861-18 to the early application years;

(ii) This section and ¡ì1.861-18 are applied to the early application years by all persons related to the taxpayer (within the meaning of sections 267(b) and 707(b));

(iii) The period of limitations on assessment for each early application year of the taxpayer and all related parties (within the meaning of sections 267(b) and 707(b)) is open under section 6501; and

(iv) The taxpayer would not be required under this section to change its method of accounting as a result of such election.

* * * * *

Douglas W. O¡¯Donnell, Deputy Commissioner.

(obÌåÓýd by the Office of the Federal Register January 10, 2025, 8:45 a.m., and published in the issue of the Federal Register for January 14, 2025, 90 FR 3075)

This document contains proposed regulations under section 355 of the Internal Revenue Code (Code) that would amend the Income Tax Regulations (26 CFR part 1) by substantially revising the information reporting requirements of ¡ì1.355-5 (proposed regulations). The proposed regulations are issued under the express delegation of section 7805(a) of the Code, which authorizes the Secretary to ¡°prescribe all needful rules and regulations for the enforcement of [the Code], including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.¡±

The Treasury Department and the IRS are of the view that enhancing the reporting requirements for section 355 transactions would improve the IRS¡¯s ability to administer section 355 (and related provisions of the Code) to ensure that transactions intended to qualify under section 355 (and such related provisions) satisfy the requirements for nonrecognition treatment. Accordingly, these proposed regulations would revise ¡ì1.355-5 to require all covered filers, as defined in proposed ¡ì1.355-5(b)(1), to file with the IRS an annual report with regard to each section 355 transaction (Form 7216, Multi-Year Reporting Related to Section 355 Transactions) that would be attached to the covered filer¡¯s Federal income tax return.

For purposes of the proposed regulations, the term ¡°section 355 transaction¡± includes both divisive reorganizations and section 355(c) distributions. The term ¡°covered filer¡± would include, with regard to any section 355 transaction: (i) a distributing corporation or a person that, immediately before the first distribution, was a United States shareholder (within the meaning of section 951(b)) with respect to a controlled foreign corporation (within the meaning of section 957 of the Code, but determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3) of the Code) that is the distributing corporation; (ii) a controlled corporation or a person that, immediately before the first distribution, was a United States shareholder with respect to a controlled foreign corporation that is the controlled corporation; (iii) a significant distributee or a person that, immediately before the first distribution, was a United States shareholder with respect to a controlled foreign corporation that is a significant distributee; or (iv) any other person required by the Commissioner of Internal Revenue (Commissioner) to file Form 7216 (or any successor form) in instructions, guidance, or publications published in the Internal Revenue Bulletin (see ¡ì¡ì601.601(d)(2) and 601.602 of this chapter). The term ¡°covered filer¡± also would include any successor (within the meaning of section 381(a) of the Code) to an entity described in the preceding sentence. The proposed regulations also would revise the definition of a ¡°significant distributee¡± in current ¡ì1.355-5(c)(1)(i) by raising the ownership threshold for non-publicly traded stock from one percent to five percent.

However, the term ¡°covered filer¡± would be defined to encompass solely taxpayers required to file certain specified Federal income tax returns. These returns would be limited to: (i) Form 1040, U.S. Individual Income Tax Return; (ii) Form 1040-NR, U.S Nonresident Alien Income Tax Return; (iii) Form 1065, U.S. Return of Partnership Income; (iv) Form 1120, U.S. Corporation Income Tax Return; (v) Form 1120-F, U.S. Income Tax Return of a Foreign Corporation; (vi) Form 1120-S, U.S. Income Tax Return for an S Corporation; and (vii) any other form listed in instructions, guidance, or publications published in the Internal Revenue Bulletin (see ¡ì¡ì601.601(d)(2) and 601.602 of this chapter). Accordingly, a taxpayer that is not required to file one of these specified Federal income tax returns (such as an estate, a trust, or a regulated investment company (as defined in section 851(a) of the Code)) would not be required to file Form 7216. The Treasury Department and the IRS request comments as to whether taxpayers required to file additional types of Federal income tax returns should be required to file Form 7216.

Each covered filer would be required to file Form 7216 with regard to each section 355 transaction for the required reporting period. For this purpose, the term ¡°required reporting period¡± would mean the period (i) beginning in the covered filer¡¯s taxable year in which the first distribution occurs, and (ii) ending in the fifth taxable year of the covered filer after the taxable year in which the control distribution occurs. The five-year required reporting period would apply to a covered filer (or its successor) even in cases where the covered filer (or its successor) ceases to be a United States shareholder with respect to a relevant corporation and is no longer required to file Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, with respect to such corporation.

Consistent with current ¡ì1.355-5(d), the proposed regulations would require that, under ¡ì1.6001-1(e), a covered filer must retain its permanent books and records and make those books and records available for inspection by any authorized IRS officers and employees. In addition, the proposed regulations would provide that, in connection with the section 355 transaction, the covered filer¡¯s books and records, as relevant to the section 355 transaction, will be considered to be complete and accurate if they contain all information necessary to document and substantiate satisfaction of the requirements under section 355.

The proposed regulations would significantly enhance the IRS¡¯s ability to identify section 355 transactions that pose the highest risk of potential Federal income tax noncompliance and abuse. These proposed regulations also would help effectuate a broader effort by the Treasury Department and the IRS to close the portion of the Federal tax gap (that is, the difference between all Federal taxes that are owed and those that are collected) due to such potential noncompliance and abuse.

Because the enhanced reporting requirements in these proposed regulations would augment the IRS¡¯s ability to identify section 355 transactions with the highest risk of potential noncompliance and abuse, the Treasury Department and the IRS are of the view that additional flexibility can be provided in the substantive rules applicable to section 355 transactions (for example, by affording taxpayers additional time to carry out a plan of distribution). Proposed regulations that would provide guidance regarding certain matters relating to corporate separations, incorporations, and reorganizations qualifying, in whole or in part, for nonrecognition of gain or loss are published elsewhere in the Proposed Rules section of this issue of the Federal Register.

The proposed reporting requirements would apply to all types of section 355 transactions with a covered filer. Specifically, the proposed regulations would apply to (i) section 355 transactions within an affiliated group (as defined in section 1504(a)(1) of the Code, without regard to the exceptions in section 1504(b)) (internal section 355 transaction), and (ii) section 355 transactions in which stock or securities of a controlled corporation are distributed to a distributing corporation shareholder or security holder that is not a member of the distributing corporation¡¯s affiliated group (external section 355 transaction). To reflect the differences between internal section 355 transactions and external section 355 transactions (including the different statutory requirements and potential for Federal income tax noncompliance or abuse), the proposed regulations would impose, through the annual Form 7216, different reporting requirements for each type of section 355 transaction.

These proposed regulations are consistent with the recommendations set forth in the Treasury Inspector General for Tax Administration (TIGTA) report titled ¡°A Strategy Is Needed to Assess the Compliance of Corporate Mergers and Acquisitions With Federal Tax Requirements,¡± Ref. No. 2019-30-050 (Sept. 5, 2019). In that report, TIGTA recommended that the Commissioner determine whether merger and acquisition (M&A) tax forms, and information provided on those forms, could be used as a compliance tool within a larger strategy to assess risk and ensure that corporate M&A transactions are compliant with the Code. These proposed regulations would enable the IRS to collect information on section 355 transactions from taxpayers engaging in those transactions and utilize that information to identify potential noncompliance with section 355 and other related provisions of the Code.

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in the preamble under the ADDRESSES heading. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. All commenters are strongly encouraged to submit comments electronically. The Treasury Department and the IRS will publish for public availability any comment submitted electronically or on paper to its public docket on https://www.regulations.gov.

A public hearing will be scheduled if requested in writing by any person who timely submits electronic or written comments. Requests for a public hearing also are encouraged to be made electronically. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register.

The principal author of these proposed regulations is Barrett D. Cappadonna of the Office of Associate Chief Counsel (Corporate). However, other personnel from the Treasury Department and the IRS participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows:

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

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

* * * * *

Par. 2. Section 1.355-5 is revised to read as follows:

(a) Reporting of transaction information¡ª(1) Annual reporting form¡ª(¾±) In general. For each taxable year of the required reporting period, a covered filer must file annually with the IRS a complete and accurate Form 7216, Multi-Year Reporting Related to Section 355 Transactions (or as provided in publications, forms, instructions, or other guidance), with regard to a section 355 transaction.

(ii) Manner of filing form. A covered filer must file Form 7216 (or any successor form)¡ª

(A) With the specified Federal income tax return of the covered filer for the taxable year (see section 6011 of the Code and ¡ì1.6011-1); and

(B) In the manner prescribed by the Commissioner in instructions, guidance, or publications published in the Internal Revenue Bulletin (see ¡ì¡ì601.601(d)(2) and 601.602 of this chapter).

(2) [Reserved]

(3) [Reserved]

(b) Definitions. The following definitions apply for purposes of this section:

(1) Covered filer¡ª(¾±) In general. The term covered filer means a taxpayer that is required to file a specified Federal income tax return and that is¡ª

(A) A distributing corporation or a person that, immediately before the first distribution, was a United States shareholder (within the meaning of section 951(b) of the Code) with respect to a controlled foreign corporation (within the meaning of section 957 of the Code, but determined without applying subparagraphs (A), (B), and (C) of section 318(a)(3)) that is the distributing corporation;

(B) A controlled corporation or a person that, immediately before the first distribution, was a United States shareholder with respect to a controlled foreign corporation that is the controlled corporation;

(C) A significant distributee or a person that, immediately before the first distribution, was a United States shareholder with respect to a controlled foreign corporation that is a significant distributee; or

(D) Any other person required by the Commissioner to file Form 7216 (or any successor form) in accordance with instructions, guidance, or publications published in the Internal Revenue Bulletin (see ¡ì¡ì601.601(d)(2) and 601.602 of this chapter).

(ii) Successors. The term covered filer includes any successor (within the meaning of section 381(a) of the Code) to an entity described in paragraph (b)(1)(i) of this section.

(2) Required reporting period. The term required reporting period means the period¡ª

(i) Beginning in the taxable year of the covered filer during which the first distribution occurs; and

(ii) Ending in the fifth taxable year of the covered filer after the taxable year in which the control distribution occurs.

(3) Significant distributee. The term significant distributee means:

(i) A holder of stock of a distributing corporation that¡ª

(A) Receives stock of a controlled corporation in a section 355 transaction; and

(B) Owned at least five percent (by vote or value) of the total outstanding stock of the distributing corporation immediately before the first distribution.

(ii) A holder of securities of a distributing corporation that¡ª

(A) Receives stock or securities of a controlled corporation in a section 355 transaction; and

(B) Owned securities in the distributing corporation with a basis of at least $1,000,000 immediately before the first distribution.

(4) Specified Federal income tax return. The term specified Federal income tax return ³¾±ð²¹²Ô²õ¡ª

(i) Form 1040, U.S. Individual Income Tax Return;

(ii) Form 1040-NR, U.S. Nonresident Alien Income Tax Return;

(iii) Form 1065, U.S. Return of Partnership Income;

(iv) Form 1120, U.S. Corporation Income Tax Return;

(v) Form 1120-F, U.S. Income Tax Return of a Foreign Corporation;

(vi) Form 1120-S, U.S. Income Tax Return for an S Corporation; or

(vii) Any other form listed in instructions, guidance, or publications published in the Internal Revenue Bulletin (see ¡ì¡ì601.601(d)(2) and 601.602 of this chapter).

(c) Substantiation information. Under ¡ì1.6001-1(e), a covered filer must retain its permanent books and records and make those books and records available for inspection by any authorized IRS officers and employees. In connection with the section 355 transaction, the covered filer¡¯s books and records, as relevant to the section 355 transaction, will be considered to be complete and accurate if they contain all information necessary to document and substantiate satisfaction of the requirements under section 355.

(d) Applicability date¡ª(1) In general. Except as provided in paragraph (d)(2) of this section, the rules of this section apply to taxable years ending after [date of publication of final regulations in the Federal Register] with respect to section 355 transactions occurring after January 16, 2025. For rules applicable to prior taxable years, see ¡ì1.355-5 as in effect and contained in 26 CFR part 1, as revised April 1, 2024.

(2) [Reserved]

Douglas W. O¡¯Donnell, Deputy Commissioner.

(obÌåÓýd by the Office of the Federal Register January 13, 2025, 4:15 p.m., and published in the issue of the Federal Register for January 16, 2025, 90 FR 4687)

These proposed regulations are issued under the express delegation of authority under section 7805 of the Code. Section 7805(a) directs the Secretary of the Treasury or her delegate to prescribe all needful rules and regulations for the enforcement of the Code, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.

This document sets forth proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 162(m). Section 162(m)(1) disallows a deduction by any publicly held corporation for applicable employee remuneration that is otherwise deductible with respect to any covered employee to the extent that such remuneration for the taxable year exceeds $1,000,000.¹ Section 162(m) was added to the Internal Revenue Code (Code) by section 13211(a) of the Omnibus Budget Reconciliation Act of 1993 (Pub. L. 103-66, 107 Stat. 312, 469). Proposed regulations under section 162(m) were published in the Federal Register by the Treasury Department and the IRS on December 20, 1993 (58 FR 66310) (1993 proposed regulations). On December 2, 1994, the Treasury Department and the IRS published in the Federal Register amendments to the proposed regulations (59 FR 61884) (1994 proposed regulations). On December 20, 1995, the Treasury Department and the IRS published in the Federal Register final regulations under section 162(m) (TD 8650) (60 FR 65534) (1995 regulations).

In 2017, section 162(m) was amended by section 13601 of the Tax Cuts and Jobs Act (TCJA) (Pub. L. 115-97, 131 Stat. 2054, 2155 (2017)). Specifically, section 13601 of TCJA amended the definitions of covered employee, publicly held corporation, and applicable employee remuneration in section 162(m). On December 20, 2019, the Treasury Department and the IRS published in the Federal Register proposed regulations relating to the TCJA amendments (84 FR 70356). On December 30, 2020, the Treasury Department and the IRS published in the Federal Register final regulations (TD 9932) relating to the TCJA amendments (85 FR 86481) (the current regulations).

Section 162(m)(3) provides the definition of ¡°covered employee.¡± Specifically, section 162(m)(3) defines the term ¡°covered employee¡± as an ¡°employee of the taxpayer¡± if (1) the employee is the principal executive officer (PEO) or principal financial officer (PFO) of the taxpayer at any time during the taxable year, or was an individual acting in such a capacity, (2) the total compensation of the employee for the taxable year is required to be reported to shareholders under the Securities Exchange Act of 1934 (Exchange Act) by reason of the employee being among the three highest compensated officers for the taxable year (other than the PEO and PFO), or (3) the individual was a covered employee of the taxpayer (or any predecessor) for any preceding taxable year beginning after December 31, 2016. Section 162(m)(3) also contains flush language providing that a covered employee includes any employee of the taxpayer whose total compensation for the taxable year places the individual among the three highest compensated officers for the taxable year (other than any individual who is the PEO or PFO of the taxpayer at any time during the taxable year, or was an individual acting in such a capacity) even if the compensation of the officer is not required to be reported to shareholders under the Exchange Act.

In 2021, section 162(m) was amended by section 9708 of the American Rescue Plan Act of 2021 (ARP) (Pub. L. 117-2, 135 Stat. 4, 206) to expand the definition of covered employee for taxable years beginning after December 31, 2026. The ARP amended the definition of ¡°covered employee¡± in section 162(m)(3) by adding section 162(m)(3)(C),² which includes any employee who is among the five highest compensated employees for the taxable year other than the PEO or PFO (as identified in section 162(m)(3)(A)) or the three highest compensated executive officers for the taxable year (as identified in section 162(m)(3)(B)). This amendment is effective for taxable years beginning after December 31, 2026. These proposed regulations (proposed regulations) would provide guidance on this amendment.

These regulations generally are proposed to apply to compensation that is otherwise deductible for taxable years beginning after the later of December 31, 2026, or the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. The amendment to the conclusion of Example 23 in section 1.162-33(c)(1)(vi)(W)(2)) of the current regulations is proposed to apply to taxable years ending on or after January 16, 2025.

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

Before these proposed amendments to the regulations are adopted as final regulations, consideration will be given to comments that are submitted timely to the IRS as prescribed in the preamble under the ¡°ADDRESSES¡± section. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. All comments submitted will be made available at www.regulations.gov or upon request.

A public hearing will be scheduled if requested in writing by any person who timely submits electronic or written comments. Requests for a public hearing are also encouraged to be made electronically by sending an email to [email protected]. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register.

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

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows:

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

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

* * * * *

Par. 2. Section 1.162-33 is amended by:

a. Revising paragraphs (c)(1)(vi)(W)(2) and (c)(2)(i)(C);

b. Adding paragraphs (c)(2)(i)(D) and (c)(2)(vii)(CC) through (EE);

c. Redesignating paragraphs (c)(3)(iii) and (iv) as paragraphs (c)(3)(v) and (vi);

d. Adding new paragraphs (c)(3)(iii) and (iv) and adding paragraphs (c)(3)(vi)(D) and (E);

e. Revising paragraph (h)(2)(ii)(C); and

f. Adding paragraphs (h)(2)(ii)(F) and G.

The revisions and additions read as follows:

* * * * *

(c) * * *

(1) * * *

(vi) * * *

(W) * * *

(2) Conclusion. The result is the same as in paragraph (c)(1)(vi)(T) of this section (Example 20). Even though Corporations P, Q, and R each are publicly held corporations, they comprise an affiliated group. Because Employee C is a covered employee of both Corporations P and Q, the amount disallowed as a deduction is prorated separately between Corporations P and R and between Corporations Q and R.

* * * * *

(2) * * *

(i) * * *

(C) Any individual who was a covered employee of the publicly held corporation (or any predecessor of a publicly held corporation, within the meaning of paragraph (c)(2)(ii) of this section) for any preceding taxable year beginning after December 31, 2016, other than an individual who was a covered employee in that year solely on account of paragraph (c)(2)(i)(D) of this section. For taxable years beginning prior to January 1, 2018, covered employees are identified in accordance with the rules in ¡ì1.162-27(c)(2).

(D) The five highest compensated employees of the publicly held corporation for the taxable year regardless of whether the individual is serving at the end of the publicly held corporation¡¯s taxable year, other than any individual described in paragraph (c)(2)(i)(A) or (B) of this section, determined in accordance with the rules in this paragraph (c)(2)(i)(D). See paragraph (c)(3)(iv) of this section for a special rule treating certain employees of a person other than the publicly held corporation as employees of the publicly held corporation.

(1) Compensation. The amount of compensation used to identify the five most highly compensated employees for the taxable year for purposes of paragraph (c)(2)(i)(D) of this section is the amount of compensation as defined in paragraph (c)(3) of this section, provided that, in determining compensation for purposes of applying this paragraph (c)(2)(i)(D), references to ¡°covered employee¡± or ¡°covered employee (as defined in paragraphs (c)(2)(i) through (v) of this section)¡± in paragraph (c)(3) of this section shall be replaced with references to ¡°employee.¡±

(2) Employee. For purposes of this paragraph (c)(2)(i)(D), the term ¡°employee¡± means an employee as defined in section 3401(c).

(3) Determining the employees eligible to be the five highest compensated employees with respect to an affiliated group with one publicly held corporation. In the case of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) that includes one publicly held corporation (as defined in paragraph (c)(1)(i) of this section), an employee of any member of the affiliated group is eligible to be one of the five highest compensated employees of the publicly held corporation regardless of whether the individual is an employee of the publicly held corporation itself or performs services for the publicly held corporation itself.

(4) Determining the employees eligible to be the five highest compensated employees with respect to an affiliated group with more than one publicly held corporation. In the case of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) that includes more than one publicly held corporation (as defined in paragraph (c)(1)(i) of this section), the group of employees eligible to be the five highest compensated employees is determined separately with respect to the parent corporation (as defined below) and each publicly held corporation (as defined in paragraph (c)(1)(i) of this section) that is not the parent corporation (an additional publicly held corporation). For this purpose, the parent corporation is the highest corporation in the chain or chains of includible corporations (that comprise the affiliated group) that is a publicly held corporation as defined in paragraph (c)(1)(i) of this section. In the case of an affiliated group in which more than one member may be the parent corporation (such as where a common parent that is not publicly held owns multiple publicly held corporations), the affiliated group must choose which member to treat as the parent corporation for the taxable year. With respect to the parent corporation, an employee of any member of the affiliated group, excluding a member of an affiliated group of an additional publicly held corporation (as defined below), is eligible to be one of its five highest compensated employees regardless of whether the individual is an employee of the parent corporation itself or performs services for the parent corporation itself. Similarly, with respect to an additional publicly held corporation, any employee of the affiliated group of the additional publicly held corporation is eligible to be one of its five highest compensated employees regardless of whether the individual is an employee of the additional publicly held corporation itself or performs services for the additional publicly held corporation itself. For this purpose, an affiliated group of an additional publicly held corporation means, with respect to any corporation, the affiliated group which would be determined under section 1504(a) if such corporation were the common parent and if section 1504(b) did not apply. These rules similarly apply to all additional publicly held corporations, beginning at the bottom of each chain of corporations and proceeding up until all members of the affiliated group that may be so allocated have been allocated to one (and only one) affiliated group of an additional publicly held corporation. If the affiliated group includes only publicly held corporations (as defined in paragraph (c)(1)(i) of this section), the affiliated group used to determine the employees eligible to be each publicly held corporation¡¯s five highest compensated employees is that publicly held corporation itself.

(5) Determining the five highest compensated employees in an affiliated group. In determining whether an employee is one of the five highest compensated employees with respect to the parent corporation (as defined in paragraph (c)(2)(i)(D)(4) of this section) for the taxable year, compensation paid by each member of the affiliated group (as defined in paragraph (c)(1)(ii) of this section) in the taxable year, excluding any member of an affiliated group of an additional publicly held corporation (as defined in paragraph (c)(2)(i)(D)(4) of this section), is aggregated. In determining whether an employee is one of the five highest compensated employees with respect to a publicly held corporation (as defined in paragraph (c)(1)(i) of this section) in an affiliated group of an additional publicly held corporation, compensation paid by each member of the affiliated group of the additional publicly held corporation in the taxable year is aggregated.

(6) Application of proration rules. The proration rules in paragraph (c)(1)(ii)(B) of this section generally apply in the same way to covered employees determined under this paragraph (c)(2)(i)(D), except that a publicly held corporation or publicly held payor corporation refers to the portion of the affiliated group of which the publicly held corporation (as defined in paragraph (c)(1)(i) of this section) is a part, as determined under paragraph (c)(2)(i)(D)(4) of this section.

* * * * *

(vii) * * *

(CC) Example 29 (Individual as one of the five highest compensated employees of a publicly held corporation that includes the affiliated group)--(1) Facts. Corporation CO is a publicly held corporation for its 2026 and 2027 taxable years. Corporation CP is a foreign corporation and is a wholly-owned subsidiary of Corporation CO. Corporation CP is a controlled foreign corporation, but the only income it has is effectively connected with a U.S. trade or business. Corporation CO is a partner in Partnership CQ (a partnership for Federal tax purposes). Under the partnership agreement, Corporation CO has a 50% distributive share of the partnership¡¯s income, gain, loss, deductions, and credits. These allocations comply with section 704(b) and its regulations. Employee EO is an employee of Corporation CO. In 2026, Employee EO is a covered employee of Corporation CO because Employee EO is one of the three highest compensated executive officers of Corporation CO. In 2027, Employee EO is not an executive officer of Corporation CO but performs services for and receives compensation from Corporation CO for services as its employee. Furthermore, in 2027, Employee EO performs services for and receives compensation from Corporation CP and Partnership CQ (Employee EO is not a partner of Partnership CQ). In 2027, the total compensation paid to Employee EO is $3,600,000, of which Corporation CO pays $1,500,000, Corporation CP pays $900,000, and Partnership CQ pays $1,200,000. For the 2027 taxable year, the total compensation paid to any employee of Corporations CO and CP did not exceed $2,500,000.

(2) Conclusion (Compensation paid by Corporation CO). The $1,500,000 in compensation paid by Corporation CO is taken into account to determine whether Employee EO is one of the five highest compensated employees of Corporation CO for its 2027 taxable year.

(3) Conclusion (Compensation paid by Corporation CP). Corporations CO and CP are an affiliated group as defined in paragraph (c)(1)(ii) of this section. Therefore, the $900,000 in compensation paid by Corporation CP is taken into account to determine whether Employee EO is one of the five highest compensated employees of Corporation CO for its 2027 taxable year. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if there were intermediary privately held subsidiaries between Corporations CO and CP as long as all these corporations comprised an affiliated group.

(4) Conclusion (Compensation paid by Partnership CQ). Under paragraph (c)(3)(ii) of this section, Corporation CO¡¯s $600,000 distributive share of Partnership CQ¡¯s deduction (50% of $1,200,000) is compensation that is taken into account to determine whether Employee EO is one of the five highest compensated employees of Corporation CO for its 2027 taxable year. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if there were an intermediary privately held subsidiary between Corporation CO and Partnership CQ (so that, instead of Corporation CO, an intermediary subsidiary was a partner in Partnership CQ), as long as Corporation CO and the intermediary subsidiary comprised an affiliated group.

(5) Conclusion (Employee EO as a covered employee). Because the aggregate compensation taken into account with respect to Employee EO is $3,000,000 ($1,500,000 + $900,000 + $600,000), Employee EO is a covered employee of Corporation CO for its 2027 taxable year by reason of being one of its five highest compensated employees for the taxable year as provided in paragraph (c)(2)(i)(D) of this section (even though Employee EO is also a covered employee of Corporation CO for its 2027 taxable year by reason of being a covered employee for its 2026 taxable year (as provided in paragraph (c)(2)(i)(C) of this section)).

(6) Conclusion (Amount disallowed as a deduction). Because the compensation paid by all affiliated group members is aggregated for purposes of section 162(m)(1), the aggregate compensation of $3,000,000 exceeds the limitation in section 162(m)(1) and $2,000,000 of the compensation paid to Employee EO is nondeductible. Corporations CO and CP each are treated as paying a ratable portion of the nondeductible compensation. Thus, two thirds of each corporation¡¯s payment will be nondeductible. Taking into account Corporation CO¡¯s $600,000 distributive share of the Partnership CQ¡¯s deduction, Corporation CO has an otherwise allowable deduction of $2,100,000 ($1,500,000 + $600,000). Therefore, Corporation CO has a nondeductible compensation expense of $1,400,000 ($2,100,000 x $2,000,000/$3,000,000). Corporation CP has an otherwise allowable deduction of $900,000, of which $600,000 ($900,000 x $2,000,000/$3,000,000) is a nondeductible compensation expense.

(DD) Example 30 (Individual as one of the five highest compensated employees of a publicly held corporation that includes the affiliated group and affiliated groups of additional publicly held corporations)--(1) Facts. Corporations CR, CT, and CV are publicly held corporations for their 2027 taxable years. Corporations CS and CU are privately held for their 2027 taxable years. Corporation CT is a subsidiary of Corporation CS, which is a subsidiary of Corporation CR. Corporation CV is a subsidiary of Corporation CU, which is a subsidiary of Corporation CT. Corporations CR, CS, CT, CU, and CV are members of an affiliated group. Employee EP is an employee of Corporations CR, CS, CU, and CV. In 2027, Employee EP performs services for and receives compensation from Corporations CR, CS, CU, and CV. The total compensation paid to Employee EP from the affiliated group members is $7,000,000 for the taxable year, of which Corporation CR pays $1,200,000, Corporation CS pays $1,800,000, Corporation CU pays $1,500,000, and Corporation CV pays $2,500,000.

(2) Conclusion (Employee EP is eligible to be a covered employee of Corporation CR). Because Employee EP is an employee of Corporation CR, Employee EP is eligible to be one of the five highest compensated employees of Corporation CR. Even though Corporations CR, CS, CT, CU, and CV comprise an affiliated group as defined in paragraph (c)(1)(ii) of this section, because Corporations CT and CV are additional publicly held corporations of the affiliated group, the affiliated group contains affiliated groups of these additional publicly held corporations (as defined in paragraph (c)(2)(i)(D)(4) of this section). Compensation paid by the affiliated groups of these additional publicly held corporations is not taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. Accordingly, Corporations CT and CU comprise an affiliated group of an additional publicly held corporation (Corporation CT), and compensation paid by Corporation CU is not taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. Furthermore, Corporation CV is an affiliated group of an additional publicly held corporation (Corporation CV), and compensation paid by Corporation CV is not taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. Therefore, only the $1,200,000 in compensation paid by Corporation CR and the $1,800,000 paid by Corporation CS are taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year.

(3) Conclusion (Employee EP is eligible to be a covered employee of Corporation CT). Because Corporation CT is a publicly held corporation, Corporations CT and CU comprise an affiliated group of an additional publicly held corporation (as defined in paragraph (c)(2)(i)(D)(4) of this section). Because an employee of any member of the affiliated group is eligible to be one of the five highest compensated employees of the publicly held corporation (regardless of whether the employee performs services for the publicly held corporation), Employee EP is eligible to be a covered employee of Corporation CT, even though Employee EP does not perform services for Corporation CT. Because only compensation paid by a member of the affiliated group of the additional publicly held corporation in the taxable year is taken into account to determine whether an individual is one of the five highest compensated employees with respect to the additional publicly held corporation, only compensation paid by Corporation CU is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CT for its 2027 taxable year. Accordingly, the $1,500,000 in compensation paid by Corporation CU is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CT for its 2027 taxable year.

(4) Conclusion (Employee EP is eligible to be a covered employee of Corporation CV). Because Employee EP is an employee of Corporation CV, Employee EP is eligible to be one of the five highest compensated employees of Corporation CV. Because Corporation CV is a publicly held corporation, Corporation CV comprises an affiliated group of an additional publicly held corporation (as defined in paragraph (c)(2)(i)(D)(4) of this section). Because only compensation paid by a member of the affiliated group of the additional publicly held corporation in the taxable year is taken into account to determine whether an individual is one of the five highest compensated employees with respect to the additional publicly held corporation, only compensation paid by Corporation CV is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CV for its 2027 taxable year. Accordingly, the $2,500,000 in compensation paid by Corporation CV is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CV for its 2027 taxable year.

(5) Conclusion (Employee EP as covered employee of Corporation CR). The $1,200,000 in compensation paid by Corporation CR and the $1,800,000 in compensation paid by Corporation CS are taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CR for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EP is a covered employee of Corporation CR, then Corporation CR¡¯s deduction for $1,200,000 and Corporation CS¡¯s deduction for $1,800,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Because the compensation paid by the affiliated group members is aggregated for purposes of section 162(m)(1), the aggregate compensation of $3,000,000 exceeds the limitation in section 162(m)(1) and $2,000,000 of the compensation paid to Employee EP would be nondeductible. Corporations CR and CS each are treated as paying a ratable portion of the nondeductible compensation. Corporation CR has an otherwise allowable deduction of $1,200,000, of which $800,000 ($1,200,000 x $2,000,000/$3,000,000) would be a nondeductible compensation expense. Corporation CS has an otherwise allowable deduction of $1,800,000, of which $1,200,000 ($1,800,000 x $2,000,000/$3,000,000) would be a nondeductible compensation expense.

(6) Conclusion (Employee EP as covered employee of Corporation CT). The $1,500,000 in compensation paid by Corporation CU is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CT for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EP is a covered employee of Corporation CT, then Corporation CU¡¯s deduction for $1,500,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Accordingly, pursuant to paragraph (c)(2)(i)(D)(6) of this section, Corporation CU would have a nondeductible compensation expense of $500,000.

(7) Conclusion (Employee EP as covered employee of Corporation CV). The $2,500,000 in compensation paid by Corporation CV is taken into account to determine whether Employee EP is one of the five highest compensated employees of Corporation CV for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EP is a covered employee of Corporation CV, then Corporation CV¡¯s deduction for $2,500,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Accordingly, Corporation CV would have a nondeductible compensation expense of $1,500,000.

(EE) Example 31 (Individual as one of the five highest compensated employees of a publicly held corporation that includes the affiliated group that chooses a parent corporation)--(1) Facts. Corporations CX and CY are publicly held corporations for their 2027 taxable years. Corporations CW and CZ are privately held corporations for their 2027 taxable years. Corporations CX and CY are subsidiaries of Corporation CW. Corporations CX and CY each directly own 50% (by vote and value) of Corporation CZ¡¯s only class of stock. In 2027, Employee EQ performs services for and receives compensation from Corporations CW, CX, CY, and CZ. The total compensation paid to Employee EQ from all corporations is $4,700,000 for the taxable year, of which Corporation CW pays $1,500,000, Corporation CX pays $900,000, Corporation CY pays $1,700,000, and Corporation CZ pays $600,000.

(2) Conclusion (Employee EQ is eligible to be a covered employee of Corporations CX and CY). Because Employee EQ is an employee of Corporations CX and CY, Employee EQ is eligible to be one of the five highest compensated employees of these publicly held corporations. Because both Corporations CX and CY are the highest publicly held corporations in the chain of includible corporations that comprise an affiliated group (composed of Corporations CW, CX, CY, and CZ) as defined in paragraph (c)(1)(ii) of this section, the affiliated group may choose to treat either Corporation CX or CY as the parent corporation for the 2027 taxable year. If the affiliated group chooses to treat Corporation CX as the parent corporation, then only compensation paid by Corporations CW, CX, and CZ is taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CX for the 2027 taxable year. Because Corporation CY is an affiliated group of the additional publicly held corporation composed of one corporation (Corporation CY), only compensation paid by Corporation CY is taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CY. A similar analysis would apply if the affiliated group chose to treat Corporation CY as the parent.

(3) Conclusion (Employee EQ as a covered employee of Corporation CX). The $1,500,000 in compensation paid by Corporation CW, the $900,000 paid by Corporation CX, and the $600,000 in compensation paid by Corporation CZ (that is, aggregate compensation of $3,000,000) are taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CX for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EQ is a covered employee of Corporation CX, then Corporation CW¡¯s deduction for $1,500,000, Corporation CX¡¯s deduction for $900,000, and Corporation CZ¡¯s deduction for $600,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Because the compensation paid by the affiliated group members is aggregated for purposes of section 162(m)(1), the aggregate compensation of $3,000,000 exceeds the limitation in section 162(m)(1) and $2,000,000 of the compensation paid to Employee EQ would be nondeductible. Corporations CW, CX, and CZ each are treated as paying a ratable portion of the nondeductible compensation. Corporation CW would have a nondeductible compensation expense of $1,000,000 ($1,500,000 x $2,000,000/$3,000,000). Corporation CX would have a nondeductible compensation expense of $600,000 ($900,000 x $2,000,000/$3,000,000). Corporation CZ would have a nondeductible compensation expense of $400,000 ($600,000 x $2,000,000/$3,000,000).

(4) Conclusion (Employee EQ as a covered employee of Corporation CY). The $1,700,000 in compensation paid by Corporation CY is taken into account to determine whether Employee EQ is one of the five highest compensated employees of Corporation CY for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Employee EQ is a covered employee of Corporation CY, then Corporation CY¡¯s deduction for $1,700,000 for the 2027 taxable year would be subject to the section 162(m)(1) limit. Accordingly, Corporation CY would have a nondeductible compensation expense of $700,000.

(3) * * *

(iii) Compensation paid by a controlled foreign corporation that is a member of an affiliated group. For purposes of paragraph (c)(3)(i) of this section, compensation includes a publicly held corporation¡¯s pro rata share (as determined under the principles of sections 951(a)(2) and 951A(e)(1)) of the amounts that would be claimed by a controlled foreign corporation (as defined in section 957) that is a member of an affiliated group (as defined in paragraph (c)(1)(ii) of this section) as properly allocable to gross income included under sections 951(a)(1) and 951A(a) under sections 954(b)(5), 951A(c)(2)(A)(ii), and similar provisions, determined without regard to the disallowance of any such expenses by reason of section 162(m) and these regulations, for compensation expenses attributable to the remuneration paid by the controlled foreign corporation to a covered employee of a publicly held corporation for services performed by the covered employee.

(iv) Amounts paid to individuals performing substantially all their services for a publicly held corporation. Notwithstanding paragraph (c)(2)(i)(D)(2) of this section, for purposes of paragraph (c)(2)(i)(D) of this section, an employee of a publicly held corporation includes an individual who, pursuant to section 3401(c), is an employee of a person other than the publicly held corporation but performs substantially all the individual¡¯s services during the relevant taxable year for the publicly held corporation. Consequently, for purposes of paragraph (c)(3) of this section, compensation includes the aggregate amount allowable as a deduction to the publicly held corporation under chapter 1 of the Internal Revenue Code for the taxable year (determined without regard to section 162(m)(1)) to obtain the services performed by such individual, whether or not the particular services that give rise to the deduction were performed during the relevant taxable year. This rule applies regardless of how the amounts allowable as a deduction are paid or denominated, and regardless of whether the individual is compensated directly or by a third-party payor, including a related organization or certified professional employer organization under section 7705. The disallowance under paragraph (b) of this section likewise is applied to those amounts, however denominated, otherwise allowable as a deduction to obtain those services. Nothing in the previous sentence is intended to imply that such amounts paid to a third party for services by a covered employee, however denominated, are not already treated as remuneration for those services and thus compensation for purposes of paragraph (c)(3) of this section.

* * * * *

(D) Example 4--(1) Facts. Corporation U is a publicly held corporation for its 2027 taxable year and is not a member of an affiliated group. Corporation U has a services agreement with unrelated Corporation V. In Corporation U¡¯s 2027 taxable year, it pays $1,500,000 to Corporation V pursuant to the agreement in exchange for the services of an interim chief accountant (Individual E) in the same year. The $1,500,000 is otherwise deductible for Corporation U¡¯s 2027 taxable year. Individual E performs substantially all Individual E¡¯s services in 2027 for Corporation U.

(2) Conclusion. Pursuant to paragraph (c)(3)(iv) of this section, Individual E is treated as an employee of Corporation U for purposes of this section. The $1,500,000 paid to Corporation V by Corporation U in 2027 is compensation within the meaning of paragraph (c)(3) of this section and is taken into account to determine whether Individual E is a covered employee as one of the five highest compensated employees of Corporation U for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Individual E is a covered employee of Corporation U, then Corporation U¡¯s deduction for $1,500,000 for the 2027 taxable year is subject to the section 162(m)(1) limit. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if Corporation U owned a privately held subsidiary, and Individual E performed substantially all Individual E¡¯s services for the subsidiary. In addition, the result would also be the same if Individual E performed substantially all Individual E¡¯s services for both Corporation U and its subsidiary, as long as Corporation U and its subsidiary comprised an affiliated group (regardless of whether Corporation U or its subsidiary paid the $1,500,000 to Corporation V). In such case, pursuant to paragraph (c)(1)(ii) of this section, the amount disallowed as a deduction would be prorated between Corporation U and its subsidiary. Furthermore, the result would be the same even if Individual E were an employee of Corporation U (regardless of whether Individual E were also an employee of Corporation V).

(E) Example 5--(1) Facts. Corporation W is a publicly held corporation for its 2027 taxable year and is not a member of an affiliated group. Corporation W is a partner in Partnership X (a partnership for Federal tax purposes), that owns all the stock of Corporation Y. Under the partnership agreement, Corporation W has a 50% distributive share of the partnership¡¯s income, gain, loss, deductions, and credits. These allocations comply with section 704(b) and its regulations. Individual F is a partner of Partnership X. In 2027, Individual F performs services for the partnership, and the partnership pays $1,000,000 to Individual F as a guaranteed payment for these services. With respect to the $1,000,000 paid to Individual F, a deduction of $500,000 is allocated to Corporation W. Corporation W¡¯s $500,000 distributive share of the partnership¡¯s deduction is reported separately to Corporation W pursuant to ¡ì1.702-1(a)(8)(iii). Individual F is also an employee (within the meaning of section 3401(c)) of Corporation Y. In Corporation W¡¯s 2027 taxable year, it pays $8,000,000 to Corporation Y in exchange for Individual F¡¯s services. The $8,000,000 is otherwise deductible for Corporation W¡¯s 2027 taxable year. Individual F performs substantially all Individual F¡¯s services in 2027 for Corporation W.

(2) Conclusion. Pursuant to paragraph (c)(3)(iv) of this section, Individual F is treated as an employee of Corporation W for purposes of this section. The entire $8,000,000 paid to Corporation Y by Corporation W in 2027 is compensation within the meaning of paragraph (c)(3) of this section and is taken into account to determine whether Individual F is one of the five highest compensated employees of Corporation W for its 2027 taxable year. Because Corporation W¡¯s $500,000 distributive share of the partnership¡¯s deduction is attributable to the compensation paid by the partnership for services performed by Individual F (who is treated as an employee of Corporation W), the $500,000 is compensation within the meaning of paragraph (c)(3)(ii) of this section. Accordingly, Corporation W¡¯s $500,000 distributive share of the partnership¡¯s deduction is aggregated with Corporation W¡¯s deduction for $8,000,0000 paid to Corporation Y in determining whether Individual F is a covered employee as one of the five highest compensated employees of Corporation W for its 2027 taxable year. If, pursuant to paragraph (c)(2)(i)(D) of this section, Individual F is a covered employee of Corporation W, then Corporation W¡¯s deduction for $8,500,000 for its 2027 taxable year is subject to the section 162(m)(1) limit. Because a publicly held corporation includes an affiliated group for purposes of paragraph (c)(3) of this section, the result would be the same even if there were an intermediary privately held subsidiary between Corporation W and Partnership X (so that, instead of Corporation W, an intermediary subsidiary was a partner in Partnership X), as long as Corporation W and the intermediary subsidiary comprised an affiliated group, and as long as Individual F performed substantially all Individual F¡¯s services for the intermediary subsidiary. Furthermore, the result would also be the same if Individual F performed substantially all Individual F¡¯s services for both Corporation W and the intermediary subsidiary (regardless of whether Corporation W or the intermediary subsidiary paid the $8,000,000 to Corporation Y). In such case, pursuant to paragraph (c)(1)(ii) of this section, the amount disallowed as a deduction would be prorated between Corporation W and the intermediary subsidiary.

* * * * *

(h) * * *

(2) * * *

(ii) * * *

(C) Definition of compensation. The definition of compensation provided in paragraph (c)(3)(ii) of this section (relating to distributive share of partnership deductions for compensation paid) applies to any deduction for compensation that is paid after December 18, 2020. The definition of compensation in paragraph (c)(3)(ii) of this section does not apply to compensation paid pursuant to a written binding contract that is in effect on December 20, 2019, and that is not materially modified after that date. For purposes of paragraph (h)(2)(C) of this section, written binding contract and material modification have the same meanings as provided in paragraphs (g)(1) and (2) of this section. The definition of compensation provided in paragraphs (c)(3)(iii) and (iv) of this section and the examples in paragraphs (c)(3)(vi)(D) and (E) of this section apply to any deduction for compensation that is otherwise deductible for taxable years beginning after the later of December 31, 2026, or the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

* * * * *

(F) Five highest compensated employees. Paragraph (c)(2)(i)(D) of this section (describing the five highest compensated employees of a publicly held corporation) and the examples in paragraphs (c)(2)(vii)(CC) through (EE) of this section apply to taxable years beginning after the later of December 31, 2026, or the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

(G) Amendment to paragraph (c)(1)(vi)(W)(2) of this section. The amendment to paragraph (c)(1)(vi)(W)(2) of this section (Example 23) to reference paragraph (c)(1)(vi)(T) of this section (Example 20) is proposed to apply to taxable years ending on or after January 16, 2025.

Douglas W. O¡¯Donnell, Deputy Commissioner.

(obÌåÓýd by the Office of the Federal Register January 14, 2025, 8:45 a.m., and published in the issue of the Federal Register for January 16, 2025, 90 FR 4691)

¹ As a result, for example, such disallowed amounts generally may not be capitalized. See ¡ì¡ì1.263(a)-1(b) and 1.263A-1(c)(2).

² The addition of section 162(m)(3)(C) resulted in pre-ARP section 162(m)(3)(C) being redesignated as section 162(m)(3)(D).

³ This interpretation is consistent with the description of section 162(m)(3)(C) by the Joint Committee on Taxation in General Explanation of the Tax Legislation Enacted in the 117th Congress. JCS-1-23, 129 (Dec. 2023).

⁴ These proposed regulations take the same approach as the current regulations of using ¡°publicly held corporation¡± to mean the affiliated group (as defined in ¡ì1.162-33(c)(1)(ii)) of which the corporation that is a publicly held corporation (as defined in ¡ì1.162-33(c)(1)(i)) is a part, and distinguishing between the two only where necessary.

⁵ See 17 C.F.R. ¡ì229.402, Instructions to Item 402(a)(3).

⁶ See H.R. Conf. Rep. No. 103-213, at 585 (1993) (¡°Unless specifically excluded, the deduction limitation applies to all remuneration for services.¡±).

⁷ See, for example, the Joint Committee on Taxation estimate that the amendment would raise $7.8 billion through Fiscal Year 2031. JCX-14-21, 3 (March 9, 2021).

⁸ See section 882(c)(1).

⁹ In relevant part, section 957(a) defines a controlled foreign corporation as a foreign corporation of which more than 50% (vote or value) is owned by United States shareholders as defined in section 951(b). Publicly held corporations as defined in section 162(m)(2) can be treated as United States shareholders.