Class 1

United States Tax Cases (1913-1999), [49-1 USTC ¶9323], Commissioner
of Internal Revenue, Petitioner, v. W. O. Culbertson, Sr., and Gladys

Culbertson, Family partnership: Intent to contribute capital or services
in the future: Intent to join in present conduct of enterprise(June 27,
1949), U.S. Supreme Court, (Jun. 27, 1949)
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[49-1 USTC ¶9323]Commissioner of Internal Revenue, Petitioner, v. W. O. Culbertson, Sr., and Gladys
Culbertson
Supreme Court of the United States, No. 313. October Term 1948, 337 US 733, 69 SCt 1210, June 27, 1949
On writ of certiorari to the United States Court of Appeals for the Fifth Circuit.
Family partnership: Intent to contribute capital or services in the future: Intent to join in present
conduct of enterprise.--Although an intention to contribute capital or services to a partnership some time
in the future is not sufficient to satisfy ordinary concepts of partnership, the Tower case, 327 U. S. 280, 46-1
USTC ¶9189, provides no support for the practice of treating the contribution of “vital services” or “original
capital” as essential to membership in a family partnership for tax purposes. The question is not whether the
services or capital contributed by a partner is sufficient to meet some objective standard, but whether the
parties in good faith and acting with a business purpose intended to join together in the present conduct of
the enterprise, having agreed that the services or capital to be contributed presently by each is of such value
to the partnership that the contributor should participate in the distribution of profits. Concurring opinion by
Frankfurter, J. Burton, J., also concurs. Black and Rutledge, JJ., acquiesce. Jackson, J., dissents. Reversing
the decision of the Court of Appeals for the Fifth Circuit, 168 Fed. (2d) 979, 48-2 USTC ¶9324, and remanding
the case to the Tax Court.
Philip B. Perlman, Solicitor General. Theron Lamar Caudle, Assistant Attorney General. Arnold Raum,
Ellis N. Slack, and Harry Baum, Special Assistants to the Attorney General, for the petitioner. Benjamin L.
Bird, Weeks, Bird, Cannon & Appleman, of Counsel, 909-913 Sinclair Bldg., Fort Worth 2, Texas, for the
respondent.
MR. CHIEF JUSTICE VINSON delivered the opinion of the Court.
This case requires our further consideration of the family partnership problem. The Commissioner of Internal
Revenue ruled that the entire income from a partnership allegedly entered into by respondent and his
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four sons must be taxed to respondent, and the Tax Court sustained that determination. The Court of
Appeals for the Fifth Circuit reversed. 168 F. 2d 979. We granted certiorari, 335 U. S. 883, to consider the
Commissioner’s claim that the principles of Commissioner v. Tower, 327 U. S. 280 [46-1 USTC ¶9189] (1946),
and Lusthaus v. Commissioner, 327 U. S. 293 [46-1 USTC ¶9190] (1946), have been departed from in this
and other courts of appeals decisions.
[Statement of Facts]
Respondent taxpayer is a rancher. From 1915 until October 1939, he had operated a cattle business in
partnership with R. S. Coon. Coon, who had numerous business interests in the Southwest and had largely
financed the partnership, was 79 years old in 1939 and desired to dissolve the partnership because of ill
health. To that end, the bulk of the partnership herd was sold until, in October of that year, only about 1,500
head remained. These cattle were all registered Herefords, the brood or foundation herd. Culbertson wished
to keep these cattle and approached Coon with an offer of $65 a head. Coon agreed to sell at that price,
but only upon condition that Culbertson would sell an undivided one-half interest in the herd to his four
sons at the same price. His reasons for imposing this condition were his intense interest in maintaining the
Hereford strain which he and Culbertson had developed, his conviction that Culbertson was too old to carry
on the work alone, and his personal interest in the Culbertson boys. Culbertson’s sons were enthusiastic
about the proposition, so respondent thereupon bought the remaining cattle from the Coon and Culbertson
partnership for $99,440. Two days later Culbertson sold an undivided one-half interest to the four boys, and
the following day they gave their father a note for $49,720 at 4 per cent interest due one year from date.
©2011 Wolters Kluwer. All rights reserved.

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Several months later a new note for $57,674 was executed by the boys to replace the earlier note. The
increase in amount covered the purchase by Culbertson and his sons of other properties formerly owned by
Coon and Culbertson. This note was paid by the boys in the following, manner:
Credit for overcharge ............. $ 5,930
Gifts from respondent ............. 21,744
One-half of a loan procured by
Culbertson & Sons partnership ..... 30,000
The loan was repaid from the proceeds from operation of the ranch.
The partnership agreement between taxpayer and his sons was oral. The local paper announced the
dissolution of the Coon and Culbertson partnership and the continuation of the business by respondent
and his boys under the name of Culbertson & Sons. A bank account was opened in this name, upon which
taxpayer, his four sons and a bookkeeper could check. At the time of formation of the new partnership,
Culbertson’s oldest son was 24 years old, married, and living on the ranch, of which he had for two years
been foreman under the Coon and Culbertson partnership. He was a college graduate and received $100 a
month plus board and lodging for himself and his wife both before and after formation of Culbertson & Sons
and until entering the Army. The second son was 22 years old, was married and finished college in 1940, the
first year during which the new partnership operated. He went directly into the Army following graduation and
rendered no services to the partnership. The two younger sons, who were 18 and 16 years old respectively
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in 1940, went to school during the winter and worked on the ranch during the summer.
The tax years here involved are 1940 and 1941. A partnership return was filed for both years indicating a
division of income approximating the capital attributed to each partner. It is the disallowance of this division
of the income from the ranch that brings this case into the courts.
[Validity of Family Partnership]
First. The Tax Court read our decision in Commissioner v. Tower, supra, and Lusthaus v. Commissioner,
supra, as setting out two essential tests of partnership for income-tax purposes: that each partner contribute
to the partnership either vital services or capital originating with him. Its decision was based upon a finding
that none of respondent’s sons had satisfied those requirements during the tax years in question. Sanction
for the use of these “tests” of partnership is sought in this paragraph from our opinion in the Tower case:
“There can be no question that a wife and a husband may, under certain circumstances, become partners
for tax, as for other, purposes. If she either invests capital originating with her or substantially contributes to
the control and management of the business, or otherwise performs vital services, or does all of these things
she may be a partner as contemplated by 26 U. S. C. Secs. 181, 182. The Tax Court has recognized that
under such circumstances the income belongs to the wife. A wife may become a general or a limited partner
with her husband. But when she does not share in the management and control of the business, contributes
no vital additional service, and where the husband purports in some way to have given her a partnership
interest, the Tax Court may properly take these circumstances into consideration in determining whether the
partnership is real within the meaning of the federal revenue laws.” 327 U. S. at 290 [46-1 USTC ¶9190].
It is the Commissioner’s contention that the Tax Court’s decision can and should be reinstated upon the
mere reaffirmation of the quoted paragraph.
[Future Contribution of Capital or Services]
The Court of Appeals, on the other hand, was of the opinion that a family partnership entered into without
thought of tax avoidance should be given recognition tax-wise whether or not it was intended that some of
the partners contribute either capital or services during the tax year and whether or not they actually made
such contributions, since it was formed “with the full expectation and purpose that the boys would, in the
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future, contribute their time and services to the partnership.” We must consider, therefore, whether an
intention to contribute capital or services sometime in the future is sufficient to satisfy ordinary concepts of

2
partnership, as required by the Tower case. The sections of the Internal Revenue Code involved are §§ 181
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and 182, which set out the method of taxing partnership income, and §§ 11 and 22(a), which relate to
the taxation of individual incomes.
In the Tower case we held that despite the claimed partnership, the evidence fully justified the Tax Court’s
holding that the husband, through his ownership of the capital and his management of the business, actually
created the right to receive and enjoy the benefit of the income and was thus taxable upon that entire income
under §§ 11 and 22(a). In such case, other members of the partnership cannot be considered “Individuals
carrying on business in partnership” and thus “liable for income tax . . . in their individual capacity” within
the meaning of §181. If it is conceded that some of the partners contributed neither capital nor services to
the partnership during the tax years in question, as the Court of Appeals was apparently willing to do in the
present case, it can hardly be contended that they are in any way responsible for the production of income
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during those years. The partnership sections of the Code are, of course, geared to the sections relating
to taxation of individual income, since no tax is imposed upon partnership income as such. To hold that
“Individuals carrying on business in partnership” include persons who contribute nothing during the tax period
would violate the first principle of income taxation: that income must be taxed to him who earns it. Lucas
v. Earl, 281 U. S. 111 [2 USTC ¶496] (1930); Helvering v. Clifford, 309 U. S. 331 [40-1 USTC ¶9265] (1940);
National Carbide Corp. v. Commissioner, 336 U. S. 422 [49-1 USTC ¶9223] (1949).
Furthermore, our decision in Commissioner v. Tower, supra, clearly indicates the importance of participation
in the business by the partners during the tax year. We there said that a partnership is created “when
persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession,
or business and where there is community of interest in the profits and losses.” This is, after all, but the
application of an often iterated definition of income--the gain derived from capital, from labor, or from both
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combined --to a particular form of business organization. A partnership is, in other words, an organization
for the production of income to which each partner contributes one or both of the ingredients of income--
capital or service. Ward v. Thompson, 22 How. 330, 334 (1859). The intent to provide money, goods,
labor, or skill sometime in the future cannot meet the demands of §§ 11 and 22(a) of the Code that he who
presently earns the income through his own labor and skill and the utilization of his own capital be taxed
therefor. The vagaries of human experience preclude reliance upon even good faith intent as to future
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conduct as a basis for the present taxation of income.
[Intent to Join in Present Conduct of Enterprise]
Second. We turn next to a consideration of the Tax Court’s approach to the family partnership problem. It
treated as essential to membership in a family partnership for tax purposes the contribution of either “vital
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services” or “original capital.” Use of these “tests” of partnership indicates, at best, an error in emphasis. It
ignores what we said is the ultimate question for decision, namely, “whether the partnership is real within the
meaning of the federal revenue laws” and makes decisive what we described as “circumstances [to be taken]
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into consideration” in making that determination.
The Tower case thus provides no support for such an approach. We there said that the question whether the
family partnership is real for income-tax purposes depends upon
“whether the partners really and truly intended to join together for the purpose of carrying on the business
and sharing in the profits and losses or both. And their intention in this respect is a question of fact, to be
determined from testimony disclosed by their ‘agreement, considered as a whole, and by their conduct in
execution of its provisions.’ Drennen v. London Assurance Co., 113 U. S. 51, 56; Cox v. Hickman, 8 H. L.
Cas. 268. We see no reason why this general rule should not apply in tax cases where the Government
challenges the existence of a partnership for tax purposes.” 327 U. S. at 287 [46-1 USTC ¶9190.]
The question is not whether the services or capital contributed by a partner are of sufficient importance
to meet some objective standard supposedly established by the Tower case, but whether, considering
all the facts-- the agreement, the conduct of the parties in execution of its provisions, their statements,
the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital
contributions, the actual control of income and the purposes for which it is used, and any other facts throwing
light on their true intent--the parties in good faith and acting with a business purpose intended to join together

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in the present conduct of the enterprise. There is nothing new or particularly difficult about such a test.
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Triers of fact are constantly called upon to determine the intent with which a person acted. The Tax
Court, for example, must make such a determination in every estate tax case in which it is contended that
a transfer was made in contemplation of death, for “The question, necessarily, is as to the state of mind
of the donor.” United States v. Wells, 283 U. S. 102, 117 [2 USTC ¶715] (1931). See Allen v. Trust Co. of
Georgia, 326 U. S. 630 [46-1 USTC ¶10,254] (1946). Whether the parties really intended to carry on business
as partners is not, we think, any more difficult of determination or the manifestations of such intent any less
perceptible than is ordinarily true of inquiries into the subjective.
But the Tax Court did not view the question as one concerning the bona fide intent of the parties to join
together as partners Not once in its opinion is there even an oblique reference to any lack of intent on the
part of respondent and his sons to combine their capital and services “for the purpose of carrying on the
business.” Instead, the court, focusing entirely upon concepts of “vital services” and “original capital,” simply
decided that the alleged partners had not satisfied those tests when the facts were compared with those in
the Tower case. The court’s opinion is replete with such statements as “we discern nothing constituting what
we think is a requisite contribution to a real partnership. . . . We find no son adding ‘vital additional service’
which would take the place of capital contributed because of formation of a partnership . . . it is clear that the
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sons made no capital contribution within the meaning of the Tower case.”
Unquestionably a court’s determination that the services contributed by a partner are not “vital” and that he
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has not participated in “management and control of the business” or contributed “original capital” has the
effect of placing a heavy burden on the taxpayer to show the bona fide intent of the parties to join together
as partners. But such a determination is not conclusive, and that is the vice in the “tests” adopted by the
Tax Court. It assumes that there is no room for an honest difference of opinion as to whether the services or
capital furnished by the alleged partner are of sufficient importance to justify his inclusion in the partnership.
If, upon a consideration of all the facts, it is found that the partners joined together in good faith to conduct a
business, having agreed that the services or capital to be contributed presently by each is of such value to
the partnership that the contributor should participate in the distribution of profits, that is sufficient. The Tower
case did not purport to authorize the Tax Court to substitute its judgment for that of the parties; it simply
furnished some guides to the determination of their true intent. Even though it was admitted in the Tower
case that the wife contributed no original capital, management of the business, or other vital services, this
Court did not say as a matter of law that there was no valid partnership. We said, instead, that “There was,
thus, more than ample evidence to support the Tax Court’s finding that no genuine union for partnership
purposes was ever intended and that the husband earned the income.” 327 U. S. at 292. [46-1 USTC ¶9190].
(Italics added.)
[Contribution of Original Capital]
Third. The Tax Court’s isolation of “original capital” as an essential of membership in a family partnership
also indicates an erroneous reading of the Tower opinion. We did not say that the donee of an intrafamily gift
could never become a partner through investment of the capital in the family partnership, any more than we
said that all family trusts are invalid for tax purposes in Helvering v. Clifford, supra. The facts may indicate,
on the contrary, that the amount thus contributed and the income therefrom should be considered the
property of the donee for tax, as well as general law, purposes. In the Tower and Lusthaus cases this Court,
applying the principles of Lucas v. Earl, supra; Helvering v. Clifford, supra; and Helvering v. Horst, supra;
found that the purported gift, whether or not technically complete, had made no substantial change in the
economic relation of members of the family to the income. In each case the husband continued to manage
and control the business as before, and income from the property given to the wife and invested by her in
the partnership continued to be used in the business or expended for family purposes. We characterized the
results of the transactions entered into between husband and wife as “a mere paper reallocation among the
family members,” noting that “The actualities of their relation to the income did not change.” This, we thought,
provided ample grounds for the finding that no true partnership was intended; that the husband was still the
true earner of the income.
But application of the Clifford-Horst principle does not follow automatically upon a gift to a member of one’s
family, followed by its investment in the family partnership. If it did, it would be necessary to define “family”
and to set precise limits of membership therein. We have not done so for the obvious reason that existence

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of the family relationship does not create a status which itself determines tax questions, but is simply a
warning that things may not be what they seem. It is frequently stated that transactions between members
of a family will be carefully scrutinized. But more particularly, the family relationship often makes it possible
for one to shift tax incidence by surface changes of ownership without disturbing in the least his dominion
and control over the subject of the gift or the purposes for which the income from the property is used. He is
able, in other words, to retain “the substance of full enjoyment of all the rights which previously he had in the
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property.” Helvering v. Clifford, supra, at 336.
The fact that transfers to members of the family group may be mere camouflage does not, however, mean
that they invariably are. The Tower case recognized that one’s participation in control and management
of the business is a circumstance indicating an intent to be a bona fide partner despite the fact that the
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capital contributed originated elsewhere in the family. If the donee of property who then invests it in the
family partnership exercises dominion and control over that property--and through that control influences the
conduct of the partnership and the disposition of its income--he may well be a true partner. Whether he is
free to, and does, enjoy the fruits of the partnership is strongly indicative of the reality of his participation in
the enterprise. In the Tower and Lusthaus cases we distinguished between active participation in the affairs
of the business by a donee of a share in the partnership on the one hand, and his passive acquiescence
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to the will of the donor on the other. This distinction is of obvious importance to a determination of the
true intent of the parties. It is meaningless if “original capital” is an essential test of membership in a family
partnership.
The cause must therefore be remanded to the Tax Court for a decision as to which, if any, of respondent’s
sons were partners with him in the operation of the ranch during 1940 and 1941. As to which of them, in
other words, was there a bona fide intent that they be partners in the conduct of the cattle business, either
because of services to be performed during those years, or because of contributions of capital of which they
were the true owners, as we have defined that term in the Clifford, Horst, and Tower cases? No question
as to the allocation of income between capital and services is presented in this case, and we intimate no
opinion on that subject.
The decision of the Court of Appeals is reversed with directions to remand the cause to the Tax Court for
further proceedings in conformity with this opinion.
Reversed and remanded.
MR. JUSTICE BLACK and MR. JUSTICE RUTLEDGE think that the Tax Court properly applied the principles of
the Tower and Lusthaus decisions (327 U. S. 280 [46-1 USTC ¶9189], id., 293 [46-1 USTC ¶9190]) in this
case. However, they consider it of paramount importance in this case to have a court interpretation of the
applicable taxing statute, for guidance in its application. Accordingly, they acquiesce in the Court’s opinion
and judgment.
[Concurring Opinions]
MR. JUSTICE BURTON, concurring.
States that, upon remand of the cause to the Tax Court, there is nothing in the facts which have been
presented here which, as a matter of law, will preclude that court from finding that the 1940 and 1941 income
was properly taxable on a partnership basis. The physical absence of some of the Culbertson boys from the
ranch does not necessarily preclude them or others from the obligations or the benefits of the partnership
for tax purposes. Their contributions of capital, their participation in the income and their commitments
to return to the ranch or otherwise to render service to the partnership are among the material factors
to be considered. A present commitment to render future services to a partnership is in itself a material
consideration to be weighed with all other material considerations for the purposes of taxation as well as for
other partnership purposes.
MR. JUSTICE JACKSONwould affirm on the opinion of the court below, being of the view that the ordinary
common-law tests of validity of partnerships are the tests for tax purposes and that they were met in this
case.
MR. JUSTICE FRANKFURTER, concurring:

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The Court finds that the Tax Court applied wrong legal standards in determining that the arrangement in
controversy did not constitute a partnership. It remands the case to the Tax Court because it is for that court,
and not for the Court of Appeals, to ascertain, on the basis of appropriate legal criteria, the existence of a
partnership within the provisions of Int. Rev. Code §§ 181 and 182. With these conclusions I agree. I think,
however, that it is due to the Tax Court, the Courts of Appeals, the Treasury and the bar to make more
explicit what the appropriate legal criteria are.
The Tax Court’s decision rested on a misconception of our decision in Commissioner v. Tower, 327 U. S.
280 [46-1 USTC ¶9189]. It is, however, fair to say that it was led into that misconception by phrases which it
culled from the Tower opinion with inadequate attention to the opinion in its entirety--both what it said and
what it significantly did not say. The Tower opinion did not say what the Government now urges upon this
Court; the Court’s opinion did not take the position of the concurring opinion. In short, the opinion did not say
that family partnerships are not to be regarded as partnerships for income-tax purposes even though they
be genuine commercial partnerships; the opinion did not even announce hobbling presumptions under the
income-tax law against such partnerships.
On the contrary, in defining the relevant considerations for determining the existence of a partnership, the
Court in the Tower case relied on familiar decisions formulating the concept of partnership for purposes of
various commercial situations in which the nature of that concept was decisive. It is significant that among
the cases cited was the leading case of Cox v. Hickman, 8 H. L. Cas. 268. The Court today reaffirms this
reliance by its quotation from the Tower case. The final sentence of the portion quoted underlines the fact
that the Court did not purport to announce a special concept of “partnership” for tax purposes differing from
the concept that rules in ordinary commercial-law cases. The sentence is:
“We see no reason why this general rule should not apply in tax cases where the Government challenges the
existence of a partnership for tax purposes.” 327 U. S. at 280 [46-1 USTC ¶9189].
The taxability of income under §§ 181 and 182 is not a purely economic problem like the determination
under §22(a) of what is income and to whom it is attributable. The word “income” has none but an economic
significance, and so the application of §22(a) is properly a matter of economic analysis. Cf. Lucas v. Earl,
281 U. S. 111 [2 USTC ¶496]. But §§ 181 and 182 import a concept of a different sort. These sections make
taxability turn on the existence of the relation of “partnership.” The term carries its own meaning, just as does
“negligence” in the Federal Employers’ Liability Act, because such a common-law concept has a content
familiar throughout the country to those to whom the law speaks. The basic criteria, which determine its
applicability have been so well and so long established that they were implicitly incorporated by the Internal
1
Revenue Code’s definition of “partnership.” Congress has thereby stamped a nationwide meaning upon
the term which disregards minor local variants or an occasional legal sport. Only in the application to a
given case of the criteria thus incorporated do economic data become relevant, and such data are inevitably
subject to differing inferences by different triers of fact. It is in the appraisal of facts, therefore, that difficulty
arises, and this difficulty is reflected by an appellate court in the degree of respect it accords to the particular
tribunal whose appraisal of the facts is before it for review.
That, as I see it, is the crux of the problem that is presented by these family partnerships in their relation to
the income tax. Men may put on the habiliments of a partnership whenever it advantages them to be treated
as partners underneath, although in fact it may be a case of “The King has no clothes on” to the sharp eyes
of the law. Since there are special temptations to appear as a partnership in order to avoid the hardships of
heavy taxation, the tribunal which presumably is gifted with superior discernment in differentiating between
the real thing and the imitation--the Tax Court--will naturally be on the alert against being taken in. Therefore,
a finding by the Tax Court that that which has the outward appearance of an arrangement to engage
in a common enterprise is not in fact such an associated business venture ought to be respected when
challenged in another court, unless such a determination is wholly without warrant in fact or, as in this case,
the wrong standards for judgment have been applied.
A fair reading of our Tower opinion in its entirety reflects the formulation of the concept of partnership which
is set forth at the beginning of its analysis and which the Court now quotes. While recognizing the importance
of the question “who actually owned a share of the capital attributed to the wife on the partnership books,”
the Tower opinion states the ultimate issue to be “whether this husband and wife really intended to carry
on business as a partnership.” 327 U. S. at 289 [46-1 USTC ¶9189]. To that determination it was of course

6
relevant that no new capital was brought into the business as a result of the formation of the partnership,
that the wife drew on income of the partnership only to pay for the type of things she had previously bought
for the family, and that the consequence was a mere paper reallocation of income. But these circumstances
were not cited as giving the term “partnership” a content peculiar to the Internal Revenue Code. They
were characterized, rather, simply as “more than ample evidence to support the Tax Court’s finding that no
genuine union for partnership business purposes was ever intended” and, as a corollary, “that the husband
earned the income.” 327 U. S. at 292 [46-1 USTC ¶9189].
Recognition of the importance, in applying §§ 181 and 182, of the appraisal of facts makes manifest why,
quite apart from the definition contained in §3797, a determination by a State court should not, as the Tower
opinion pointed out, foreclose a contrary determination by a federal tribunal charged with administration
of the tax laws. Such an inconsistency would not mean that the legal standards applied by each were
inconsistent; it would be a result simply of the commonplace that no finder of fact can see through the eyes
of any other finder of fact. See Texas v. Florida, 306 U. S. 398, 411. Nor would inconsistency be created
by a State court’s concern for the protection of creditors which lead it to seize upon adoption of the outward
form as the vital fact. So, indeed, might the taxing authorities refuse to be precluded from holding the
taxpayer to his election to adopt the form of a partnership. Cf. Higgins v. Smith, 308 U. S. 473, 477 [40-1
USTC ¶9160]. The need for guarding against misuse of the outward form of a partnership as a device for
obtaining tax advantages is properly satisfied by reliance on the vigilance of the Tax Court, not by distorting
the concept of partnership. It is not for this Court, by redefinition or the erection of presumptions, to amend
the Internal Revenue Code so as virtually to ban partnerships composed of the members of an intimate
family group.
The present case, nevertheless, is not the first manifestation of an impression that the Tower opinion had
2
precisely such an effect. It seems to me important, therefore, to make crystal clear that there is no special
concept of “partnership” for tax purposes, while at the same time recognizing that in view of the temptations
to assume a virtue that they have not for the sake of tax savings, men and women may appear in a guise
which the gimlet eye of the Tax Court is entitled to pierce. We should leave no doubt in the minds of the Tax
Court, of the Courts of Appeals, of the Treasury and of the bar that the essential holding of the Tower case is
that there is “no reason” why the “general rule” by which the existence of a partnership is determined “should
not apply in tax cases where the Government challenges the existence of a partnership for tax purposes.”
In plain English, if an arrangement among men is not an arrangement which puts them all in the same
business boat, then they cannot get into the same boat merely to seek the benefits of §§ 181 and 182. But
if they are in the same business boat, although they may have varying rewards and varied responsibilities,
they do not cease to be in it when the tax collector appears.
Footnotes
1 Gladys Culbertson, the wife of W. O. Culbertson, Sr., is joined as a party because of her community of
interest in the property and income of her husband under Texas law.
2 A daughter was also made a member of the partnership some time after its formation upon the gift
by respondent of one-quarter of his one-half interest in the partnership. Respondent did not contend
before the Tax Court that she was a partner for tax purposes.
3 168 Fed. (2d) 979 at 982 [48-2 USTC ¶9324]. The court further said: “Neither statute, common sense,
nor impelling precedent requires the holding that a partner must contribute capital or render services
to the partnership prior to the time that he is taken into it. These tests are equally effective whether the
capital and the services are presently contributed or are later to be contributed or to be rendered.” Id. at
983. See Note, 47 Mich. L. Rev. 595.
4 26 U. S. C. §§ 181, 182.
5 26 U. S. C. §§ 11, 22(a).
6 Of course one who has been a bona fide partner does not lose that status when he is called into
military or government service, and the Commissioner has not so contended. On the other hand, one

7
hardly becomes a partner in the conventional sense merely because he might have done so had he not
been called.
7 Eisner v. Macomber, 252 U. S. 189, 207 [1 USTC ¶32] (1920); Merchants Loan & Trust Co. v.
Smietanka, 255 U. S. 509, 519 [1 USTC ¶42] (1921). See Treas. Reg. 101, Art. 22(a)-1. See 1 Mertens,
Law of Federal Income Taxation, 159 et seq.
8 The reductio ad absurdum of the theory that children may be partners with their parents before they
are capable of being entrusted with the disposition of partnership funds or of contributing substantial
services occurred in Tinkoff v. Commissioner, 120 Fed. (2d) 564 [41-1 USTC ¶9391], where a taxpayer
made his son a partner in his accounting firm the day the son was born.
9 While the Tax Court went on to consider other factors, it is clear from its opinion that a contribution of
either “vital services” or “original capital” was considered essential to membership in the partnership.
After finding that none of respondent’s sons had, in the court’s opinion, contributed either, the court
continued: “In addition to the above inquiry as to the presence of those elements deemed by the Tower
case essential to partnerships recognizable for Federal tax purposes, . . ..” 6 CCH TCM 692, 699 [Dec.
15,874(M)]. Again, the court commented:
“Though the petitioner urges that many cattle businesses are composed of fathers and sons, and that
the nature of the industry so requires, we think the same is probably equally true of other industries
where men wish to take children into business with them. Nevertheless, we think that fact does not
override the many decisions to the general effect that partners must contribute capital originating with
them, or vital services.” Id. at 700.
10 See Mannheimer and Mook, A Taxwise Evaluation of Family Partnerships, 32 Iowa L. Rev. 436,
447-48.
11 This is not, as we understand it, contrary to the approach taken by the Bureau of Internal Revenue in its
most recent statement of policy. I. T. 3845, 1947 Cum. Bull. 66, states at p. 67:
“Where persons who are closely related by blood or marriage enter into an agreement purporting to
create a so-called family partnership or other arrangement with respect to the operation of a business
or income-producing venture, under which agreement all of the parties are accorded substantially
the same treatment and consideration with respect to their designated interests and prescribed
responsibilities in the business as if they were strangers dealing at arm’s length; where the actions of
the parties as legally responsible persons evidence an intent to carry on a business in a partnership
relation; and where the terms of such agreement are substantially followed in the operation of the
business or venture, as well as in the dealings of the partners or members with each other, it is the
policy of the Bureau to disregard the close family relationship existing between the parties and to
recognize, for Federal income tax purposes, the division of profits prescribed by such agreement.
However, where the instrument purporting to create the family partnership expressly provides that the
wife or child or other member of the family shall not be required to participate in the management of the
business, or is merely silent on that point, the extent and nature of the services of such individual in the
actual conduct of the business will be given appropriate evidentiary weight as to the question of intent
to carry on the business as partners.”
12 Nearly three-quarters of a century ago, Bowen, L. J., made the classic statement that “the state of a
man’s mind is as much a fact as the state of his digestion.” Eddington v. Fitzmaurice, 29 L. R. Ch. Div.
459, 483. State of mind has always been determinative of the question whether a partnership has been
formed as betweeen the parties. See, e.g., Drennen v. London Assurance Co., 13 U. S. 51, 56 (1884);
Meehan v. Valentine, 145 U. S. 611, 621 (1892); Barker v. Kraft, 259 Mich. 70, 242 N. W. 841 (1932);
Zuback v. Bakmaz, 346 Pa. 279, 29 Atl. 2d 473 (1943); Kennedy v. Mullins, 155 Va. 166, 154 S. E. 568
(1930).
13 In the Tower case the taxpayer argued that he had a right to reduce his taxes by any legal means,
to which this Court agreed. We said, however, that existence of a tax avoidance motive gives some
indication that there was no bona fide intent to carry on business as a partnership. If Tower had set
up objective requirements of membership in a family partnership, such as “vital services” and “original
capital,” the motives behind adoption of the partnership form would have been irrelevant.

8
14 Although “management and control of the business” was one of the circumstances emphasized by
the Tower case, along with “vital services” and “original capital,” the Tax Court did not consider it an
alternative “test” of partnership. See discussion, infra, at part Third, and note 17.
15 Except, of course, when Congress defines “family” and attaches tax consequences thereto. See, e.g.
26 U. S. C. §503(a)(2).
16 It is not enough to say in this case, as we did in the Clifford case, that “It is hard to imagine that
respondent felt himself the poorer after this [partnership agreement] had been executed or, if he did,
that it had any rational foundation in fact.” 309 U. S. at 336. Culbertson’s interest in his partnership with
Coon was worth about $50,000 immediately prior to dissolution of the partnership. In order to sustain
the Tax Court, we would have to conclude that he felt himself worth approximately twice that much
upon his purchase of Coon’s interest, even though he had agreed to sell that interest to his sons at the
same price.
17 As noted above (note 13), participation in control and management of the business, although given
equal prominence with contributions of “vital services” and “original capital” as circumstances indicating
an intent to enter into a partnership relation, was discarded by the Tax Court as a “test” of partnership.
This indicates a basic and erroneous assumption that one can never make a gift to a member of one’s
family without retaining the essentials of ownership, if the gift is then invested in a family partnership.
We included participation in management and control of the business as a circumstance indicative of
intent to carry on business as a partner to cover the situation in which active dominion and control of
the subject of the gift had actually passed to the donee. It is a circumstance of prime importance.
18 There is testimony in the record as to the participation by respondent’s sons in the management of the
ranch. Since such evidence did not fall within either of the “tests” adopted by the Tax Court, it failed
to consider this testimony. Without intimating any opinion as to its probative value, we think that it is
clearly relevant evidence of the intent to carry on business as partners.
1 The Code defines “partnership” in the following terms:
“§3797. Definitions.
“(2) Partnership and partner.
The term ‘partnership’ includes a syndicate, group, pool, joint venture, or other unincorporated
organization, through or by means of which any business, financial operation, or venture is carried on,
and which is not, within the meaning of this title, a trust or estate or a corporation; and the term ‘partner’
includes a member in such a syndicate, group, pool, joint venture, or organization.”
This definition carries two necessary implications: (1) recourse to the law of a particular State is
precluded, see Treas. Reg. 111, §§ 29.3797(1), 29.3797(4); see also Lyeth v. Hoey, 305 U. S. 188
[38-2 USTC ¶9602], 193-94; (2) use of the words “The term ‘partnership’ includes” presupposes that the
term has a recognized content. If this is not to be found in the law of a particular State, it can only be
found in the general law of partnership.
2 See, e.g., Fletcher v. Commissioner, 164 Fed. (2d) 182 [47-2 USTC ¶9379] (C. A. 2d Cir.); Hougland v.
Commissioner, 166 Fed. (2d) 815 [48-1 USTC ¶9217] (C. A. 6th Cir.). In this connection see also Tuttle
and Wilson, The Confusion on Family Partnerships, 9 Ga. B. J. 353 (1947).

9
IRS Rulings & Other Documents (2002-Current), Rev. Rul.
2004-77, Internal Revenue Service, (Aug. 2, 2004)
Rev. Rul. 2004-77, I.R.B. 2004-31, 119, August 2, 2004.
[ Code Sec. 7701]
Classification of entities—Check-the-Box Rules: Classification election: Disregarded entities,
partnerships.–
The IRS has provided guidance concerning disregarded entities and partnership classification. If
an eligible entity has two members under local law, but one of the members of the eligible entity is,
for federal tax purposes, disregarded as an entity separate from the other member of the eligible
entity, then the eligible entity cannot be classified as a partnership. In this case, the entity is either
disregarded as an entity separate from its owner or is classified as an association taxable as a
corporation. Back reference: ¶43,084.11.
ISSUE
How is an eligible entity (as defined in §301.7701-3(a) of the Procedure and Administration Regulations)
classified for federal tax purposes if the entity has two members under local law, but one of the members of
the eligible entity is disregarded as an entity separate from the other member of the eligible entity for federal
tax purposes?
FACTS
Situation 1. X, a domestic corporation, is the sole owner of L, a domestic limited liability company (LLC).
Under §301.7701-3(b)(1), L is disregarded as an entity separate from its owner, X. L and X are the only
members under local law of P, a state law limited partnership or LLC. There are no other constructive or
beneficial owners of P other than L and X. L and P are eligible entities that do not elect under §301.7701-3(c)
to be treated as associations for federal tax purposes.
Situation 2. X is an entity that is classified as a corporation under §301.7701-2(b). X is the sole owner of L,
a foreign eligible entity. Under §301.7701-3(c), L has elected to be disregarded as an entity separate from
its owner. L and X are the only members under local law of P, a foreign eligible entity. There are no other
constructive or beneficial owners of P other than L and X.
LAW AND ANALYSIS
Section 7701(a)(2) of the Internal Revenue Code provides that the term partnership includes a syndicate,
group, pool, joint venture, or other unincorporated organization through or by means of which any business,
financial operation, or venture is carried on, and which is not a trust, estate, or corporation.
Section 301.7701-1(a)(1) provides that whether an organization is an entity separate from its owners for
federal tax purposes is a matter of federal tax law and does not depend on whether the organization is
recognized as an entity under local law.
Section 301.7701-2(a) provides that a business entity is any entity recognized for federal tax purposes
(including an entity with a single owner that may be disregarded as an entity separate from its owner under
§301.7701-3) that is not properly classified as a trust under §301.7701-4 or otherwise subject to special
treatment under the Code. A business entity with two or more owners is classified for federal tax purposes as
either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is
disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship,
branch, or division of the owner.
Section 301.7701-2(c)(1) provides that, for federal tax purposes, the term “partnership” means a business
entity that is not a corporation under §301.7701-2(b) and that has at least two owners.
Section 301.7701-2(c)(2)(i) provides, in general, that a business entity that has a single owner and is not a
corporation under §301.7701-2(b) is disregarded as an entity separate from its owner.

10
Section 301.7701-3(a) provides that a business entity that is not classified as a corporation under
§301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax
purposes. An eligible entity with at least two owners can elect to be classified as either an association (and
thus a corporation under §301.7701-2(b)(2)) or a partnership, and an eligible entity with a single owner can
elect to be classified as an association or to be disregarded as an entity separate from its owner.
Section 301.7701-3(b)(1) provides generally that in the absence of an election otherwise, a domestic eligible
entity is (a) a partnership if it has at least two members, or (b) disregarded as an entity separate from its
owner if it has a single owner.
Section 301.7701-3(b)(2) provides generally that, in the absence of an election otherwise, a foreign eligible
entity is (a) a partnership if it has two or more owners and at least one owner does not have limited liability,
(b) an association if all its owners have limited liability, or (c) disregarded as an entity separate from its owner
if it has a single owner that does not have limited liability.
Situation 1. Under §301.7701-2(c)(2), L is disregarded as an entity separate from its owner, X, and its
activities are treated in the same manner as a branch or division of X. Because L is disregarded as an
entity separate from X, X is treated as owning all of the interests in P. P is a domestic entity, with only one
owner for federal tax purposes, that has not made an election to be classified as an association taxable as a
corporation. Because P has only one owner for federal tax purposes, P cannot be classified as a partnership
under §7701(a)(2). For federal tax purposes, P is disregarded as an entity separate from its owner.
Situation 2. Under §301.7701-3(c), L is disregarded as an entity separate from its owner, X, and its activities
are treated in the same manner as a branch or division of X. Because L is disregarded as an entity separate
from X, X is treated as owning all of the interests in P. Because P has only one owner for federal tax
purposes, P cannot be classified as a partnership under §7701(a)(2). For federal tax purposes, P is either
disregarded as an entity separate from its owner or an association taxable as a corporation.
HOLDING
If an eligible entity has two members under local law, but one of the members of the eligible entity is, for
federal tax purposes, disregarded as an entity separate from the other member of the eligible entity, then the
eligible entity cannot be classified as a partnership and is either disregarded as an entity separate from its
owner or an association taxable as a corporation.
DRAFTING INFORMATION
The principal author of this revenue ruling is Jason T. Smyczek of the Office of the Associate Chief Counsel
(Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr.
Smyczek at (202) 622-3050 (not a toll-free call).

11
IRS Rulings & Other Documents (2001-Earlier), Partnership;
coownership of apartment project., Rev. Rul. 75-374, 1975-2 CB
261, Internal Revenue Service, (Jan. 1, 1975)
Section 761.--Terms Defined
26 CFR 1.761-1: Terms defined.
[IRS Headnote] Partnership; coownership of apartment project.--
A life insurance company and a real estate investment trust, each of which owns an undivided one-half
interest in an apartment project for which they retain an unrelated corporation under a management contract
to furnish customary tenant services and various additional services for which it makes separate charges,
pays all costs incident thereto, and retains any profits therefrom, will not be treated as a partnership.
[Text]
Advice has been requested whether, under the circumstance described below, the coowners of an
apartment project would be treated as a partnership for Federal income tax purposes.
X, a life insurance company, and Y, a real estate investment trust, each own an undivided one-half interest in
an apartment project. X and Y entered into a management agreement with Z, an unrelated corporation, and
retained it to manage, operate, maintain, and service the project.
Generally, under the management agreement Z negotiates and executes leases for apartment units in the
project; collects rents and other payments from tenants; pays taxes, assessments, and insurance premiums
payable with respect to the project; performs all other services customarily performed in connection with the
maintenance and repair of an apartment project; and performs certain additional services for the tenants
beyond those customarily associated with maintenance and repair. Z is responsible for determining the
time and manner of performing its obligations under the agreement and for the supervision of all persons
performing services in connection with the carrying out of such obligations.
Customary tenant services, such as heat, air conditioning, hot and cold water, unattended parking, normal
repairs, trash removal, and cleaning of public areas are furnished at no additional charge above the basic
rental payments. All costs incurred by Z in rendering these customary services are paid for by X and Y.
As compensation for the customary services rendered by Z under the agreement, X and Y each pay Z a
percentage of one-half of the gross rental receipts derived from the operation of the project.
Additional services, such as attendant parking, cabanas, and gas, electricity, and other utilities are provided
by Z to tenants for a separate charge. Z pays the costs incurred in providing the additional services, and
retains the charges paid by tenants for its own use. These charges provide Z with adequate compensation
for the rendition of these additional services.
Section 761(a) of the Internal Revenue Code of 1954 provides that the term “partnership” includes a
syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any
business, financial operation, or venture is carried on, and which is not a corporation or a trust or estate.
Section 1.761-1(a) of the Income Tax Regulations provides that mere coownership of property that is
maintained, kept in repair, and rented or leased does not constitute a partnership. Tenants in common may
be partners if they actively carry on a trade, business, financial operation, or venture and divide the profits
thereof. For example, a partnership exists if coowners of an apartment building lease space and in addition
provide services to the occupants either directly or through an agent.
The furnishing of customary services in connection with the maintenance and repair of the apartment project
will not render a coownership a partnership. However, the furnishing of additional services will render a
coownership a partnership if the additional services are furnished directly by the coowners or through their
agent. In the instant case by reason of the contractual arrangement with Z, X and Y are not furnishing the
additional services either directly or through an agent. Z is solely responsible for determining the time and
manner of furnishing the services, bears all the expenses of providing these services, and retains for its

12
own use all the income from these services. None of the profits arising from the rendition of these additional
services are divided between X and Y.
Accordingly, X and Y will be treated as coowners and not as partners for purposes of section 761 of the
Code.

13
Standard Federal Income Tax Reporter (2011), Regulation, §301.7701-4.
, Internal Revenue Service, Trusts
(a) Ordinary trusts.— In general, the term "trust" as used in the Internal Revenue Code refers to
an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to
property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules
applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept
the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the
beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under
the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property
for beneficiaries who stand in the same relation to the trust as they would if the trust had been created
by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal
Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility
for the protection and conservation of property for beneficiaries who cannot share in the discharge of this
responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.
(b) Business trusts.— There are other arrangements which are known as trusts because the legal title
to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for
purposes of the Internal Revenue Code because they are not simply arrangements to protect or conserve
the property for the beneficiaries. These trusts, which are often known as business or commercial trusts,
generally are created by the beneficiaries simply as a device to carry on a profit-making business which
normally would have been carried on through business organizations that are classified as corporations
or partnerships under the Internal Revenue Code. However, the fact that the corpus of the trust is
not supplied by the beneficiaries is not sufficient reason in itself for classifying the arrangement as an
ordinary trust rather than as an association or partnership. The fact that any organization is technically
cast in the trust form, by conveying title to property to trustees for the benefit of persons designated as
beneficiaries, will not change the real character of the organization if the organization is more properly
classified as a business entity under § 301.7701-2.
(c) Certain investment trusts

(1) An "investment" trust will not be classified as a trust if there is a power under the trust agreement
to vary the investment of the certificate holders. See Commissioner v. North American Bond Trust,
122 F2d 545 [41-2 USTC ¶9644] (2d Cir. 1941), cert. denied, 314 US 701 (1942). An investment trust
with a single class of ownership interests, representing undivided beneficial interests in the assets
of the trust, will be classified as a trust if there is no power under the trust agreement to vary the
investment of the certificate holders. An investment trust with multiple classes of ownership interests
ordinarily will be classified as a business entity under § 301.7701-2; however, an investment trust with
multiple classes of ownership interests, in which there is no power under the trust agreement to vary
the investment of the certificate holders, will be classified as a trust if the trust is formed to facilitate
direct investment in the assets of the trust and the existence of multiple classes of ownership interests
is incidental to that purpose.
(2) The provisions of paragraph (c)(1) of this section may be illustrated by the following examples:
Example (1): A corporation purchases a portfolio of residential mortgages and transfers the mortgages
to a bank under a trust agreement. At the same time, the bank as trustee delivers to the corporation
certificates evidencing rights to payments from the pooled mortgages; the corporation sells the
certificates to the public. The trustee holds legal title to the mortgages in the pool for the benefit of
the certificate holders but has no power to reinvest proceeds attributable to the mortgages in the
pool or to vary investments in the pool in any other manner. There are two classes of certificates.
Holders of class A certificates are entitled to all payments of mortgage principal, both scheduled and
prepaid, until their certificates are retired; holders of class B certificates receive payments of principal
only after all class A certificates have been retired. The different rights of the class A and class B
certificates serve to shift to the holders of the class A certificates, in addition to the earlier scheduled

14
payments of principal, the risk that mortgages in the pool will be prepaid so that the holders of the
class B certificates will have "call protection" (freedom from premature termination of their interests
on account of prepayments). The trust thus serves to create investment interests with respect to the
mortgages held by the trust that differ significantly from direct investment in the mortgages. As a
consequence, the existence of multiple classes of trust ownership is not incidental to any purpose
of the trust to facilitate direct investment, and, accordingly, the trust is classified as a business entity
under § 301.7701-2.
Example (2): Corporation M is the originator of a portfolio of residential mortgages and transfers the
mortgages to a bank under a trust agreement. At the same time, the bank as trustee delivers to M
certificates evidencing rights to payments from the pooled mortgages. The trustee holds legal title
to the mortgages in the pool for the benefit of the certificate holders, but has no power to reinvest
proceeds attributable to the mortgages in the pool or to vary investments in the pool in any other
manner. There are two classes of certificates. Holders of class C certificates are entitled to receive
90 percent of the payments of principal and interest on the mortgages; class D certificate holders are
entitled to receive the other ten percent. The two classes of certificates are identical except that, in the
event of a default on the underlying mortgages, the payment rights of class D certificate holders are
subordinated to the rights of class C certificate holders. M sells the class C certificates to investors and
retains the class D certificates. The trust has multiple classes of ownership interests, given the greater
security provided to holders of class C certificates. The interests of certificate holders, however,
are substantially equivalent to undivided interests in the pool of mortgages, coupled with a limited
recourse guarantee running from M to the holders of class C certificates. In such circumstances, the
existence of multiple classes of ownership interests is incidental to the trust's purpose of facilitating
direct investment in the assets of the trust. Accordingly, the trust is classified as a trust.
Example (3): A promoter forms a trust in which shareholders of a publicly traded corporation can
deposit their stock. For each share of stock deposited with the trust, the participant receives two
certificates that are initially attached, but may be separated and traded independently of each other.
One certificate represents the right to dividends and the value of the underlying stock up to a specified
amount; the other certificate represents the right to appreciation in the stock's value above the
specified amount. The separate certificates represent two different classes of ownership interest in the
trust, which effectively separate dividend rights on the stock held by the trust from a portion of the right
to appreciation in the value of such stock. The multiple classes of ownership interests are designed
to permit investors, by transferring one of the certificates and retaining the other, to fulfill their varying
investment objectives of seeking primarily either dividend income or capital appreciation from the stock
held by the trust. Given that the trust serves to create investment interests with respect to the stock
held by the trust that differ significantly from direct investment in such stock, the trust is not formed to
facilitate direct investment in the assets of the trust. Accordingly, the trust is classified as a business
entity under § 301.7701-2.
Example (4): Corporation N purchases a portfolio of bonds and transfers the bonds to a bank under
a trust agreement. At the same time, the trustee delivers to N certificates evidencing interests in the
bonds. These certificates are sold to public investors. Each certificate represents the right to receive a
particular payment with respect to a specific bond. Under section 1286, stripped coupons and stripped
bonds are treated as separate bonds for federal income tax purposes. Although the interest of each
certificate holder is different from that of each other certificate holder, and the trust thus has multiple
classes of ownership, the multiple classes simply provide each certificate holder with a direct interest
in what is treated under section 1286 as a separate bond. Given the similarity of the interests acquired
by the certificate holders to the interests that could be acquired by direct investment, the multiple
classes of trust interests merely facilitate direct investment in the assets held by the trust. Accordingly,
the trust is classified as a trust.
(d) Liquidating trusts.— Certain organizations which are commonly known as liquidating trusts
are treated as trusts for purposes of the Internal Revenue Code. An organization will be considered
a liquidating trust if it is organized for the primary purpose of liquidating and distributing the assets
transferred to it, and if its activities are all reasonably necessary to, and consistent with, the
accomplishment of that purpose. A liquidating trust is treated as a trust for purposes of the Internal

15
Revenue Code because it is formed with the objective of liquidating particular assets and not as an
organization having as its purpose the carrying on of a profit-making business which normally would be
conducted through business organizations classified as corporations or partnerships. However, if the
liquidation is unreasonably prolonged or if the liquidation purpose becomes so obscured by business
activities that the declared purpose of liquidation can be said to be lost or abandoned, the status of the
organization will no longer be that of a liquidating trust. Bondholders' protective committees, voting trusts,
and other agencies formed to protect the interests of security holders during insolvency, bankruptcy, or
corporate reorganization proceedings are analogous to liquidating trusts but if subsequently utilized to
further the control or profitable operation of a going business on a permanent continuing basis, they will
lose their classification as trusts for purposes of the Internal Revenue Code.
(e) Environmental remediation trusts

(1) An environmental remediation trust is considered a trust for purposes of the Internal Revenue
Code. For purposes of this paragraph (e), an organization is an environmental remediation trust if
the organization is organized under state law as a trust; the primary purpose of the trust is collecting
and disbursing amounts for environmental remediation of an existing waste site to resolve, satisfy,
mitigate, address, or prevent the liability or potential liability of persons imposed by federal, state, or
local environmental laws; all contributors to the trust have (at the time of contribution and thereafter)
actual or potential liability or a reasonable expectation of liability under federal, state, or local
environmental laws for environmental remediation of the waste site; and the trust is not a qualified
settlement fund within the meaning of § 1.468B-1(a) of this chapter. An environmental remediation
trust is classified as a trust because its primary purpose is environmental remediation of an existing
waste site and not the carrying on of a profit-making business that normally would be conducted
through business organizations classified as corporations or partnerships. However, if the remedial
purpose is altered or becomes so obscured by business or investment activities that the declared
remedial purpose is no longer controlling, the organization will no longer be classified as a trust.
For purposes of this paragraph (e), environmental remediation includes the costs of assessing
environmental conditions, remedying and removing environmental contamination, monitoring remedial
activities and the release of substances, preventing future releases of substances, and collecting
amounts from persons liable or potentially liable for the costs of these activities. For purposes of this
paragraph (e), persons have potential liability or a reasonable expectation of liability under federal,
state, or local environmental laws for remediation of the existing waste site if there is authority under
a federal, state, or local law that requires or could reasonably be expected to require such persons to
satisfy all or a portion of the costs of the environmental remediation.
(2) Each contributor (grantor) to the trust is treated as the owner of the portion of the trust contributed
by that grantor under rules provided in section 677 and § 1.677(a)-1(d) of this chapter. Section 677
and § 1.677(a)-1(d) of this chapter provide rules regarding the treatment of a grantor as the owner of a
portion of a trust applied in discharge of the grantor's legal obligation. Items of income, deduction, and
credit attributable to an environmental remediation trust are not reported by the trust on Form 1041,
but are shown on a separate statement to be attached to that form. See § 1.671-4(a) of this chapter.
The trustee must also furnish to each grantor a statement that shows all items of income, deduction,
and credit of the trust for the grantor's taxable year attributable to the portion of the trust treated as
owned by the grantor. The statement must provide the grantor with the information necessary to take
the items into account in computing the grantor's taxable income, including information necessary to
determine the federal tax treatment of the items (for example, whether an item is a deductible expense
under section 162(a) or a capital expenditure under section 263(a)) and how the item should be taken
into account under the economic performance rules of section 461(h) and the regulations thereunder.
See § 1.461-4 of this chapter for rules relating to economic performance.
(3) All amounts contributed to an environmental remediation trust by a grantor (cash-out grantor)
who, pursuant to an agreement with the other grantors, contributes a fixed amount to the trust and is
relieved by the other grantors of any further obligation to make contributions to the trust, but remains
liable or potentially liable under the applicable environmental laws, will be considered amounts
contributed for remediation. An environmental remediation trust agreement may direct the trustee

16
to expend amounts contributed by a cash-out grantor (and the earnings thereon) before expending
amounts contributed by other grantors (and the earnings thereon). A cash-out grantor will cease to be
treated as an owner of a portion of the trust when the grantor's portion is fully expended by the trust.
(4) The provisions of this paragraph (e) may be illustrated by the following example:
Example. (a) X, Y, and Z are calendar year corporations that are liable for the remediation of an
existing waste site under applicable federal environmental laws. On June 1, 1996, pursuant to an
agreement with the governing federal agency, X, Y, and Z create an environmental remediation trust
within the meaning of paragraph (e)(1) of this section to collect funds contributed to the trust by X, Y,
and Z and to carry out the remediation of the waste site to the satisfaction of the federal agency. X,
Y, and Z are jointly and severally liable under the federal environmental laws for the remediation of
the waste site, and the federal agency will not release X, Y, or Z from liability until the waste site is
remediated to the satisfaction of the agency.
(b) The estimated cost of the remediation is $20,000,000. X, Y, and Z agree that, if Z contributes
$1,000,000 to the trust, Z will not be required to make any additional contributions to the trust, and X
and Y will complete the remediation of the waste site and make additional contributions if necessary.
(c) On June 1, 1996, X, Y, and Z each contribute $1,000,000 to the trust. The trust agreement
directs the trustee to spend Z's contributions to the trust and the income allocable to Z's portion
before spending X's and Y's portions. On November 30, 1996, the trustee disburses $2,000,000 for
remediation work performed from June 1, 1996, through September 30, 1996. For the six-month
period ending November 30, 1996, the interest earned on the funds in the trust was $75,000, which is
allocated in equal shares of $25,000 to X's, Y's, and Z's portions of the trust.
(d) Z made no further contributions to the trust. Pursuant to the trust agreement, the trustee expended
Z's portion of the trust before expending X's and Y's portion. Therefore, Z's share of the remediation
disbursement made in 1996 is $1,025,000 ($1,000,000 contribution by Z plus $25,000 of interest
allocated to Z's portion of the trust). Z takes the $1,025,000 disbursement into account under the
appropriate federal tax accounting rules. In addition, X's share of the remediation disbursement made
in 1996 is $487,500, and Y's share of the remediation disbursement made in 1996 is $487,500. X
and Y take their respective shares of the disbursement into account under the appropriate federal tax
accounting rules.
(e) The trustee made no further remediation disbursements in 1996, and X and Y made no further
contributions in 1996. From December 1, 1996, to December 31, 1996, the interest earned on the
funds remaining in the trust was $5,000, which is allocated $2,500 to X's portion and $2,500 to Y's
portion. Accordingly, for 1996, X and Y each had interest income of $27,500 from the trust and Z had
interest income of $25,000 from the trust.
(5) This paragraph (e) is applicable to trusts meeting the requirements of paragraph (e)(1) of this
section that are formed on or after May 1, 1996. This paragraph (e) may be relied on by trusts formed
before May 1, 1996, if the trust has at all times met all requirements of this paragraph (e) and the
grantors have reported items of income and deduction consistent with this paragraph (e) on original
or amended returns. For trusts formed before May 1, 1996, that are not described in the preceding
sentence, the Commissioner may permit by letter ruling, in appropriate circumstances, this paragraph
(e) to be applied subject to appropriate terms and conditions.
(f) Effective date.— The rules of this section generally apply to taxable years beginning after December
31, 1960. Paragraph (e)(5) of this section contains rules of applicability for paragraph (e) of this section.
In addition, the last sentences of paragraphs (b), (c)(1), and (c)(2) Example 1 and Example 3 of this
section are effective as of January 1, 1997. [Reg. §301.7701-4.]
.01 Historical Comment: Proposed 12/23/59. Adopted 11/15/60 by T.D. 6503. Amended 3/21/86 by T.D. 8080, 4/30/96 by
T.D. 8668 and 12/17/96 by T.D. 8697.

17
Federal Tax Regulations (TRC Version), Regulation, §301.7701-3.
, Internal Revenue Service, Classification of certain business entities
(a) In general.— A business entity that is not classified as a corporation under §301.7701-2(b)(1),
(3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes as
provided in this section. An eligible entity with at least two members can elect to be classified as either
an association (and thus a corporation under §301.7701-2(b)(2)) or a partnership, and an eligible entity
with a single owner can elect to be classified as an association or to be disregarded as an entity separate
from its owner. Paragraph (b) of this section provides a default classification for an eligible entity that
does not make an election. Thus, elections are necessary only when an eligible entity chooses to be
classified initially as other than the default classification or when an eligible entity chooses to change
its classification. An entity whose classification is determined under the default classification retains
that classification (regardless of any changes in the members' liability that occurs at any time during the
time that the entity's classification is relevant as defined in paragraph (d) of this section) until the entity
makes an election to change that classification under paragraph (c)(1) of this section. Paragraph (c) of
this section provides rules for making express elections. Paragraph (d) of this section provides special
rules for foreign eligible entities. Paragraph (e) of this section provides special rules for classifying entities
resulting from partnership terminations and divisions under section 708(b). Paragraph (f) of this section
sets forth the effective date of this section and a special rule relating to prior periods.
(b) Classification of eligible entities that do not file an election

(1) Domestic eligible entities.— Except as provided in paragraph (b)(3) of this section, unless the
entity elects otherwise, a domestic eligible entity is—
(i) A partnership if it has two or more members; or
(ii) Disregarded as an entity separate from its owner if it has a single owner.
(2) Foreign eligible entities

(i) In general.— Except as provided in paragraph (b)(3) of this section, unless the entity elects
otherwise, a foreign eligible entity is—
(A) A partnership if it has two or more members and at least one member does not have
limited liability;
(B) An association if all members have limited liability; or
(C) Disregarded as an entity separate from its owner if it has a single owner that does not have
limited liability.
(ii) Definition of limited liability.— For purposes of paragraph (b)(2)(i) of this section, a member
of a foreign eligible entity has limited liability if the member has no personal liability for the debts
of or claims against the entity by reason of being a member. This determination is based solely
on the statute or law pursuant to which the entity is organized, except that if the underlying statute
or law allows the entity to specify in its organizational documents whether the members will have
limited liability, the organizational documents may also be relevant. For purposes of this section, a
member has personal liability if the creditors of the entity may seek satisfaction of all or any portion
of the debts or claims against the entity from the member as such. A member has personal liability
for purposes of this paragraph even if the member makes an agreement under which another
person (whether or not a member of the entity) assumes such liability or agrees to indemnify that
member for any such liability.
(3) Existing eligible entities

18
(i) In general.— Unless the entity elects otherwise, an eligible entity in existence prior to the
effective date of this section will have the same classification that the entity claimed under
§§301.7701-1 through 301.7701-3 as in effect on the date prior to the effective date of this
section; except that if an eligible entity with a single owner claimed to be a partnership under those
regulations, the entity will be disregarded as an entity separate from its owner under this paragraph
(b)(3)(i). For special rules regarding the classification of such entities prior to the effective date of
this section, see paragraph (h)(2) of this section.
(ii) Special rules.— For purposes of paragraph (b)(3)(i) of this section, a foreign eligible entity
is treated as being in existence prior to the effective date of this section only if the entity's
classification was relevant (as defined in paragraph (d) of this section) at any time during the sixty
months prior to the effective date of this section. If an entity claimed different classifications prior
to the effective date of this section, the entity's classification for purposes of paragraph (b)(3)(i) of
this section is the last classification claimed by the entity. If a foreign eligible entity's classification
is relevant prior to the effective date of this section, but no federal tax or information return is
filed or the federal tax or information return does not indicate the classification of the entity, the
entity's classification for the period prior to the effective date of this section is determined under the
regulations in effect on the date prior to the effective date of this section.
(c) Elections
(1) Time and place for filing
(i) In general.— Except as provided in paragraphs (c)(1)(iv) and (v) of this section, an eligible
entity may elect to be classified other than as provided under paragraph (b) of this section, or to
change its classification, by filing Form 8832, Entity Classification Election, with the service center
designated on Form 8832. An election will not be accepted unless all of the information required
by the form and instructions, including the taxpayer identifying number of the entity, is provided
on Form 8832. See §301.6109-1 for rules on applying for and displaying Employer Identification
Numbers.
(ii) Further notification of elections.— An eligible entity required to file a Federal tax or
information return for the taxable year for which an election is made under §301.7701-3(c)(1)(i)
must attach a copy of its Form 8832 to its Federal tax or information return for that year. If the
entity is not required to file a return for that year, a copy of its Form 8832 ("Entity Classification
Election") must be attached to the Federal income tax or information return of any direct or indirect
owner of the entity for the taxable year of the owner that includes the date on which the election
was effective. An indirect owner of the entity does not have to attach a copy of the Form 8832 to
its return if an entity in which it has an interest is already filing a copy of the Form 8832 with its
return. If an entity, or one of its direct or indirect owners, fails to attach a copy of a Form 8832 to
its return as directed in this section, an otherwise valid election under §301.7701-3(c)(1)(i) will
not be invalidated, but the non-filing party may be subject to penalties, including any applicable
penalties if the Federal tax or information returns are inconsistent with the entity's election under
§301.7701-3(c)(1)(i). In the case of returns for taxable years beginning after December 31, 2002,
the copy of Form 8832 attached to a return pursuant to this paragraph (c)(1)(ii) is not required to be
a signed copy.
(iii) Effective date of election.— An election made under paragraph (c)(1)(i) of this section will
be effective on the date specified by the entity on Form 8832 or on the date filed if no such date
is specified on the election form. The effective date specified on Form 8832 can not be more than
75 days prior to the date on which the election is filed and can not be more than 12 months after
the date on which the election is filed. If an election specifies an effective date more than 75 days
prior to the date on which the election is filed, it will be effective 75 days prior to the date it was
filed. If an election specifies an effective date more than 12 months from the date on which the
election is filed, it will be effective 12 months after the date it was filed. If an election specifies an
effective date before January 1, 1997, it will be effective as of January 1, 1997. If a purchasing
corporation makes an election under section 338 regarding an acquired subsidiary, an election

19
under paragraph (c)(1)(i) of this section for the acquired subsidiary can be effective no earlier than
the day after the acquisition date (within the meaning of section 338(h)(2)).
(iv) Limitation.— If an eligible entity makes an election under paragraph (c)(1)(i) of this section
to change its classification (other than an election made by an existing entity to change its
classification as of the effective date of this section), the entity cannot change its classification
by election again during the sixty months succeeding the effective date of the election. However,
the Commissioner may permit the entity to change its classification by election within the sixty
months if more than fifty percent of the ownership interests in the entity as of the effective date
of the subsequent election are owned by persons that did not own any interests in the entity on
the filing date or on the effective date of the entity's prior election. An election by a newly formed
eligible entity that is effective on the date of formation is not considered a change for purposes of
this paragraph (c)(1)(iv).
(v) Deemed elections

(A) Exempt organizations.— An eligible entity that has been determined to be, or claims to
be, exempt from taxation under section 501(a) is treated as having made an election under
this section to be classified as an association. Such election will be effective as of the first
day for which exemption is claimed or determined to apply, regardless of when the claim or
determination is made, and will remain in effect unless an election is made under paragraph
(c)(1)(i) of this section after the date the claim for exempt status is withdrawn or rejected or the
date the determination of exempt status is revoked.
(B) Real estate investment trusts.— An eligible entity that files an election under section
856(c)(1) to be treated as a real estate investment trust is treated as having made an election
under this section to be classified as an association. Such election will be effective as of the first
day the entity is treated as a real estate investment trust.
(C) S corporations.— An eligible entity that timely elects to be an S corporation under section
1362(a)(1) is treated as having made an election under this section to be classified as an
association, provided that (as of the effective date of the election under section 1362(a)
(1)) the entity meets all other requirements to qualify as a small business corporation under
section 1361(b). Subject to §301.7701-3(c)(1)(iv), the deemed election to be classified as an
association will apply as of the effective date of the S corporation election and will remain in
effect until the entity makes a valid election, under §301.7701-3(c)(1)(i), to be classified as other
than an association.
(vi) Examples.— The following examples illustrate the rules of this paragraph (c)(1):
Example 1. On July 1, 1998, X, a domestic corporation, purchases a 10% interest in Y, an eligible
entity formed under Country A law in 1990. The entity's classification was not relevant to any
person for federal tax or information purposes prior to X's acquisition of an interest in Y. Thus, Y
is not considered to be in existence on the effective date of this section for purposes of paragraph
(b)(3) of this section. Under the applicable Country A statute, all members of Y have limited liability
as defined in paragraph (b)(2)(ii) of this section. Accordingly, Y is classified as an association
under paragraph (b)(2)(i)(B) of this section unless it elects under this paragraph (c) to be classified
as a partnership. To be classified as a partnership as of July 1, 1998, Y must file a Form 8832
by September 14, 1998. See paragraph (c)(1)(i) of this section. Because an election cannot be
effective more than 75 days prior to the date on which it is filed, if Y files its Form 8832 after
September 14, 1998, it will be classified as an association from July 1, 1998, until the effective date
of the election. In that case, it could not change its classification by election under this paragraph
(c) during the sixty months succeeding the effective date of the election.
Example 2. (i) Z is an eligible entity formed under Country B law and is in existence on the effective
date of this section within the meaning of paragraph (b)(3) of this section. Prior to the effective
date of this section, Z claimed to be classified as an association. Unless Z files an election under

20
this paragraph (c), it will continue to be classified as an association under paragraph (b)(3) of this
section.
(ii) Z files a Form 8832 pursuant to this paragraph (c) to be classified as a partnership, effective as
of the effective date of this section. Z can file an election to be classified as an association at any
time thereafter, but then would not be permitted to change its classification by election during the
sixty months succeeding the effective date of that subsequent election.
(2) Authorized signatures

(i) In general.— An election made under paragraph (c)(1)(i) of this section must be signed by—
(A) Each member of the electing entity who is an owner at the time the election is filed; or
(B) Any officer, manager, or member of the electing entity who is authorized (under local law or
the entity's organizational documents) to make the election and who represents to having such
authorization under penalties of perjury.
(ii) Retroactive elections.— For purposes of paragraph (c)(2)(i) of this section, if an election
under paragraph (c)(1)(i) of this section is to be effective for any period prior to the time that it is
filed, each person who was an owner between the date the election is to be effective and the date
the election is filed, and who is not an owner at the time the election is filed, must also sign the
election.
(iii) Changes in classification.— For paragraph (c)(2)(i) of this section, if an election under
paragraph (c)(1)(i) of this section is made to change the classification of an entity, each person who
was an owner on the date that any transactions under paragraph (g) of this section are deemed
to occur, and who is not an owner at the time the election is filed, must also sign the election. This
paragraph (c)(2)(iii) applies to elections filed on or after November 29, 1999.
(d) Special rules for foreign eligible entities

(1) Definition of relevance
(i) General rule.— For purposes of this section, a foreign eligible entity's classification is relevant
when its classification affects the liability of any person for federal tax or information purposes. For
example, a foreign entity's classification would be relevant if U.S. income was paid to the entity
and the determination by the withholding agent of the amount to be withheld under chapter 3 of
the Internal Revenue Code (if any) would vary depending upon whether the entity is classified as
a partnership or as an association. Thus, the classification might affect the documentation that the
withholding agent must receive from the entity, the type of tax or information return to file, or how
the return must be prepared. The date that the classification of a foreign eligible entity is relevant is
the date an event occurs that creates an obligation to file a federal tax return, information return, or
statement for which the classification of the entity must be determined. Thus, the classification of a
foreign entity is relevant, for example, on the date that an interest in the entity is acquired which will
require a U.S. person to file an information return on Form 5471.
(ii) Deemed relevance

(A) General rule.— For purposes of this section, except as provided in paragraph (d)(1)(ii)(B) of
this section, the classification for Federal tax purposes of a foreign eligible entity that files Form
8832, "Entity Classification Election", shall be deemed to be relevant only on the date the entity
classification election is effective.
(B) Exception.— If the classification of a foreign eligible entity is relevant within the meaning of
paragraph (d)(1)(i) of this section, then the rule in paragraph (d)(1)(ii)(A) of this section shall not
apply.
(2) Entities the classification of which has never been relevant.— If the classification of a foreign
eligible entity has never been relevant (as defined in paragraph (d)(1) of this section), then the entity's

21
classification will initially be determined pursuant to the provisions of paragraph (b)(2) of this section
when the classification of the entity first becomes relevant (as defined in paragraph (d)(1)(i) of this
section).
(3) Special rule when classification is no longer relevant.— If the classification of a foreign eligible
entity is not relevant (as defined in paragraph (d)(1) of this section) for 60 consecutive months, then
the entity's classification will initially be determined pursuant to the provisions of paragraph (b)(2)
of this section when the classification of the foreign eligible entity becomes relevant (as defined in
paragraph (d)(1)(i) of this section). The date that the classification of a foreign entity is not relevant is
the date an event occurs that causes the classification to no longer be relevant, or, if no event occurs
in a taxable year that causes the classification to be relevant, then the date is the first day of that
taxable year.
(4) Effective date.— Paragraphs (d)(1)(ii), (d)(2), and (d)(3) of this section apply on or after October
22, 2003.
(e) Coordination with section 708(b).— Except as provided in §301.7701-2(d)(3) (regarding termination
of grandfather status for certain foreign business entities), an entity resulting from a transaction described
in section 708(b)(1)(B) (partnership termination due to sales or exchanges) or section 708(b)(2)(B)
(partnership division) is a partnership.
(f) Changes in number of members of an entity

(1) Associations.— The classification of an eligible entity as an association is not affected by any
change in the number of members of the entity.
(2) Partnerships and single member entities.— An eligible entity classified as a partnership
becomes disregarded as an entity separate from its owner when the entity's membership is reduced
to one member. A single member entity disregarded as an entity separate from its owner is classified
as a partnership when the entity has more than one member. If an elective classification change under
paragraph (c) of this section is effective at the same time as a membership change described in this
paragraph (f)(2), the deemed transactions in paragraph (g) of this section resulting from the elective
change preempt the transactions that would result from the change in membership.
(3) Effect on sixty month limitation.— A change in the number of members of an entity does not
result in the creation of a new entity for purposes of the sixty month limitation on elections under
paragraph (c)(1)(iv) of this section.
(4) Examples.— The following examples illustrate the application of this paragraph (f):
Example 1. A, a U.S. person, owns a domestic eligible entity that is disregarded as an entity separate
from its owner. On January 1, 1998, B, a U.S. person, buys a 50 percent interest in the entity from A.
Under this paragraph (f), the entity is classified as a partnership when B acquires an interest in the
entity. However, A and B elect to have the entity classified as an association effective on January
1, 1998. Thus, B is treated as buying shares of stock on January 1, 1998. (Under paragraph (c)(1)
(iv) of this section, this election is treated as a change in classification so that the entity generally
cannot change its classification by election again during the sixty months succeeding the effective
date of the election.) Under paragraph (g)(1) of this section, A is treated as contributing the assets and
liabilities of the entity to the newly formed association immediately before the close of December 31,
1997. Because A does not retain control of the association as required by section 351, A's contribution
will be a taxable event. Therefore, under section 1012, the association will take a fair market value
basis in the assets contributed by A, and A will have a fair market value basis in the stock received.
A will have no additional gain upon the sale of stock to B, and B will have a cost basis in the stock
purchased from A.
Example 2. (i) On April 1, 1998, A and B, U.S. persons, form X, a foreign eligible entity. X is treated as
an association under the default provisions of paragraph (b)(2)(i) of this section, and X does not make
an election to be classified as a partnership. A subsequently purchases all of B's interest in X.

22
(ii) Under paragraph (f)(1) of this section, X continues to be classified as an association. X, however,
can subsequently elect to be disregarded as an entity separate from A. The sixty month limitation of
paragraph (c)(1)(iv) of this section does not prevent X from making an election because X has not
made a prior election under paragraph (c)(1)(i) of this section.
Example 3. (i) On April 1, 1998, A and B, U.S. persons, form X, a foreign eligible entity. X is treated
as an association under the default provisions of paragraph (b)(2)(i) of this section, and X does not
make an election to be classified as a partnership. On January 1, 1999, X elects to be classified as
a partnership effective on that date. Under the sixty month limitation of paragraph (c)(1)(iv) of this
section, X cannot elect to be classified as an association until January 1, 2004 (i.e., sixty months after
the effective date of the election to be classified as a partnership).
(ii) On June 1, 2000, A purchases all of B's interest in X. After A's purchase of B's interest, X can no
longer be classified as a partnership because X has only one member. Under paragraph (f)(2) of this
section, X is disregarded as an entity separate from A when A becomes the only member of X. X,
however, is not treated as a new entity for purposes of paragraph (c)(1)(iv) of this section. As a result,
the sixty month limitation of paragraph (c)(1)(iv) of this section continues to apply to X, and X cannot
elect to be classified as an association until January 1, 2004 (i.e., sixty months after January 1, 1999,
the effective date of the election by X to be classified as a partnership).
(5) Effective date.— This paragraph (f) applies as of November 29, 1999.
(g) Elective changes in classification

(1) Deemed treatment of elective change
(i) Partnership to association.— If an eligible entity classified as a partnership elects under
paragraph (c)(1)(i) of this section to be classified as an association, the following is deemed to
occur: The partnership contributes all of its assets and liabilities to the association in exchange for
stock in the association, and immediately thereafter, the partnership liquidates by distributing the
stock of the association to its partners.
(ii) Association to partnership.— If an eligible entity classified as an association elects under

paragraph (c)(1)(i) of this section to be classified as a partnership, the following is deemed to
occur: The association distributes all of its assets and liabilities to its shareholders in liquidation of
the association, and immediately thereafter, the shareholders contribute all of the distributed assets
and liabilities to a newly formed partnership.
(iii) Association to disregarded entity.— If an eligible entity classified as an association elects

under paragraph (c)(1)(i) of this section to be disregarded as an entity separate from its owner, the
following is deemed to occur: The association distributes all of its assets and liabilities to its single
owner in liquidation of the association.
(iv) Disregarded entity to an association.— If an eligible entity that is disregarded as an entity

separate from its owner elects under paragraph (c)(1)(i) of this section to be classified as an
association, the following is deemed to occur: The owner of the eligible entity contributes all of the
assets and liabilities of the entity to the association in exchange for stock of the association.
(2) Effect of elective chanqes

(i) In general.— The tax treatment of a change in the classification of an entity for federal tax
purposes by election under paragraph (c)(1)(i) of this section is determined under all relevant
provisions of the Internal Revenue Code and general principles of tax law, including the step
transaction doctrine.
(ii) Adoption of plan of liquidation.— For purposes of satisfying the requirement of adoption of
a plan of liquidation under section 332, unless a formal plan of liquidation that contemplates the
election to be classified as a partnership or to be disregarded as an entity separate from its owner
is adopted on an earlier date, the making, by an association, of an election under paragraph (c)(1)

23
(i) of this section to be classified as a partnership or to be disregarded as an entity separate from
its owner is considered to be the adoption of a plan of liquidation immediately before the deemed
liquidation described in paragraph (g)(1)(ii) or (iii) of this section. This paragraph (g)(2)(ii) applies
to elections filed on or after December 17, 2001. Taxpayers may apply this paragraph (g)(2)(ii)
retroactively to elections filed before December 17, 2001, if the corporate owner claiming treatment
under section 332 and its subsidiary making the election take consistent positions with respect to
the federal tax consequences of the election.
(3) Timing of election

(i) In general.— An election under paragraph (c)(1)(i) of this section that changes the classification
of an eligible entity for federal tax purposes is treated as occurring at the start of the day for which
the election is effective. Any transactions that are deemed to occur under this paragraph (g) as
a result of a change in classification are treated as occurring immediately before the close of the
day before the election is effective. For example, if an election is made to change the classification
of an entity from an association to a partnership effective on January 1, the deemed transactions
specified in paragraph (g)(1)(ii) of this section (including the liquidation of the association) are
treated as occurring immediately before the close of December 31 and must be reported by the
owners of the entity on December 31. Thus, the last day of the association's taxable year will be
December 31 and the first day of the partnership's taxable year will be January 1.
(ii) Coordination with section 338 election.— A purchasing corporation that makes a qualified
stock purchase of an eligible entity taxed as a corporation may make an election under section
338 regarding the acquisition if it satisfies the requirements for the election, and may also make
an election to change the classification of the target corporation. If a taxpayer makes an election
under section 338 regarding its acquisition of another entity taxable as a corporation and makes
an election under paragraph (c) of this section for the acquired corporation (effective at the earliest
possible date as provided by paragraph (c)(1)(iii) of this section), the transactions under paragraph
(g) of this section are deemed to occur immediately after the deemed asset purchase by the new
target corporation under section 338.
(iii) Application to successive elections in tiered situations.— When elections under paragraph
(c)(1)(i) of this section for a series of tiered entities are effective on the same date, the eligible
entities may specify the order of the elections on Form 8832. If no order is specified for the
elections, any transactions that are deemed to occur in this paragraph (g) as a result of the
classification change will be treated as occurring first for the highest tier entity's classification
change, then for the next highest tier entity's classification change, and so forth down the chain
of entities until all the transactions under this paragraph (g) have occurred. For example, Parent,
a corporation, wholly owns all of the interest of an eligible entity classified as an association (S1),
which wholly owns another eligible entity classified as an association (S2), which wholly owns
another eligible entity classified as an association (S3). Elections under paragraph (c)(1)(i) of this
section are filed to classify S1, S2, and S3 each as disregarded as an entity separate from its
owner effective on the same day. If no order is specified for the elections, the following transactions
are deemed to occur under this paragraph (g) as a result of the elections, with each successive
transaction occurring on the same day immediately after the preceding transaction: S1 is treated
as liquidating into Parent, then S2 is treated as liquidating into Parent, and finally S3 is treated as
liquidating into Parent.
(4) Effective date.— Except as otherwise provided in paragraph (g)(2)(ii) of this section, this
paragraph (g) applies to elections that are filed on or after November 29, 1999. Taxpayers may apply
this paragraph (g) retroactively to elections filed before November 29, 1999 if all taxpayers affected by
the deemed transactions file consistently with this paragraph (g).
(h) Effective date

24
(1) In general.— Except as otherwise provided in this section, the rules of this section are applicable
as of January 1, 1997.
(2) Prior treatment of existing entities.— In the case of a business entity that is not described in
§301.7701-2(b)(1), (3), (4), (5), (6), or (7), and that was in existence prior to January 1, 1997, the
entity's claimed classification(s) will be respected for all periods prior to January 1, 1997, if—
(i) The entity had a reasonable basis (within the meaning of section 6662) for its claimed
classification;
(ii) The entity and all members of the entity recognized the federal tax consequences of any
change in the entity's classification within the sixty months prior to January 1, 1997; and
(iii) Neither the entity nor any member was notified in writing on or before May 8, 1996, that the
classification of the entity was under examination (in which case the entity's classification will be
determined in the examination).
(3) Deemed elections for S corporations.— Paragraph (c)(1)(v)(C) of this section applies to timely
S corporation elections under section 1362(a) filed on or after July 20, 2004. Eligible entities that
filed timely S elections before July 20, 2004 may also rely on the provisions of the regulation. [Reg.
§301.7701-3.]
# [T.D. 6503, 11-15-60. Amended by T.D. 8632, 12-19-95; T.D. 8697, 12-17-96; T.D. 8767, 3-23-98; T.D. 8827, 7-12-99 (corrected
10-29-99); T.D. 8844, 11-26-99; T.D. 8970, 12-14-2001; T.D. 9093, 10-21-2003; T.D. 9100, 12-18-2003; T.D. 9139, 7-19-2004;
T.D. 9153, 8-11-2004; T.D. 9203, 5-20-2005 and T.D. 9300, 12-7-2006.]
Federal Tax Service Explanations:

301.7701-3
PLANIND:9,108.15
301.7701-3(a)
CONSOL:7,154; CONSOL:9,204.05; PLANIND:9,108.15
301.7701-3(b)(1)
CONSOL:41,500; NOL:42,300; NOL:6,104.15
301.7701-3(b)(1)(i)
CONSOL:41,500; NOL:42,300; NOL:6,104.15
301.7701-3(b)(2)(i)(A)
CONSOL:41,500; NOL:42,300; NOL:6,104.15
301.7701-3(b)(2)(i)(B)
CONSOL:41,500; NOL:42,300; NOL:6,104.15
301.7701-3(g)(1)(iii)
REORG:6,052

25
Federal Tax Regulations, Regulation, §301.7701-2. , Internal Revenue
Service, Business entities; definitions
(a) Business entities.— For purposes of this section and §301.7701-3, a business entityis any entity
recognized for federal tax purposes (including an entity with a single owner that may be disregarded
as an entity separate from its owner under §301.7701-3) that is not properly classified as a trust under
§301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. A business
entity with two or more members is classified for federal tax purposes as either a corporation or a
partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the
entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or
division of the owner. But see paragraphs (c)(2)(iv) and (v) of this section for special employment and
excise tax rules that apply to an eligible entity that is otherwise disregarded as an entity separate from its
owner.
(b) Corporations.— For federal tax purposes, the term corporation means—
(1) A business entity organized under a Federal or State statute, or under a statute of a federally
recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a
corporation, body corporate, or body politic;
(2) An association (as determined under §301.7701-3);
(3) A business entity organized under a State statute, if the statute describes or refers to the entity as
a joint-stock company or joint-stock association;
(4) An insurance company;
(5) A State-chartered business entity conducting banking activities, if any of its deposits are insured
under the Federal Deposit Insurance Act, as amended, 12 U.S.C. 1811 et seq., or a similar federal
statute;
(6) A business entity wholly owned by a State or any political subdivision thereof, or a business entity
wholly owned by a foreign government or any other entity described in §1.892-2T;
(7) A business entity that is taxable as a corporation under a provision of the Internal Revenue Code
other than section 7701(a)(3); and
(8) Certain foreign entities

(i) In general.— Except as provided in paragraphs (b)(8)(ii) and (d) of this section, the following
business entities formed in the following jurisdictions:
American Samoa, Corporation
Argentina, Sociedad Anonima
Australia, Public Limited Company
Austria, Aktiengesellschaft
Barbados, Limited Company
Belgium, Societe Anonyme
Belize, Public Limited Company
Bolivia, Sociedad Anonima
Brazil, Sociedade Anonima
Bulgaria, Aktsionerno Druzhestvo
Canada, Corporation and Company

26
Chile, Sociedad Anonima
People's Republic of China, Gufen Youxian Gongsi
Republic of China (Taiwan), Ku-fen Yu-hsien Kung-szu
Colombia, Sociedad Anonima
Costa Rica, Sociedad Anonima
Cyprus, Public Limited Company
Czech Republic, Akciova Spolecnost
Denmark, Aktieselskab
Ecuador, Sociedad Anonima or Compania Anonima
Egypt, Sharikat Al-Mossahamah
El Salvador, Sociedad Anonima
Estonia, Aktsiaselts
European Economic Area/European Union, Societas Europaea
Finland, Julkinen Osakeyhtio/Publikt Aktiebolag
France, Societe Anonyme
Germany, Aktiengesellschaft
Greece, Anonymos Etairia
Guam, Corporation
Guatemala, Sociedad Anonima
Guyana, Public Limited Company
Honduras, Sociedad Anonima
Hong Kong, Public Limited Company
Hungary, Reszvenytarsasag
Iceland, Hlutafelag
India, Public Limited Company
Indonesia, Perseroan Terbuka
Ireland, Public Limited Company
Israel, Public Limited Company
Italy, Societa per Azioni
Jamaica, Public Limited Company
Japan, Kabushiki Kaisha
Kazakstan, Ashyk Aktsionerlik Kogham
Republic of Korea, Chusik Hoesa
Latvia, Akciju Sabiedriba
Liberia, Corporation
Liechtenstein, Aktiengesellschaft
Lithuania, Akcine Bendroves
Luxembourg, Societe Anonyme
Malaysia, Berhad
Malta, Public Limited Company

27
Mexico, Sociedad Anonima
Morocco, Societe Anonyme
Netherlands, Naamloze Vennootschap
New Zealand, Limited Company
Nicaragua, Compania Anonima
Nigeria, Public Limited Company
Northern Mariana Islands, Corporation
Norway, Allment Aksjeselskap
Pakistan, Public Limited Company
Panama, Sociedad Anonima
Paraguay, Sociedad Anonima
Peru, Sociedad Anonima
Philippines, Stock Corporation
Poland, Spolka Akcyjna
Portugal, Sociedade Anonima
Puerto Rico, Corporation
Romania, Societate pe Actiuni
Russia, Otkrytoye Aktsionernoy Obshchestvo
Saudi Arabia, Sharikat Al-Mossahamah
Singapore, Public Limited Company
Slovak Republic, Akciova Spolocnost
Slovenia, Delniska Druzba
South Africa, Public Limited Company
Spain, Sociedad Anonima
Surinam, Naamloze Vennootschap
Sweden, Publika Aktiebolag
Switzerland, Aktiengesellschaft
Thailand, Borisat Chamkad (Mahachon)
Trinidad and Tobago, Limited Company
Tunisia, Societe Anonyme
Turkey, Anonim Sirket
Ukraine, Aktsionerne Tovaristvo Vidkritogo Tipu
United Kingdom, Public Limited Company
United States Virgin Islands, Corporation
Uruguay, Sociedad Anonima
Venezuela, Sociedad Anonima or Compania Anonima
(ii) Clarification of list of corporations in paragraph (b)(8)(i) of this

section
(A) Exceptions in certain cases.— The following entities will not be treated as corporations
under paragraph (b)(8)(i) of this section:

28
(1) With regard to Canada, a Nova Scotia Unlimited Liability Company (or any other
company or corporation all of whose owners have unlimited liability pursuant to federal or
provincial law).
(2) With regard to India, a company deemed to be a public limited company solely by
operation of Section 43A(1) (relating to corporate ownership of the company), section
43A(1A) (relating to annual average turnover), or section 43A(1B) (relating to ownership
interests in other companies) of the Companies Act, 1956 (or any combination of these),
provided that the organizational documents of such deemed public limited company continue
to meet the requirements of section 3(1)(iii) of the Companies Act, 1956.
(3) With regard to Malaysia, a Sendirian Berhad.
(B) Inclusions in certain cases.— With regard to Mexico, the term Sociedad Anonima includes
a Sociedad Anonima that chooses to apply the variable capital provision of Mexican corporate
law (Sociedad Anonima de Capital Variable).
(iii) Public companies.— For purposes of paragraph (b)(8)(i) of this section, with regard to
Cyprus, Hong Kong, and Jamaica, the term Public Limited Company includes any Limited
Company that is not defined as a private company under the corporate laws of those jurisdictions.
In all other cases, where the term Public Limited Company is not defined, that term shall include
any Limited Company defined as a public company under the corporate laws of the relevant
jurisdiction.
(iv) Limited companies.— For purposes of this paragraph (b)(8), any reference to a Limited
Company includes, as the case may be, companies limited by shares and companies limited by
guarantee.
(v) Multilingual countries.— Different linguistic renderings of the name of an entity listed in
paragraph (b)(8)(i) of this section shall be disregarded. For example, an entity formed under the
laws of Switzerland as a Societe Anonyme will be a corporation and treated in the same manner as
an Aktiengesellschaft.
(9) Business entities with multiple charters

(i) An entity created or organized under the laws of more than one jurisdiction if the rules of this
section would treat it as a corporation with reference to any one of the jurisdictions in which it is
created or organized. Such an entity may elect its classification under §301.7701-3, subject to the
limitations of those provisions, only if it is created or organized in each jurisdiction in a manner that
meets the definition of an eligible entity in §301.7701-3(a). The determination of a business entity's
corporate or non-corporate classification is made independently from the determination of whether
the entity is domestic or foreign. See §301.7701-5 for the rules that determine whether a business
entity is domestic or foreign.
(ii) Examples.— The following examples illustrate the rule of this paragraph (b)(9):
Example 1. (i) Facts. X is an entity with a single owner organized under the laws of Country A as
an entity that is listed in paragraph (b)(8)(i) of this section. Under the rules of this section, such
an entity is a corporation for Federal tax purposes and under §301.7701-3(a) is unable to elect
its classification. Several years after its formation, X files a certificate of domestication in State B
as a limited liability company (LLC). Under the laws of State B, X is considered to be created or
organized in State B as an LLC upon the filing of the certificate of domestication and is therefore
subject to the laws of State B. Under the rules of this section and §301.7701-3, an LLC with a
single owner organized only in State B is disregarded as an entity separate from its owner for
Federal tax purposes (absent an election to be treated as an association). Neither Country A nor
State B law requires X to terminate its charter in Country A as a result of the domestication, and
in fact X does not terminate its Country A charter. Consequently, X is now organized in more than
one jurisdiction.

29
(ii) Result. X remains organized under the laws of Country A as an entity that is listed in paragraph
(b)(8)(i) of this section, and as such, it is an entity that is treated as a corporation under the rules of
this section. Therefore, X is a corporation for Federal tax purposes because the rules of this section
would treat X as a corporation with reference to one of the jurisdictions in which it is created or
organized. Because X is organized in Country A in a manner that does not meet the definition of an
eligible entity in §301.7701-3(a), it is unable to elect its classification.
Example 2. (i) Facts. Y is an entity that is incorporated under the laws of State A and has two
shareholders. Under the rules of this section, an entity incorporated under the laws of State A is a
corporation for Federal tax purposes and under §301.7701-3(a) is unable to elect its classification.
Several years after its formation, Y files a certificate of continuance in Country B as an unlimited
company. Under the laws of Country B, upon filing a certificate of continuance, Y is treated as
organized in Country B. Under the rules of this section and §301.7701-3, an unlimited company
organized only in Country B that has more than one owner is treated as a partnership for Federal
tax purposes (absent an election to be treated as an association). Neither State A nor Country B
law requires Y to terminate its charter in State A as a result of the continuance, and in fact Y does
not terminate its State A charter. Consequently, Y is now organized in more than one jurisdiction.
(ii) Result. Y remains organized in State A as a corporation, an entity that is treated as a
corporation under the rules of this section. Therefore, Y is a corporation for Federal tax purposes
because the rules of this section would treat Y as a corporation with reference to one of the
jurisdictions in which it is created or organized. Because Y is organized in State A in a manner
that does not meet the definition of an eligible entity in §301.7701-3(a), it is unable to elect its
classification.
Example 3. (i) Facts. Z is an entity that has more than one owner and that is recognized under
the laws of Country A as an unlimited company organized in Country A. Z is organized in Country
A in a manner that meets the definition of an eligible entity in §301.7701-3(a). Under the rules of
this section and §301.7701-3, an unlimited company organized only in Country A with more than
one owner is treated as a partnership for Federal tax purposes (absent an election to be treated
as an association). At the time Z was formed, it was also organized as a private limited company
under the laws of Country B. Z is organized in Country B in a manner that meets the definition of an
eligible entity in §301.7701-3(a). Under the rules of this section and §301.7701-3, a private limited
company organized only in Country B is treated as a corporation for Federal tax purposes (absent
an election to be treated as a partnership). Thus, Z is organized in more than one jurisdiction. Z
has not made any entity classification elections under §301.7701-3.
(ii) Result. Z is organized in Country B as a private limited company, an entity that is treated
(absent an election to the contrary) as a corporation under the rules of this section. However,
because Z is organized in each jurisdiction in a manner that meets the definition of an eligible entity
in §301.7701-3(a), it may elect its classification under §301.7701-3, subject to the limitations of
those provisions.
Example 4. (i) Facts. P is an entity with more than one owner organized in Country A as a general
partnership. Under the rules of this section and §301.7701-3, an eligible entity with more than
one owner in Country A is treated as a partnership for federal tax purposes (absent an election
to be treated as an association). P files a certificate of continuance in Country B as an unlimited
company. Under the rules of this section and §301.7701-3, an unlimited company in Country
B with more than one owner is treated as a partnership for federal tax purposes (absent an
election to be treated as an association). P is not required under either the laws of Country A or
Country B to terminate the general partnership in Country A, and in fact P does not terminate its
Country A partnership. P is now organized in more than one jurisdiction. P has not made any entity
classification elections under §301.7701-3.
(ii) Result. P's organization in both Country A and Country B would result in P being classified as
a partnership. Therefore, since the rules of this section would not treat P as a corporation with
reference to any jurisdiction in which it is created or organized, it is not a corporation for federal tax
purposes.

30
(c) Other business entities.— For federal tax purposes—
(1) The term partnership means a business entity that is not a corporation under paragraph (b) of this
section and that has at least two members.
(2) Wholly owned entities

(i) In general.— Except as otherwise provided in this paragraph (c), a business entity that has a
single owner and is not a corporation under paragraph (b) of this section is disregarded as an entity
separate from its owner.
(ii) Special rule for certain business entities.— If the single owner of a business entity is a bank
(as defined in section 581, or, in the case of a foreign bank, as defined in section 585(a)(2)(B)
without regard to the second sentence thereof), then the special rules applicable to banks under
the Internal Revenue Code will continue to apply to the single owner as if the wholly owned entity
were a separate entity. For this purpose, the special rules applicable to banks under the Internal
Revenue Code do not include the rules under sections 864(c), 882(c), and 884.
(iii) [Reserved].— For further guidance, see §301.7701-2T(c)(2)(iii).
(iv) Special rule for employment tax purposes

(A) In general.— Paragraph (c)(2)(i) of this section (relating to certain wholly owned entities)
does not apply to taxes imposed under Subtitle C — Employment Taxes and Collection of
Income Tax (Chapters 21, 22, 23, 23A, 24, and 25 of the Internal Revenue Code). Paragraph
(c)(2)(i) of this section does apply to taxes imposed under Subtitle A, including Chapter 2 -
Tax on Self-Employment Income. The owner of an entity that is treated in the same manner
as a sole proprietorship under paragraph (a) of this section will be subject to the tax on self-
employment income.
(B) [Reserved].— For further guidance, see §301.7701-2T(c)(2)(iv)(B).
(C) Example.— The following example illustrates the application of paragraph (c)(2)(iv) of this
section:
Example. (i) LLCA is an eligible entity owned by individual A and is generally disregarded as
an entity separate from its owner for Federal tax purposes. However, LLCA is treated as an
entity separate from its owner for purposes of subtitle C of the Internal Revenue Code. LLCA
has employees and pays wages as defined in sections 3121(a), 3306(b), and 3401(a).
(ii) LLCA is subject to the provisions of subtitle C of the Internal Revenue Code and related
provisions under 26 CFR subchapter C, Employment Taxes and Collection of Income Tax
at Source, parts 31 through 39. Accordingly, LLCA is required to perform such acts as are
required of an employer under those provisions of the Internal Revenue Code and regulations
thereunder that apply. All provisions of law (including penalties) and the regulations prescribed
in pursuance of law applicable to employers in respect of such acts are applicable to LLCA.
Thus, for example, LLCA is liable for income tax withholding, Federal Insurance Contributions
Act (FICA) taxes, and Federal Unemployment Tax Act (FUTA) taxes. See sections 3402 and
3403 (relating to income tax withholding); 3102(b) and 3111 (relating to FICA taxes), and 3301
(relating to FUTA taxes). In addition, LLCA must file under its name and EIN the applicable
Forms in the 94X series, for example, Form 941, "Employer's Quarterly Employment Tax
Return," Form 940, "Employer's Annual Federal Unemployment Tax Return;" file with the Social
Security Administration and furnish to LLCA's employees statements on Forms W-2, "Wage and
Tax Statement;" and make timely employment tax deposits. See §§31.6011(a)-1, 31.6011(a)-3,
31.6051-1, 31.6051-2, and 31.6302-1 of this chapter.
(iii) A is self-employed for purposes of subtitle A, chapter 2, Tax on Self-Employment Income,
of the Internal Revenue Code. Thus, A is subject to tax under section 1401 on A's net earnings
from self-employment with respect to LLCA's activities. A is not an employee of LLCA for

31
purposes of subtitle C of the Internal Revenue Code. Because LLCA is treated as a sole
proprietorship of A for income tax purposes, A is entitled to deduct trade or business expenses
paid or incurred with respect to activities carried on through LLCA, including the employer's
share of employment taxes imposed under sections 3111 and 3301, on A's Form 1040,
Schedule C, "Profit or Loss for Business (Sole Proprietorship)."
(v) Special rule for certain excise tax purposes

(A) In general.— Paragraph (c)(2)(i) of this section (relating to certain wholly owned entities)
does not apply for purposes of—
(1) Federal tax liabilities imposed by Chapters 31, 32 (other than section 4181), 33, 34, 35,
36 (other than section 4461), and 38 of the Internal Revenue Code, or any floor stocks tax
imposed on articles subject to any of these taxes;
(2) Collection of tax imposed by Chapter 33 of the Internal Revenue Code;
(3) Registration under sections 4101, 4222, and 4412; and
(4) Claims of a credit (other than a credit under section 34), refund, or payment related to a
tax described in paragraph (c)(2)(v)(A)(1) of this section or under section 6426 or 6427.
(B) [Reserved].— For further guidance, see §301.7701-2T(c)(2)(v)(B).
(C) Example.— The following example illustrates the provisions of this paragraph (c)(2)(v):
Example. (i) LLCB is an eligible entity that has a single owner, B. LLCB is generally disregarded
as an entity separate from its owner. However, under paragraph (c)(2)(v) of this section, LLCB
is treated as an entity separate from its owner for certain purposes relating to excise taxes.
(ii) LLCB mines coal from a coal mine located in the United States. Section 4121 of chapter
32 of the Internal Revenue Code imposes a tax on the producer's sale of such coal. Section
48.4121-1(a) of this chapter defines a "producer" generally as the person in whom is vested
ownership of the coal under state law immediately after the coal is severed from the ground.
LLCB is the person that owns the coal under state law immediately after it is severed from the
ground. Under paragraph (c)(2)(v)(A)(1) of this section, LLCB is the producer of the coal and is
liable for tax on its sale of such coal under chapter 32 of the Internal Revenue Code. LLCB must
report and pay tax on Form 720, "Quarterly Federal Excise Tax Return," under its own name
and taxpayer identification number.
(iii) LLCB uses undyed diesel fuel in an earthmover that is not registered or required to be
registered for highway use. Such use is an off-highway business use of the fuel. Under section
6427(l), the ultimate purchaser is allowed to claim an income tax credit or payment related to
the tax imposed on diesel fuel used in an off-highway business use. Under paragraph (c)(2)
(v) of this section, for purposes of the credit or payment allowed under section 6427(l), LLCB is
the person that could claim the amount on its Form 720 or on a Form 8849, "Claim for Refund
of Excise Taxes." Alternatively, if LLCB did not claim a payment during the time prescribed
in section 6427(i)(2) for making a claim under section 6427, §1.34-1 of this chapter provides
that B, the owner of LLCB, could claim the income tax credit allowed under section 34 for the
nontaxable use of diesel fuel by LLCB.
(iv) [Reserved]. For further guidance, see §301.7701-2T(c)(2)(v)(C)Example (iv).
(d) Special rule for certain foreign business entities

(1) In general.— Except as provided in paragraph (d)(3) of this section, a foreign business entity
described in paragraph (b)(8)(i) of this section will not be treated as a corporation under paragraph (b)
(8)(i) of this section if—

32
(i) The entity was in existence on May 8, 1996;
(ii) The entity's classification was relevant (as defined in §301.7701-3(d)) on May 8, 1996;
(iii) No person (including the entity) for whom the entity's classification was relevant on May 8,
1996, treats the entity as a corporation for purposes of filing such person's federal income tax
returns, information returns, and withholding documents for the taxable year including May 8, 1996;
(iv) Any change in the entity's claimed classification within the sixty months prior to May 8, 1996,
occurred solely as a result of a change in the organizational documents of the entity, and the
entity and all members of the entity recognized the federal tax consequences of any change in the
entity's classification within the sixty months prior to May 8, 1996;
(v) A reasonable basis (within the meaning of section 6662) existed on May 8, 1996, for treating
the entity as other than a corporation; and
(vi) Neither the entity nor any member was notified in writing on or before May 8, 1996, that the
classification of the entity was under examination (in which case the entity's classification will be
determined in the examination).
(2) Binding contract rule.— If a foreign business entity described in paragraph (b)(8)(i) of this section
is formed after May 8, 1996, pursuant to a written binding contract (including an accepted bid to
develop a project) in effect on May 8, 1996, and all times thereafter, in which the parties agreed to
engage (directly or indirectly) in an active and substantial business operation in the jurisdiction in
which the entity is formed, paragraph (d)(1) of this section will be applied to that entity by substituting
the date of the entity's formation for May 8, 1996.
(3) Termination of grandfather status

(i) In general.— An entity that is not treated as a corporation under paragraph (b)(8)(i) of this
section by reason of paragraph (d)(1) or (d)(2) of this section will be treated permanently as a
corporation under paragraph (b)(8)(i) of this section from the earliest of:
(A) The effective date of an election to be treated as an association under §301.7701-3;
(B) A termination of the partnership under section 708(b)(1)(B) (regarding sale or exchange
of 50 percent or more of the total interest in an entity's capital or profits within a twelve month
period);
(C) A division of the partnership under section 708(b)(2)(B); or
(D) The date any person or persons, who were not owners of the entity as of November 29,
1999, own in the aggregate a 50 percent or greater interest in the entity.
(ii) Special rule for certain entities.— For purposes of paragraph (d)(2) of this section, paragraph
(d)(3)(i)(B) of this section shall not apply if the sale or exchange of interests in the entity is to a
related person (within the meaning of sections 267(b) and 707(b)) and occurs no later than twelve
months after the date of the formation of the entity.
(e) Effective/applicability date

(1) Except as otherwise provided in this paragraph (e), the rules of this section apply as of January
1, 1997, except that paragraph (b)(6) of this section applies on or after January 14, 2002, to a
business entity wholly owned by a foreign government regardless of any prior entity classification,
and paragraph (c)(2)(ii) of this section applies to taxable years beginning after January 12, 2001.
The reference to the Finnish, Maltese, and Norwegian entities in paragraph (b)(8)(i) of this section is
applicable on November 29, 1999. The reference to the Trinidadian entity in paragraph (b)(8)(i) of this
section applies to entities formed on or after November 29, 1999. Any Maltese or Norwegian entity that
becomes an eligible entity as a result of paragraph (b)(8)(i) of this section in effect on November 29,

33
1999, may elect by February 14, 2000, to be classified for Federal tax purposes as an entity other than
a corporation retroactive to any period from and including January 1, 1997. Any Finnish entity that
becomes an eligible entity as a result of paragraph (b)(8)(i) of this section in effect on November 29,
1999, may elect by February 14, 2000, to be classified for Federal tax purposes as an entity other than
a corporation retroactive to any period from and including September 1, 1997. However, paragraph (d)
(3)(i)(D) of this section applies on or after October 22, 2003.
(2) [Reserved].— For further guidance, see §301.7701-2T(e)(2).
(3)
(i) General rule.— Except as provided in paragraph (e)(3)(ii) of this section, the rules of paragraph
(b)(9) of this section apply as of August 12, 2004, to all business entities existing on or after that
date.
(ii) Transition rule.— For business entities created or organized under the laws of more than one
jurisdiction as of August 12, 2004, the rules of paragraph (b)(9) of this section apply as of May
1, 2006. These entities, however, may rely on the rules of paragraph (b)(9) of this section as of
August 12, 2004.
(4) The reference to the Estonian, Latvian, Liechtenstein, Lithuanian, and Slovenian entities in
paragraph (b)(8)(i) of this section applies to such entities formed on or after October 7, 2004, and to
any such entity formed before such date from the date any person or persons, who were not owners
of the entity as of October 7, 2004, own in the aggregate a 50 percent or greater interest in the entity.
The reference to the European Economic Area/European Union entity in paragraph (b)(8)(i) of this
section applies to such entities formed on or after October 8, 2004.
(5) Paragraph (c)(2)(iv) of this section applies with respect to wages paid on or after January 1, 2009.
(6) Paragraph (c)(2)(v) of this section applies to liabilities imposed and actions first required or
permitted in periods beginning on or after January 1, 2008.
(7) The reference to the Bulgarian entity in paragraph (b)(8)(i) of this section applies to such entities
formed on or after January 1, 2007, and to any such entity formed before such date from the date that,
in the aggregate, a 50 percent or more interest in such entity is owned by any person or persons who
were not owners of the entity as of January 1, 2007. For purposes of the preceding sentence, the term
interest means—
(i) In the case of a partnership, a capital or profits interest; and
(ii) In the case of a corporation, an equity interest measured by vote or value. [Reg. §301.7701-2.]
# [T.D. 6503, 11-15-60. Amended by T.D. 6797, 2-2-65; T.D. 7515, 10-17-77; T.D. 7889, 4-25-83; T.D. 8475, 5-13-93; T.D.
8697, 12-17-96 (corrected 4-3-2008); T.D. 8844, 11-26-99; T.D. 9012, 7-31-2002; T.D. 9093, 10-21-2003; T.D. 9153, 8-11-2004;
T.D. 9183, 2-24-2005 T.D. 9197, 4-13-2005; T.D. 9235, 12-15-2005; T.D. 9246, 1-27-2006; T.D. 9356, 8-15-2007; T.D. 9388,
3-20-2008; T.D. 9433, 11-26-2008 and T.D. 9462, 9-11-2009.]

34
Federal Tax Regulations, Regulation, §301.7701-1. , Internal Revenue
Service, Classification of organizations for federal tax purposes
(a) Organizations for federal tax purposes
(1) In general.— The Internal Revenue Code prescribes the classification of various organizations
for federal tax purposes. Whether an organization is an entity separate from its owners for federal
tax purposes is a matter of federal tax law and does not depend on whether the organization is
recognized as an entity under local law.
(2) Certain joint undertakings give rise to entities for federal tax purposes.— A joint venture or
other contractual arrangement may create a separate entity for federal tax purposes if the participants
carry on a trade, business, financial operation, or venture and divide the profits therefrom. For
example, a separate entity exists for federal tax purposes if co-owners of an apartment building
lease space and in addition provide services to the occupants either directly or through an agent.
Nevertheless, a joint undertaking merely to share expenses does not create a separate entity for
federal tax purposes. For example, if two or more persons jointly construct a ditch merely to drain
surface water from their properties, they have not created a separate entity for federal tax purposes.
Similarly, mere co-ownership of property that is maintained, kept in repair, and rented or leased
does not constitute a separate entity for federal tax purposes. For example, if an individual owner, or
tenants in common, of farm property lease it to a farmer for a cash rental or a share of the crops, they
do not necessarily create a separate entity for federal tax purposes.
(3) Certain local law entities not recognized.— An entity formed under local law is not always
recognized as a separate entity for federal tax purposes. For example, an organization wholly owned
by a State is not recognized as a separate entity for federal tax purposes if it is an integral part of the
State. Similarly, tribes incorporated under section 17 of the Indian Reorganization Act of 1934, as
amended, 25 U.S.C. 477, or under section 3 of the Oklahoma Indian Welfare Act, as amended, 25
U.S.C. 503, are not recognized as separate entities for federal tax purposes.
(4) Single owner organizations.— Under §§301.7701-2 and 301.7701-3, certain organizations
that have a single owner can choose to be recognized or disregarded as entities separate from their
owners.
(b) Classification of organizations.— The classification of organizations that are recognized as

separate entities is determined under §§301.7701-2, 301.7701-3, and 301.7701-4 unless a provision of
the Internal Revenue Code (such as section 860A addressing Real Estate Mortgage Investment Conduits
(REMICs)) provides for special treatment of that organization. For the classification of organizations
as trusts, see §301.7701-4. That section provides that trusts generally do not have associates or an
objective to carry on business for profit. Sections 301.7701-2 and 301.7701-3 provide rules for classifying
organizations that are not classified as trusts.
(c) Cost sharing arrangements.— A cost sharing arrangement that is described in §1.482-7T of this
chapter, including any arrangement that the Commissioner treats as a CSA under §1.482-7T(b)(5) of
this chapter, is not recognized as a separate entity for purposes of the Internal Revenue Code. See
§1.482-7T of this chapter for the rules regarding CSAs.
(d) Domestic and foreign business entities.— See §301.7701-5 for the rules that determine whether a
business entity is domestic or foreign.
(e) State.— For purposes of this section and §301.7701-2, the term State includes the District of
Columbia.

35
(f) Effective/applicability dates.— Except as provided in the following sentence, the rules of this section
are applicable as of January 1, 1997. The rules of paragraph (c) of this section are applicable on January
5, 2009. [Reg. §301.7701-1.]
# [T.D. 6503, 11-15-80. Amended by T.D. 6797, 2-2-65; T.D. 7515, 10-17-77; T.D. 8697, 12-17-96; T.D. 9153, 8-11-2004; T.D.
9246, 1-27-2006 and T.D. 9441, 12-31-2008.]

36
Current Internal Revenue Code (Standard Federal version), SEC. 7701.
DEFINITIONS.
7701(a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with
the intent thereof—
7701(a)(1) PERSON.— The term “person” shall be construed to mean and include an individual, a trust,
estate, partnership, association, company or corporation.
7701(a)(2) PARTNERSHIP AND PARTNER.— The term “partnership” includes a syndicate, group, pool,
joint venture, or other unincorporated organization, through or by means of which any business,
financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust
or estate or a corporation; and the term “partner” includes a member in such a syndicate, group, pool,
joint venture, or organization.
7701(a)(3) CORPORATION.— The term “corporation” includes associations, joint-stock companies, and
insurance companies.
7701(a)(4) DOMESTIC.— The term “domestic” when applied to a corporation or partnership means
created or organized in the United States or under the law of the United States or of any State unless,
in the case of a partnership, the Secretary provides otherwise by regulations.
7701(a)(5) FOREIGN.— The term “foreign” when applied to a corporation or partnership means a
corporation or partnership which is not domestic.
7701(a)(6) FIDUCIARY.— The term “fiduciary” means a guardian, trustee, executor, administrator,
receiver, conservator, or any person acting in any fiduciary capacity for any person.
7701(a)(7) STOCK.— The term “stock” includes shares in an association, joint-stock company, or
insurance company.
7701(a)(8) SHAREHOLDER.— The term “shareholder” includes a member in an association, joint-stock

company, or insurance company.
7701(a)(9) UNITED STATES.— The term “United States” when used in a geographical sense includes
only the States and the District of Columbia.
7701(a)(10) STATE.— The term “State” shall be construed to include the District of Columbia, where
such construction is necessary to carry out provisions of this title.
7701(a)(11) SECRETARY OF THE TREASURY AND SECRETARY.—

7701(a)(11)(A) SECRETARY OF THE TREASURY.— The term “Secretary of the Treasury” means the
Secretary of the Treasury, personally, and shall not include any delegate of his.
7701(a)(11)(B) SECRETARY.— The term “Secretary” means the Secretary of the Treasury or his
delegate.
7701(a)(12) DELEGATE.—
7701(a)(12)(A) IN GENERAL.— The term “or his delegate”—
7701(a)(12)(A)(i) when used with reference to the Secretary of the Treasury, means any
officer, employee, or agency of the Treasury Department duly authorized by the Secretary of the
Treasury directly, or indirectly by one or more redelegations of authority, to perform the function
mentioned or described in the context; and

37
7701(a)(12)(A)(ii) when used with reference to any other official of the United States, shall be
similarly construed.
7701(a)(12)(B) PERFORMANCE OF CERTAIN FUNCTIONS IN GUAM OR AMERICAN SAMOA.— The term

“delegate”, in relation to the performance of functions in Guam or American Samoa with respect
to the taxes imposed by chapters 1, 2 and 21, also includes any officer or employee of any other
department or agency of the United States, or of any possession thereof, duly authorized by
the Secretary (directly, or indirectly by one or more redelegations of authority) to perform such
functions.
7701(a)(13) COMMISSIONER.— The term “Commissioner” means the Commissioner of Internal

Revenue.
7701(a)(14) TAXPAYER.— The term “taxpayer” means any person subject to any internal revenue tax.
7701(a)(15) MILITARY OR NAVAL FORCES AND ARMED FORCES OF THE UNITED STATES.— The term “military
or naval forces of the United States” and the term “Armed Forces of the United States” each includes
all regular and reserve components of the uniformed services which are subject to the jurisdiction of
the Secretary of Defense, the Secretary of the Army, the Secretary of the Navy, or the Secretary of
the Air Force, and each term also includes the Coast Guard. The members of such forces include
commissioned officers and personnel below the grade of commissioned officers in such forces.
7701(a)(16) WITHHOLDING AGENT.— The term “withholding agent” means any person required to
deduct and withhold any tax under the provisions of section 1441, 1442, 1443, or 1461.
7701(a)(17) HUSBAND AND WIFE.— As used in sections 682 and 2516, if the husband and wife therein
referred to are divorced, wherever appropriate to the meaning of such sections, the term “wife” shall
be read “former wife” and the term “husband” shall be read “former husband”; and, if the payments
described in such sections are made by or on behalf of the wife or former wife to the husband or
former husband instead of vice versa, wherever appropriate to the meaning of such sections, the term
“husband” shall be read “wife” and the term “wife” shall be read “husband.”
7701(a)(18) INTERNATIONAL ORGANIZATION.— The term “international organization” means a public

international organization entitled to enjoy privileges, exemptions, and immunities as an international
organization under the International Organizations Immunities Act (22 U. S. C. 288-288f).
7701(a)(19) DOMESTIC BUILDING AND LOAN ASSOCIATION.— The term “domestic building and
loan association” means a domestic building and loan association, a domestic savings and loan
association, and a Federal savings and loan association—
7701(a)(19)(A) which either (i) is an insured institution within the meaning of section 401(a) of
the National Housing Act (12 U. S. C. sec. 1724(a)), or (ii) is subject by law to supervision and
examination by State or Federal authority having supervision over such associations;
7701(a)(19)(B) the business of which consists principally of acquiring the savings of the public
and investing in loans; and
7701(a)(19)(C) at least 60 percent of the amount of the total assets of which (at the close of the
taxable year) consists of—
7701(a)(19)(C)(i) cash,
7701(a)(19)(C)(ii) obligations of the United States or of a State or political subdivision thereof,

and stock or obligations of a corporation which is an instrumentality of the United States or of
a State or political subdivision thereof, but not including obligations the interest on which is
excludable from gross income under section 103,

38
7701(a)(19)(C)(iii) certificates of deposit in, or obligations of, a corporation organized under
a State law which specifically authorizes such corporation to insure the deposits or share
accounts of member associations,
7701(a)(19)(C)(iv) loans secured by a deposit or share of a member,
7701(a)(19)(C)(v) loans (including redeemable ground rents, as defined in section 1055)

secured by an interest in real property which is (or, from the proceeds of the loan, will become)
residential real property or real property used primarily for church purposes, loans made for the
improvement of residential real property or real property used primarily for church purposes,
provided that for purposes of this clause, residential real property shall include single or
multifamily dwellings, facilities in residential developments dedicated to public use or property
used on a nonprofit basis for residents, and mobile homes not used on a transient basis,
7701(a)(19)(C)(vi) loans secured by an interest in real property located within an urban

renewal area to be developed for predominantly residential use under an urban renewal plan
approved by the Secretary of Housing and Urban Development under part A or part B of title I of
the Housing Act of 1949, as amended, or located within any area covered by a program eligible
for assistance under section 103 of the Demonstration Cities and Metropolitan Development Act
of 1966, as amended, and loans made for the improvement of any such real property,
7701(a)(19)(C)(vii) loans secured by an interest in educational, health, or welfare institutions

or facilities, including structures designed or used primarily for residential purposes for students,
residents, and persons under care, employees, or members of the staff of such institutions or
facilities,
7701(a)(19)(C)(viii) property acquired through the liquidation of defaulted loans described in

clause (v), (vi), or (vii),
7701(a)(19)(C)(ix) loans made for the payment of expenses of college or university education
or vocational training, in accordance with such regulations as may be prescribed by the
Secretary,
7701(a)(19)(C)(x) property used by the association in the conduct of the business described in
subparagraph (B), and,
7701(a)(19)(C)(xi) any regular or residual interest in a REMIC, but only in the proportion which
the assets of such REMIC consist of property described in any of the preceding clauses of
this subparagraph; except that if 95 percent or more of the assets of such REMIC are assets
described in clauses (i) through (x), the entire interest in the REMIC shall qualify.
At the election of the taxpayer, the percentage specified in this subparagraph shall be applied on the
basis of the average assets outstanding during the taxable year, in lieu of the close of the taxable
year, computed under regulations prescribed by the Secretary. For purposes of clause (v), if a
multifamily structure securing a loan is used in part for nonresidential purposes, the entire loan is
deemed a residential real property loan if the planned residential use exceeds 80 percent of the
property's planned use (determined as of the time the loan is made). For purposes of clause (v),
loans made to finance the acquisition or development of land shall be deemed to be loans secured
by an interest in residential real property if, under regulations prescribed by the Secretary, there is
reasonable assurance that the property will become residential real property within a period of 3 years
from the date of acquisition of such land; but this sentence shall not apply for any taxable year unless,
within such 3-year period, such land becomes residential real property. For purposes of determining
whether any interest in a REMIC qualifies under clause (xi), any regular interest in another REMIC
held by such REMIC shall be treated as a loan described in a preceding clause under principles
similar to the principles of clause (xi); except that, if such REMIC's are part of a tiered structure, they
shall be treated as 1 REMIC for purposes of clause (xi).

39
7701(a)(20) EMPLOYEE.— For the purpose of applying the provisions of section 79 with respect to
group-term life insurance purchased for employees, for the purpose of applying the provisions of
sections 104, 105, and 106 with respect to accident and health insurance or accident and health
plans, and for the purpose of applying the provisions of subtitle A with respect to contributions to or
under a stock bonus, pension, profit-sharing, or annuity plan, and with respect to distributions under
such a plan, or by a trust forming part of such a plan, and for purposes of applying section 125 with
respect to cafeteria plans, the term “employee” shall include a full-time life insurance salesman who
is considered an employee for the purpose of chapter 21, or in the case of services performed before
January 1, 1951, who would be considered an employee if his services were performed during 1951.
7701(a)(21) LEVY.— The term “levy” includes the power of distraint and seizure by any means.
7701(a)(22) ATTORNEY GENERAL.— The term “Attorney General” means the Attorney General of the
United States.
7701(a)(23) TAXABLE YEAR.— The term “taxable year” means the calendar year, or the fiscal year
ending during such calendar year, upon the basis of which the taxable income is computed under
subtitle A. “Taxable year” means, in the case of a return made for a fractional part of a year under the
provisions of subtitle A or under regulations prescribed by the Secretary, the period for which such
return is made.
7701(a)(24) FISCAL YEAR.— The term “fiscal year” means an accounting period of 12 months ending
on the last day of any month other than December.
7701(a)(25) PAID OR INCURRED, PAID OR ACCRUED.— The terms “paid or incurred” and “paid or accrued”
shall be construed according to the method of accounting upon the basis of which the taxable income
is computed under subtitle A.
7701(a)(26) TRADE OR BUSINESS.— The term “trade or business” includes the performance of the
functions of a public office.
7701(a)(27) TAX COURT.— The term “Tax Court” means the United States Tax Court.
7701(a)(28) OTHER TERMS.— Any term used in this subtitle with respect to the application of, or in
connection with, the provisions of any other subtitle of this title shall have the same meaning as in
such provisions.
7701(a)(29) INTERNAL REVENUE CODE.— The term “Internal Revenue Code of 1986” means this title,
and the term “Internal Revenue Code of 1939” means the Internal Revenue Code enacted February
10, 1939, as amended.
7701(a)(30) UNITED STATES PERSON.— The term “United States person” means—
7701(a)(30)(A) a citizen or resident of the United States,
7701(a)(30)(B) a domestic partnership,
7701(a)(30)(C) a domestic corporation,
7701(a)(30)(D) any estate (other than a foreign estate, within the meaning of paragraph (31)), and
7701(a)(30)(E) any trust if—
7701(a)(30)(E)(i) a court within the United States is able to exercise primary supervision over
the administration of the trust, and
7701(a)(30)(E)(ii) one or more United States persons have the authority to control all
substantial decisions of the trust.

40
7701(a)(31) FOREIGN ESTATE OR TRUST.—
7701(a)(31)(A) FOREIGN ESTATE.— The term “foreign estate” means an estate the income of which,
from sources without the United States which is not effectively connected with the conduct of a
trade or business within the United States, is not includible in gross income under subtitle A.
7701(a)(31)(B) FOREIGN TRUST.— The term “foreign trust” means any trust other than a trust
described in subparagraph (E) of paragraph (30).
7701(a)(32) COOPERATIVE BANK.— The term “cooperative bank” means an institution without capital
stock organized and operated for mutual purposes and without profit, which—
7701(a)(32)(A) either—
7701(a)(32)(A)(i) is an insured institution within the meaning of section 401(a) of the National
Housing Act (12 U. S. C., sec. 1724(a)), or
7701(a)(32)(A)(ii) is subject by law to supervision and examination by State or Federal

authority having supervision over such institutions, and
7701(a)(32)(B) meets the requirements of subparagraphs (B) and (C) of paragraph (19) of this
subsection (relating to definition of domestic building and loan association).
In determining whether an institution meets the requirements referred to in subparagraph (B) of this
paragraph, any reference to an association or to a domestic building and loan association contained in
paragraph (19) shall be deemed to be a reference to such institution.
7701(a)(33) REGULATED PUBLIC UTILITY.— The term “regulated public utility” means—
7701(a)(33)(A) A corporation engaged in the furnishing or sale of—
7701(a)(33)(A)(i) electric energy, gas, water, or sewerage disposal services, or
7701(a)(33)(A)(ii) transportation (not included in subparagraph (C)) on an intrastate, suburban,

municipal, or interurban electric railroad, on an intrastate, municipal, or suburban trackless
trolley system, or on a municipal or suburban bus system, or
7701(a)(33)(A)(iii) transportation (not included in clause (ii)) by motor vehicle—
if the rates for such furnishing or sale, as the case may be, have been established or approved
by a State or political subdivision thereof, by an agency or instrumentality of the United States, by
a public service or public utility commission or other similar body of the District of Columbia or of
any State or political subdivision thereof, or by a foreign country or an agency or instrumentality or
political subdivision thereof.
7701(a)(33)(B) A corporation engaged as a common carrier in the furnishing or sale of

transportation of gas by pipe line, if subject to the jurisdiction of the Federal Energy Regulatory
Commission.
7701(a)(33)(C) A corporation engaged as a common carrier (i) in the furnishing or sale of

transportation by railroad, if subject to the jurisdiction of the Surface Transportation Board, or (ii)
in the furnishing or sale of transportation of oil or other petroleum products (including shale oil)
by pipe line, if subject to the jurisdiction of the Federal Energy Regulatory Commission or if the
rates for such furnishing or sale are subject to the jurisdiction of a public service or public utility
commission or other similar body of the District of Columbia or of any State.
7701(a)(33)(D) A corporation engaged in the furnishing or sale of telephone or telegraph service,

if the rates for such furnishing or sale meet the requirements of subparagraph (A).

41
7701(a)(33)(E) A corporation engaged in the furnishing or sale of transportation as a common
carrier by air, subject to the jurisdiction of the Secretary of Transportation.
7701(a)(33)(F) A corporation engaged in the furnishing or sale of transportation by a water carrier

subject to jurisdiction under subchapter II of chapter 135 of title 49.
7701(a)(33)(G) A rail carrier subject to part A of subtitle IV of title 49, if (i) substantially all of its
railroad properties have been leased to another such railroad corporation or corporations by an
agreement or agreements entered into before January 1, 1954, (ii) each lease is for a term of more
than 20 years, and (iii) at least 80 percent or more of its gross income (computed without regard
to dividends and capital gains and losses) for the taxable year is derived from such leases and
from sources described in subparagraphs (A) through (F), inclusive. For purposes of the preceding
sentence, an agreement for lease of railroad properties entered into before January 1, 1954, shall
be considered to be a lease including such term as the total number of years of such agreement
may, unless sooner terminated, be renewed or continued under the terms of the agreement, and
any such renewal or continuance under such agreement shall be considered part of the lease
entered into before January 1, 1954.
7701(a)(33)(H) A common parent corporation which is a common carrier by railroad subject to

part A of subtitle IV of title 49 if at least 80 percent of its gross income (computed without regard
to capital gains or losses) is derived directly or indirectly from sources described in subparagraphs
(A) through (F), inclusive. For purposes of the preceding sentence, dividends and interest, and
income from leases described in subparagraph (G), received from a regulated public utility shall
be considered as derived from sources described in subparagraphs (A) through (F), inclusive, if
the regulated public utility is a member of an affiliated group (as defined in section 1504) which
includes the common parent corporation.
The term “regulated public utility” does not (except as provided in subparagraphs (G) and (H)) include
a corporation described in subparagraphs (A) through (F), inclusive, unless 80 percent or more of its
gross income (computed without regard to dividends and capital gains and losses) for the taxable
year is derived from sources described in subparagraphs (A) through (F), inclusive. If the taxpayer
establishes to the satisfaction of the Secretary that (i) its revenue from regulated rates described
in subparagraph (A) or (D) and its revenue derived from unregulated rates are derived from the
operation of a single interconnected and coordinated system or from the operation of more than one
such system, and (ii) the unregulated rates have been and are substantially as favorable to users
and consumers as are the regulated rates, then such revenue from such unregulated rates shall be
considered, for purposes of the preceding sentence, as income derived from sources described in
subparagraph (A) or (D).
7701(a)(34) [Repealed.]
7701(a)(35) ENROLLED ACTUARY.— The term “enrolled actuary” means a person who is enrolled by the
Joint Board for the Enrollment of Actuaries established under subtitle C of the title III of the Employee
Retirement Income Security Act of 1974.
7701(a)(36) TAX RETURN PREPARER.—

7701(a)(36)(A) IN GENERAL.— The term “tax return preparer” means any person who prepares for
compensation, or who employs one or more persons to prepare for compensation, any return of
tax imposed by this title or any claim for refund of tax imposed by this title. For purposes of the
preceding sentence, the preparation of a substantial portion of a return or claim for refund shall be
treated as if it were the preparation of such return or claim for refund.
7701(a)(36)(B) EXCEPTIONS.— A person shall not be an [sic] “tax return preparer” merely because
such person—
7701(a)(36)(B)(i) furnishes typing, reproducing, or other mechanical assistance,

42
7701(a)(36)(B)(ii) prepares a return or claim for refund of the employer (or of an officer or
employee of the employer) by whom he is regularly and continuously employed,
7701(a)(36)(B)(iii) prepares as a fiduciary a return or claim for refund for any person, or
7701(a)(36)(B)(iv) prepares a claim for refund for a taxpayer in response to any notice
of deficiency issued to such taxpayer or in response to any waiver of restriction after the
commencement of an audit of such taxpayer or another taxpayer if a determination in such audit
of such other taxpayer directly or indirectly affects the tax liability of such taxpayer.
7701(a)(37) INDIVIDUAL RETIREMENT PLAN.— The term “individual retirement plan” means—
7701(a)(37)(A) an individual retirement account described in section 408(a), and
7701(a)(37)(B) an individual retirement annuity described in section 408(b).
7701(a)(38) JOINT RETURN.— The term “joint return” means a single return made jointly under section
6013 by a husband and wife.
7701(a)(39) PERSONS RESIDING OUTSIDE UNITED STATES.— If any citizen or resident of the United States
does not reside in (and is not found in) any United States judicial district, such citizen or resident shall
be treated as residing in the District of Columbia for purposes of any provision of this title relating to—
7701(a)(39)(A) jurisdiction of courts, or
7701(a)(39)(B) enforcement of summons.
7701(a)(40) INDIAN TRIBAL GOVERNMENT.—

7701(a)(40)(A) In general.— The term “Indian tribal government” means the governing body of
any tribe, band, community, village, or group of Indians, or (if applicable) Alaska Natives, which
is determined by the Secretary, after consultation with the Secretary of the Interior, to exercise
governmental functions.
7701(a)(40)(B) SPECIAL RULE FOR ALASKA NATIVES.— No determination under subparagraph

(A) with respect to Alaska Natives shall grant or defer any status or powers other than those
enumerated in section 7871. Nothing in the Indian Tribal Governmental Tax Status Act of 1982,
or in the amendments made thereby, shall validate or invalidate any claim by Alaska Natives of
sovereign authority over lands or people.
7701(a)(41) TIN.— The term “TIN” means the identifying number assigned to a person under section
6109.
7701(a)(42) SUBSTITUTED BASIS PROPERTY.— The term “substituted basis property” means property
which is—
7701(a)(42)(A) transferred basis property, or
7701(a)(42)(B) exchanged basis property.
7701(a)(43) TRANSFERRED BASIS PROPERTY.— The term “transferred basis property” means property
having a basis determined under any provision of subtitle A (or under any corresponding provision of
prior income tax law) providing that the basis shall be determined in whole or in part by reference to
the basis in the hands of the donor, grantor, or other transferor.
7701(a)(44) EXCHANGED BASIS PROPERTY.— The term “exchanged basis property” means property
having a basis determined under any provision of subtitle A (or under any corresponding provision of
prior income tax law) providing that the basis shall be determined in whole or in part by reference to
other property held at any time by the person for whom the basis is to be determined.

43
7701(a)(45) NONRECOGNITION TRANSACTION.— The term “nonrecognition transaction” means any
disposition of property in a transaction in which gain or loss is not recognized in whole or in part for
purposes of subtitle A.
7701(a)(46) DETERMINATION OF WHETHER THERE IS A COLLECTIVE BARGAINING AGREEMENT.— In

determining whether there is a collective bargaining agreement between employee representatives
and 1 or more employers, the term “employee representatives” shall not include any organization more
than one-half of the members of which are employees who are owners, officers, or executives of the
employer. An agreement shall not be treated as a collective bargaining agreement unless it is a bona
fide agreement between bona fide employee representatives and 1 or more employers.
Code Sec. 7701(a)(47) was added by P.L. 107-16, applicable to estates of decedents
dying after December 31, 2009. P.L. 111-312 removed Code Sec. 7701(a)(47),
applicable to estates of decedents dying, and transfers made, after December 31,
2009, but see P.L. 111-312, §301(c), in the amendment notes. For sunset provision,
see P.L. 107-16, §901 [as amended by P.L. 111-312], in the amendment notes.
7701(a)(47) EXECUTOR.— The term “executor” means the executor or administrator of the decedent,
or, if there is no executor or administrator appointed, qualified, and acting within the United States,
then any person in actual or constructive possession of any property of the decedent.
7701(a)(48) OFF-HIGHWAY VEHICLES.—

7701(a)(48)(A) OFF-HIGHWAY TRANSPORTATION VEHICLES.—
7701(a)(48)(A)(i) IN GENERAL.— A vehicle shall not be treated as a highway vehicle if such
vehicle is specially designed for the primary function of transporting a particular type of load
other than over the public highway and because of this special design such vehicle's capability
to transport a load over the public highway is substantially limited or impaired.
7701(a)(48)(A)(ii) DETERMINATION OF VEHICLE'S DESIGN..— For purposes of clause (i), a vehicle's

design is determined solely on the basis of its physical characteristics.
7701(a)(48)(A)(iii) DETERMINATION OF SUBSTANTIAL LIMITATION OR IMPAIRMENT.— For purposes

of clause (i), in determining whether substantial limitation or impairment exists, account may be
taken of factors such as the size of the vehicle, whether such vehicle is subject to the licensing,
safety, and other requirements applicable to highway vehicles, and whether such vehicle can
transport a load at a sustained speed of at least 25 miles per hour. It is immaterial that a vehicle
can transport a greater load off the public highway than such vehicle is permitted to transport
over the public highway.
7701(a)(48)(B) NONTRANSPORTATION TRAILERS AND SEMITRAILERS.— A trailer or semitrailer shall not

be treated as a highway vehicle if it is specially designed to function only as an enclosed stationary
shelter for the carrying on of an offhighway function at an off-highway site.
7701(a)(49) QUALIFIED BLOOD COLLECTOR ORGANIZATION.— The term "qualified blood collector
organization" means an organization which is—
7701(a)(49)(A) described in section 501(c)(3) and exempt from tax under section 501(a),
7701(a)(49)(B) primarily engaged in the activity of the collection of human blood,
7701(a)(49)(C) registered with the Secretary for purposes of excise tax exemptions, and
7701(a)(49)(D) registered by the Food and Drug Administration to collect blood.
7701(a)(50) TERMINATION OF UNITED STATES CITIZENSHIP.—

44
7701(a)(50)(A) IN GENERAL.— An individual shall not cease to be treated as a United States citizen
before the date on which the individual's citizenship is treated as relinquished under section
877A(g)(4).
7701(a)(50)(B) DUAL CITIZENS.— Under regulations prescribed by the Secretary, subparagraph (A)
shall not apply to an individual who became at birth a citizen of the United States and a citizen of
another country.
7701(b) DEFINITION OF RESIDENT ALIEN AND NONRESIDENT ALIEN.—

7701(b)(1) IN GENERAL.— For purposes of this title (other than subtitle B)—
7701(b)(1)(A) RESIDENT ALIEN.— An alien individual shall be treated as a resident of the United
States with respect to any calendar year if (and only if) such individual meets the requirements of
clause (i), (ii), or (iii):
7701(b)(1)(A)(i) LAWFULLY ADMITTED FOR PERMANENT RESIDENCE.— Such individual is a lawful

permanent resident of the United States at any time during such calendar year.
7701(b)(1)(A)(ii) SUBSTANTIAL PRESENCE TEST.— Such individual meets the substantial

presence test of paragraph (3).
7701(b)(1)(A)(iii) FIRST YEAR ELECTION.— Such individual makes the election provided in
paragraph (4).
7701(b)(1)(B) NONRESIDENT ALIEN.— An individual is a nonresident alien if such individual is

neither a citizen of the United States nor a resident of the United States (within the meaning of
subparagraph (A)).
7701(b)(2) SPECIAL RULES FOR FIRST AND LAST YEAR OF RESIDENCY.—

7701(b)(2)(A) FIRST YEAR OF RESIDENCY.—
7701(b)(2)(A)(i) IN GENERAL.— If an alien individual is a resident of the United States under
paragraph (1)(A) with respect to any calendar year, but was not a resident of the United States
at any time during the preceding calendar year, such alien individual shall be treated as a
resident of the United States only for the portion of such calendar year which begins on the
residency starting date.
7701(b)(2)(A)(ii) RESIDENCY STARTING DATE FOR INDIVIDUALS LAWFULLY ADMITTED FOR PERMANENT
RESIDENCE.— In the case of an individual who is a lawfully permanent resident of the United
States at any time during the calendar year, but does not meet the substantial presence test of
paragraph (3), the residency starting date shall be the first day in such calendar year on which
he was present in the United States while a lawful permanent resident of the United States.
7701(b)(2)(A)(iii) RESIDENCY STARTING DATE FOR INDIVIDUALS MEETING SUBSTANTIAL PRESENCE

TEST.— In the case of an individual who meets the substantial presence test of paragraph (3)
with respect to any calendar year, the residency starting date shall be the first day during such
calendar year on which the individual is present in the United States.
7701(b)(2)(A)(iv) RESIDENCY STARTING DATE FOR INDIVIDUALS MAKING FIRST YEAR ELECTION.— In
the case of an individual who makes the election provided by paragraph (4) with respect to any
calendar year, the residency starting date shall be the 1st day during such calendar year on
which the individual is treated as a resident of the United States under that paragraph.
7701(b)(2)(B) LAST YEAR OF RESIDENCY.— An alien individual shall not be treated as a resident of
the United States during a portion of any calendar year if—

45
7701(b)(2)(B)(i) such portion is after the last day in such calendar year on which the individual
was present in the United States (or, in the case of an individual described in paragraph (1)(A)
(i), the last day on which he was so described),
7701(b)(2)(B)(ii) during such portion the individual has a closer connection to a foreign country
than to the United States, and
7701(b)(2)(B)(iii) the individual is not a resident of the United States at any time during the
next calendar year.
7701(b)(2)(C) CERTAIN NOMINAL PRESENCE DISREGARDED.—

7701(b)(2)(C)(i) IN GENERAL.— For purposes of subparagraphs (A)(iii) and (B), an individual
shall not be treated as present in the United States during any period for which the individual
establishes that he has a closer connection to a foreign country than to the United States.
7701(b)(2)(C)(ii) NOT MORE THAN 10 DAYS DISREGARDED.— Clause (i) shall not apply to more than
10 days on which the individual is present in the United States.
7701(b)(3) SUBSTANTIAL PRESENCE TEST.—

7701(b)(3)(A) IN GENERAL.— Except as otherwise provided in this paragraph, an individual meets
the substantial presence test of this paragraph with respect to any calendar year (hereinafter in this
subsection referred to as the “current year”) if—
7701(b)(3)(A)(i) such individual was present in the United States on at least 31 days during the
calendar year, and
7701(b)(3)(A)(ii) the sum of the number of days on which such individual was present in the
United States during the current year and the 2 preceding calendar years (when multiplied by
the applicable multiplier determined under the following table) equals or exceeds 183 days:
The applicable
In the case of days in: multiplier is:
Current year ....................................................................................... 1
1st preceding year ............................................................................. 1/3
2nd preceding year ............................................................................ 1/6
7701(b)(3)(B) EXCEPTION WHERE INDIVIDUAL IS PRESENT IN THE UNITED STATES DURING LESS THAN
ONE-HALF OF CURRENT YEAR AND CLOSER CONNECTION TO FOREIGN COUNTRY IS ESTABLISHED.— An
individual shall not be treated as meeting the substantial presence test of this paragraph with
respect to any current year if—
7701(b)(3)(B)(i) such individual is present in the United States on fewer than 183 days during
the current year, and
7701(b)(3)(B)(ii) it is established that for the current year such individual has a tax home (as
defined in section 911(d)(3) without regard to the second sentence thereof) in a foreign country
and has a closer connection to such foreign country than to the United States.
7701(b)(3)(C) SUBPARAGRAPH (B) NOT TO APPLY IN CERTAIN CASES.— Subparagraph (B) shall not
apply to any individual with respect to any current year if at any time during such year—
7701(b)(3)(C)(i) such individual had an application for adjustment of status pending, or
7701(b)(3)(C)(ii) such individual took other steps to apply for status as a lawful permanent
resident of the United States.

46
7701(b)(3)(D) EXCEPTION FOR EXEMPT INDIVIDUALS OR FOR CERTAIN MEDICAL CONDITIONS.— An
individual shall not be treated as being present in the United States on any day if—
7701(b)(3)(D)(i) such individual is an exempt individual for such day, or
7701(b)(3)(D)(ii) such individual was unable to leave the United States on such day because
of a medical condition which arose while such individual was present in the United States.
7701(b)(4) FIRST-YEAR ELECTION.—

7701(b)(4)(A) An alien individual shall be deemed to meet the requirements of this subparagraph
if such individual—
7701(b)(4)(A)(i) is not a resident of the United States under clause (i) or (ii) of paragraph (1)(A)
with respect to a calendar year (hereinafter referred to as the “election year”),
7701(b)(4)(A)(ii) was not a resident of the United States under paragraph (1)(A) with respect
to the calendar year immediately preceding the election year,
7701(b)(4)(A)(iii) is a resident of the United States under clause (ii) of paragraph (1)(A) with
respect to the calendar year immediately following the election year, and
7701(b)(4)(A)(iv) is both—
7701(b)(4)(A)(iv)(I) present in the United States for a period of at least 31 consecutive days
in the election year, and
7701(b)(4)(A)(iv)(II) present in the United States during the period beginning with the first
day of such 31-day period and ending with the last day of the election year (hereinafter
referred to as the “testing period”) for a number of days equal to or exceeding 75 percent
of the number of days in the testing period (provided that an individual shall be treated for
purposes of this subclause as present in the United States for a number of days during the
testing period not exceeding 5 days in the aggregate, notwithstanding his absence from the
United States on such days).
7701(b)(4)(B) An alien individual who meets the requirements of subparagraph (A) shall, if he so
elects, be treated as a resident of the United States with respect to the election year.
7701(b)(4)(C) An alien individual who makes the election provided by subparagraph (B) shall be
treated as a resident of the United States for the portion of the election year which begins on the
1st day of the earliest testing period during such year with respect to which the individual meets the
requirements of clause (iv) of subparagraph (A).
7701(b)(4)(D) The rules of subparagraph (D)(i) of paragraph (3) shall apply for purposes of
determining an individual's presence in the United States under this paragraph.
7701(b)(4)(E) An election under subparagraph (B) shall be made on the individual's tax return for
the election year, provided that such election may not be made before the individual has met the
substantial presence test of paragraph (3) with respect to the calendar year immediately following
the election year.
7701(b)(4)(F) An election once made under subparagraph (B) remains in effect for the election
year, unless revoked with the consent of the Secretary.
7701(b)(5) EXEMPT INDIVIDUAL DEFINED.— For purposes of this subsection—
7701(b)(5)(A) IN GENERAL.— An individual is an exempt individual for any day if, for such day, such
individual is—

47
7701(b)(5)(A)(i) a foreign government-related individual,
7701(b)(5)(A)(ii) a teacher or trainee,
7701(b)(5)(A)(iii) a student, or
7701(b)(5)(A)(iv) a professional athlete who is temporarily in the United States to compete in a

charitable sports event described in section 274(l)(1)(B).
7701(b)(5)(B) FOREIGN GOVERNMENT-RELATED INDIVIDUAL.— The term “foreign government-related

individual” means any individual temporarily present in the United States by reason of—
7701(b)(5)(B)(i) diplomatic status, or a visa which the Secretary (after consultation with the
Secretary of State) determines represents full-time diplomatic or consular status for purposes of
this subsection,
7701(b)(5)(B)(ii) being a full-time employee of an international organization, or
7701(b)(5)(B)(iii) being a member of the immediate family of an individual described in clause

(i) or (ii).
7701(b)(5)(C) TEACHER OR TRAINEE.— The term “teacher or trainee” means any individual—
7701(b)(5)(C)(i) who is termporarily present in the United States under subparagraph (J) or (Q)
of section 101(15) of the Immigration and Nationality Act (other than as a student), and
7701(b)(5)(C)(ii) who substantially complies with the requirements for being so present.
7701(b)(5)(D) STUDENT.— The term “student” means any individual—
7701(b)(5)(D)(i) who is temporarily present in the United States—
7701(b)(5)(D)(i)(I) under subparagraph (F) or (M) of section 101(15) of the Immigration and
Nationality Act, or
7701(b)(5)(D)(i)(II) as a student under subparagraph (J) or (Q) of such section 101(15), and
7701(b)(5)(D)(ii) who substantially complies with the requirements for being so present.
7701(b)(5)(E) SPECIAL RULES FOR TEACHERS, TRAINEES, AND STUDENTS.—

7701(b)(5)(E)(i) LIMITATION ON TEACHERS AND TRAINEES.— An individual shall not be treated
as an exempt individual by reason of clause (ii) of subparagraph (A) for the current year if,
for any 2 calendar years during the preceding 6 calendar years, such person was an exempt
person under clause (ii) or (iii) of subparagraph (A). In the case of an individual all of whose
compensation is described in section 872(b)(3), the preceding sentence shall be applied by
substituting “4 calendar years” for “2 calendar years”.
7701(b)(5)(E)(ii) LIMITATION ON STUDENTS.— For any calendar year after the 5th calendar
year for which an individual was an exempt individual under clause (ii) or (iii) of subparagraph
(A), such individual shall not be treated as an exempt individual by reason of clause (iii) of
subparagraph (A), unless such individual establishes to the satisfaction of the Secretary that
such individual does not intend to permanently reside in the United States and that such
individual meets the requirements of subparagraph (D)(ii).
7701(b)(6) LAWFUL PERMANENT RESIDENT.— For purposes of this subsection, an individual is a lawful
permanent resident of the United States at any time if—

48
7701(b)(6)(A) such individual has the status of having been lawfully accorded the privilege of
residing permanently in the United States as an immigrant in accordance with the immigration laws,
and
7701(b)(6)(B) such status has not been revoked (and has not been administratively or judicially
determined to have been abandoned).
An individual shall cease to be treated as a lawful permanent resident of the United States if such
individual commences to be treated as a resident of a foreign country under the provisions of a tax
treaty between the United States and the foreign country, does not waive the benefits of such treaty
applicable to residents of the foreign country, and notifies the Secretary of the commencement of such
treatment.
7701(b)(7) PRESENCE IN THE UNITED STATES.— For purposes of this subsection—
7701(b)(7)(A) IN GENERAL.— Except as provided in subparagraph (B), (C), or (D) an individual shall
be treated as present in the United States on any day if such individual is physically present in the
United States at any time during such day.
7701(b)(7)(B) COMMUTERS FROM CANADA OR MEXICO.— If an individual regularly commutes to

employment (or self-employment) in the United States from a place of residence in Canada or
Mexico, such individual shall not be treated as present in the United States on any day during
which he so commutes.
7701(b)(7)(C) TRANSIT BETWEEN 2 FOREIGN POINTS.— If an individual, who is in transit between 2

points outside the United States, is physically present in the United States for less than 24 hours,
such individual shall not be treated as present in the United States on any day during such transit.
7701(b)(7)(D) CREW MEMBERS TEMPORARILY PRESENT.— An individual who is temporarily present

in the United States on any day as a regular member of the crew of a foreign vessel engaged
in transportation between the United States and a foreign country or a possession of the United
States shall not be treated as present in the United States on such day unless such individual
otherwise engages in any trade or business in the United States on such day.
7701(b)(8) ANNUAL STATEMENTS.— The Secretary may prescribe regulations under which an
individual who (but for subparagraph (B) or (D) of paragraph (3)) would meet the substantial presence
test of paragraph (3) is required to submit an annual statement setting forth the basis on which such
individual claims the benefits of subparagraph (B) or (D) of paragraph (3), as the case may be.
7701(b)(9) TAXABLE YEAR.—

7701(b)(9)(A) IN GENERAL.— For purposes of this title, an alien individual who has not established
a taxable year for any prior period shall be treated as having a taxable year which is the calendar
year.
7701(b)(9)(B) FISCAL YEAR TAXPAYER.— If—
7701(b)(9)(B)(i) an individual is treated under paragraph (1) as a resident of the United States
for any calendar year, and
7701(b)(9)(B)(ii) after the application of subparagraph (A), such individual has a taxable year
other than a calendar year,
he shall be treated as a resident of the United States with respect to any portion of a taxable year
which is within such calendar year.
7701(b)(10) COORDINATION WITH SECTION 877.— If—

49
7701(b)(10)(A) an alien individual was treated as a resident of the United States during any
period which includes at least 3 consecutive calendar years (hereinafter referred to as the “initial
residency period”), and
7701(b)(10)(B) such individual ceases to be treated as a resident of the United States but
subsequently becomes a resident of the United States before the close of the 3rd calendar year
beginning after the close of the initial residency period,
such individual shall be taxable for the period after the close of the initial residency period and before
the day on which he subsequently became a resident of the United States in the manner provided in
section 877(b). The preceding sentence shall apply only if the tax imposed pursuant to section 877(b)
exceeds the tax which, without regard to this paragraph, is imposed pursuant to section 871.
7701(b)(11) REGULATIONS.— The Secretary shall prescribe such regulations as may be necessary or
appropriate to carry out the purposes of this subsection.
7701(c) INCLUDES AND INCLUDING.— The terms “includes” and “including” when used in a definition
contained in this title shall not be deemed to exclude other things otherwise within the meaning of the
term defined.
7701(d) COMMONWEALTH OF PUERTO RICO.— Where not otherwise distinctly expressed or manifestly
incompatible with the intent thereof, references in this title to possessions of the United States shall be
treated as also referring to the Commonwealth of Puerto Rico.
7701(e) TREATMENT OF CERTAIN CONTRACTS FOR PROVIDING SERVICES, ETC.— For purposes of chapter 1—
7701(e)(1) IN GENERAL.— A contract which purports to be a service contract shall be treated as a lease
of property if such contract is properly treated as a lease of property, taking into account all relevant
factors including whether or not—
7701(e)(1)(A) the service recipient is in physical possession of the property,
7701(e)(1)(B) the service recipient controls the property,
7701(e)(1)(C) the service recipient has a significant economic or possessory interest in the
property,
7701(e)(1)(D) the service provider does not bear any risk of substantially diminished receipts or
substantially increased expenditures if there is nonperformance under the contract,
7701(e)(1)(E) the service provider does not use the property concurrently to provide significant
services to entities unrelated to the service recipient, and
7701(e)(1)(F) the total contract price does not substantially exceed the rental value of the property
for the contract period.
7701(e)(2) OTHER ARRANGEMENTS.— An arrangement (including a partnership or other pass-thru

entity) which is not described in paragraph (1) shall be treated as a lease if such arrangement is
properly treated as a lease, taking into account all relevant factors including factors similar to those set
forth in paragraph (1).
7701(e)(3) SPECIAL RULES FOR CONTRACTS OR ARRANGEMENTS INVOLVING SOLID

WASTE DISPOSAL, ENERGY, AND CLEAN WATER FACILITIES.—
7701(e)(3)(A) IN GENERAL.— Notwithstanding paragraphs (1) and (2), and except as provided in
paragraph (4), any contract or arrangement between a service provider and a service recipient—
7701(e)(3)(A)(i) with respect to—

50
7701(e)(3)(A)(i)(I) the operation of a qualified solid waste disposal facility,
7701(e)(3)(A)(i)(II) the sale to the service recipient of electrical or thermal energy produced
at a cogeneration or alternative energy facility, or
7701(e)(3)(A)(i)(III) the operation of a water treatment works facility, and
7701(e)(3)(A)(ii) which purports to be a service contract,
shall be treated as a service contract.
7701(e)(3)(B) QUALIFIED SOLID WASTE DISPOSAL FACILITY.— For purposes of subparagraph (A), the
term “qualified solid waste disposal facility” means any facility if such facility provides solid waste
disposal services for residents of part or all of 1 or more governmental units and substantially all of
the solid waste processed at such facility is collected from the general public.
7701(e)(3)(C) COGENERATION FACILITY.— For purposes of subparagraph (A), the term “cogeneration
facility” means a facility which uses the same energy source for the sequential generation of
electrical or mechanical power in combination with steam, heat, or other forms of useful energy.
7701(e)(3)(D) ALTERNATIVE ENERGY FACILITY.— For purposes of subparagraph (A), the term
“alternative energy facility” means a facility for producing electrical or thermal energy if the primary
energy source for the facility is not oil, natural gas, coal, or nuclear power.
7701(e)(3)(E) WATER TREATMENT WORKS FACILITY.— For purposes of subparagraph (A), the term
“water treatment works facility” means any treatment works within the meaning of section 212(2) of
the Federal Water Pollution Control Act.
7701(e)(4) PARAGRAPH (3) NOT TO APPLY IN CERTAIN CASES.—

7701(e)(4)(A) IN GENERAL.— Paragraph (3) shall not apply to any qualified solid waste disposal
facility, cogeneration facility, alternative energy facility, or water treatment works facility used under
a contract or arrangement if—
7701(e)(4)(A)(i) the service recipient (or a related entity) operates such facility,
7701(e)(4)(A)(ii) the service recipient (or a related entity) bears any significant financial burden
if there is nonperformance under the contract or arrangement (other than for reasons beyond
the control of the service provider),
7701(e)(4)(A)(iii) the service recipient (or a related entity) receives any significant financial
benefit if the operating costs of such facility are less than the standards of performance or
operation under the contract or arrangement, or
7701(e)(4)(A)(iv) the service recipient (or a related entity) has an option to purchase, or may
be required to purchase, all or a part of such facility at a fixed and determinable price (other
than for fair market value).
For purposes of this paragraph, the term “related entity” has the same meaning as when used in
section 168(h).
7701(e)(4)(B) SPECIAL RULES FOR APPLICATION OF SUBPARAGRAPH (A) WITH RESPECT TO CERTAIN
RIGHTS AND ALLOCATIONS UNDER THE CONTRACT.— For purposes of subparagraph (A), there shall
not be taken into account—
7701(e)(4)(B)(i) any right of a service recipient to inspect any facility, to exercise any sovereign
power the service recipient may possess, or to act in the event of a breach of contract by the
service provider, or

51
7701(e)(4)(B)(ii) any allocation of any financial burden or benefits in the event of any change
in any law.
7701(e)(4)(C) SPECIAL RULES FOR APPLICATION OF SUBPARAGRAPH (A) IN THE

CASE OF CERTAIN EVENTS.—
7701(e)(4)(C)(i) TEMPORARY SHUT-DOWNS, ETC.— For purposes of clause (ii) of subparagraph
(A), there shall not be taken into account any temporary shut-down of the facility for repairs,
maintenance, or capital improvements, or any financial burden caused by the bankruptcy or
similar financial difficulty of the service provider.
7701(e)(4)(C)(ii) REDUCED COSTS.— For purposes of clause (iii) of subparagraph (A), there
shall not be taken into account any significant financial benefit merely because payments by
the service recipient under the contract or arrangement are decreased by reason of increased
production or efficiency or the recovery of energy or other products.
7701(e)(5) EXCEPTION FOR CERTAIN LOW-INCOME HOUSING.— This subsection shall not apply to any
property described in clause (i), (ii), (iii), or (iv) of section 1250(a)(1)(B) (relating to low-income
housing) if—
7701(e)(5)(A) such property is operated by or for an organization described in paragraph (3) or (4)
of section 501(c), and
7701(e)(5)(B) at least 80 percent of the units in such property are leased to low-income tenants
(within the meaning of section 167(k)(3)(B)) (as in effect on the day before the date of the
enactment of the Revenue Reconciliation Act of 1990).
7701(e)(6) REGULATIONS.— The Secretary may prescribe such regulations as may be necessary or
appropriate to carry out the provisions of this subsection.
7701(f) USE OF RELATED PERSONS OR PASS-THRU ENTITIES.— The Secretary shall prescribe such
regulations as may be necessary or appropriate to prevent the avoidance of those provisions of this title
which deal with—
7701(f)(1) the linking of borrowing to investment, or
7701(f)(2) diminishing risks,
through the use of related persons, pass-thru entities, or other intermediaries.
7701(g) CLARIFICATION OF FAIR MARKET VALUE IN THE CASE OF NONRECOURSE INDEBTEDNESS.— For
purposes of subtitle A, in determining the amount of gain or loss (or deemed gain or loss) with respect to
any property, the fair market value of such property shall be treated as being not less than the amount of
any nonrecourse indebtedness to which such property is subject.
7701(h) MOTOR VEHICLE OPERATING LEASES.—

7701(h)(1) IN GENERAL.— For purposes of this title, in the case of a qualified motor vehicle operating
agreement which contains a terminal rental adjustment clause—
7701(h)(1)(A) such agreement shall be treated as a lease if (but for such terminal rental
adjustment clause) such agreement would be treated as a lease under this title, and
7701(h)(1)(B) the lessee shall not be treated as the owner of the property subject to an
agreement during any period such agreement is in effect.
7701(h)(2) QUALIFIED MOTOR VEHICLE OPERATING AGREEMENT DEFINED.— For purposes of this
subsection—

52
7701(h)(2)(A) IN GENERAL.— The term “qualified motor vehicle operating agreement” means any
agreement with respect to a motor vehicle (including a trailer) which meets the requirements of
subparagraphs (B), (C), and (D) of this paragraph.
7701(h)(2)(B) MINIMUM LIABILITY OF LESSOR.— An agreement meets the requirements of this

subparagraph if under such agreement the sum of—
7701(h)(2)(B)(i) the amount the lessor is personally liable to repay, and
7701(h)(2)(B)(ii) the net fair market value of the lessor's interest in any property pledged as
security for property subject to the agreement,
equals or exceeds all amounts borrowed to finance the acquisition of property subject to the
agreement. There shall not be taken into account under clause (ii) any property pledged which
is property subject to the agreement or property directly or indirectly financed by indebtedness
secured by property subject to the agreement.
7701(h)(2)(C) CERTIFICATION BY LESSEE; NOTICE OF TAX OWNERSHIP.— An agreement meets the

requirements of this subparagraph if such agreement contains a separate written statement
separately signed by the lessee—
7701(h)(2)(C)(i) under which the lessee certifies, under penalty of perjury, that it intends that
more than 50 percent of the use of the property subject to such agreement is to be in a trade or
business of the lessee, and
7701(h)(2)(C)(ii) which clearly and legibly states that the lessee has been advised that it will
not be treated as the owner of the property subject to the agreement for Federal income tax
purposes.
7701(h)(2)(D) LESSOR MUST HAVE NO KNOWLEDGE THAT CERTIFICATION IS FALSE.— An agreement

meets the requirements of this subparagraph if the lessor does not know that the certification
described in subparagraph (C)(i) is false.
7701(h)(3) TERMINAL RENTAL ADJUSTMENT CLAUSE DEFINED.—

7701(h)(3)(A) IN GENERAL.— For purposes of this subsection, the term “terminal rental adjustment
clause” means a provision of an agreement which permits or requires the rental price to be
adjusted upward or downward by reference to the amount realized by the lessor under the
agreement upon sale or other disposition of such property.
7701(h)(3)(B) SPECIAL RULE FOR LESSEE DEALERS.— The term “terminal rental adjustment
clause” also includes a provision of an agreement which requires a lessee who is a dealer in
motor vehicles to purchase the motor vehicle for a predetermined price and then resell such
vehicle where such provision achieves substantially the same results as a provision described in
subparagraph (A).
7701(i) TAXABLE MORTGAGE POOLS.—

7701(i)(1) TREATED AS SEPARATE CORPORATIONS.— A taxable mortgage pool shall be treated as a
separate corporation which may not be treated as an includible corporation with any other corporation
for purposes of section 1501.
7701(i)(2) TAXABLE MORTGAGE POOL DEFINED.— For purposes of this title—
7701(i)(2)(A) IN GENERAL.— Except as otherwise provided in this paragraph, a taxable mortgage

pool is any entity (other than a REMIC) if—

53
7701(i)(2)(A)(i) substantially all of the assets of such entity consists of debt obligations (or
interests therein) and more than 50 percent of such debt obligations (or interests) consists of
real estate mortgages (or interests therein),
7701(i)(2)(A)(ii) such entity is the obligor under debt obligations with 2 or more maturities, and
7701(i)(2)(A)(iii) under the terms of the debt obligations referred to in clause (ii) (or underlying
arrangement), payments on such debt obligations bear a relationship to payments on the debt
obligations (or interests) referred to in clause (i).
7701(i)(2)(B) PORTION OF ENTITIES TREATED AS POOLS.— Any portion of an entity which meets the
definition of subparagraph (A) shall be treated as a taxable mortgage pool.
7701(i)(2)(C) EXCEPTION FOR DOMESTIC BUILDING AND LOAN.— Nothing in this subsection shall be
construed to treat any domestic building and loan association (or portion thereof) as a taxable
mortgage pool.
7701(i)(2)(D) TREATMENT OF CERTAIN EQUITY INTERESTS.— To the extent provided in regulations,

equity interest of varying classes which correspond to maturity classes of debt shall be treated as
debt for purposes of this subsection.
7701(i)(3) TREATMENT OF CERTAIN REIT'S.— If—
7701(i)(3)(A) a real estate investment trust is a taxable mortgage pool, or
7701(i)(3)(B) a qualified REIT subsidiary (as defined in section 856(i)(2)) of a real estate
investment trust is a taxable mortgage pool,
under regulations prescribed by the Secretary, adjustments similar to the adjustments provided in
section 860E(d) shall apply to the shareholders of such real estate investment trust.
7701(j) TAX TREATMENT OF FEDERAL THRIFT SAVINGS FUND.—

7701(j)(1) IN GENERAL.— For purposes of this title—
7701(j)(1)(A) the Thrift Savings Fund shall be treated as a trust described in section 401(a) which
is exempt from taxation under section 501(a);
7701(j)(1)(B) any contribution to, or distribution from, the Thrift Savings Fund shall be treated in
the same manner as contributions to or distributions from such a trust; and
7701(j)(1)(C) subject to section 401(k)(4)(B) and any dollar limitation on the application of section
402(e)(3), contributions to the Thrift Savings Fund shall not be treated as distributed or made
available to an employee or Member nor as a contribution made to the Fund by an employee or
Member merely because the employee or Member has, under the provisions of subchapter III of
chapter 84 of title 5, United States Code, and section 8351 of such title 5, an election whether the
contribution will be made to the Thrift Savings Fund or received by the employee or Member in
cash.
7701(j)(2) NONDISCRIMINATION REQUIREMENTS.— Notwithstanding any other provision of the law, the
Thrift Savings Fund is not subject to the nondiscrimination requirements applicable to arrangements
described in section 401(k) or to matching contributions (as described in section 401(m)), so long as it
meets the requirements of this section.
7701(j)(3) COORDINATION WITH SOCIAL SECURITY ACT.— Paragraph (1) shall not be construed to provide
that any amount of the employee's or Member's basic pay which is contributed to the Thrift Savings
Fund shall not be included in the term “wages” for the purposes of section 209 of the Social Security
Act or section 3121(a) of this title.

54
7701(j)(4) DEFINITIONS.— For purposes of this subsection, the terms “Member”, “employee”, and “Thrift
Savings Fund” shall have the same respective meanings as when used in subchapter III of chapter 84
of title 5, United States Code.
7701(j)(5) COORDINATION WITH OTHER PROVISIONS OF LAW.— No provision of law not contained in this
title shall apply for purposes of determining the treatment under this title of the Thrift Savings Fund or
any contribution to, or distribution from, such Fund.
7701(k) TREATMENT OF CERTAIN AMOUNTS PAID TO CHARITY.— In the case of any payment which, except
for section 501(b) of the Ethics in Government Act of 1978, might be made to any officer or employee
of the Federal Government but which is made instead on behalf of such officer or employee to an
organization described in section 170(c)—
7701(k)(1) such payment shall not be treated as received by such officer or employee for all
purposes of this title and for all purposes of any tax law of a State or political subdivision thereof, and
7701(k)(2) no deduction shall be allowed under any provision of this title (or of any tax law of a State
or political subdivision thereof) to such officer or employee by reason of having such payment made to
such organization.
For purposes of this subsection, a Senator, a Representative in, or a Delegate or Resident Commissioner
to, the Congress shall be treated as an officer or employee of the Federal Government.
7701(l) REGULATIONS RELATING TO CONDUIT ARRANGEMENTS.— The Secretary may prescribe regulations
recharacterizing any multiple-party financing transaction as a transaction directly among any 2 or more
of such parties where the Secretary determines that such recharacterization is appropriate to prevent
avoidance of any tax imposed by this title.
7701(m) DESIGNATION OF CONTRACT MARKETS.— Any designation by the Commodity Futures Trading
Commission of a contract market which could not have been made under the law in effect on the day
before the date of the enactment of the Commodity Futures Modernization Act of 2000 shall apply for
purposes of this title except to the extent provided in regulations prescribed by the Secretary.
7701(n) CONVENTION OR ASSOCIATION OF CHURCHES.— For purposes of this title, any organization which
is otherwise a convention or association of churches shall not fail to so qualify merely because the
membership of such organization includes individuals as well as churches or because individuals have
voting rights in such organization.
7701(o) CLARIFICATION OF ECONOMIC SUBSTANCE DOCTRINE.—

7701(o)(1) APPLICATION OF DOCTRINE .— In the case of any transaction to which the economic
substance doctrine is relevant, such transaction shall be treated as having economic substance only if
—
7701(o)(1)(A) the transaction changes in a meaningful way (apart from Federal income tax
effects) the taxpayer's economic position, and
7701(o)(1)(B) the taxpayer has a substantial purpose (apart from Federal income tax effects) for
entering into such transaction.
7701(o)(2) SPECIAL RULE WHERE TAXPAYER RELIES ON PROFIT POTENTIAL.—

7701(o)(2)(A) IN GENERAL .— The potential for profit of a transaction shall be taken into account in
determining whether the requirements of subparagraphs (A) and (B) of paragraph (1) are met with
respect to the transaction only if the present value of the reasonably expected pre-tax profit from
the transaction is substantial in relation to the present value of the expected net tax benefits that
would be allowed if the transaction were respected.

55
7701(o)(2)(B) TREATMENT OF FEES AND FOREIGN TAXES .— Fees and other transaction expenses
shall be taken into account as expenses in determining pre-tax profit under subparagraph (A). The
Secretary shall issue regulations requiring foreign taxes to be treated as expenses in determining
pre-tax profit in appropriate cases.
7701(o)(3) STATE AND LOCAL TAX BENEFITS .— For purposes of paragraph (1), any State or local
income tax effect which is related to a Federal income tax effect shall be treated in the same manner
as a Federal income tax effect.
7701(o)(4) FINANCIAL ACCOUNTING BENEFITS .— For purposes of paragraph (1)(B), achieving a

financial accounting benefit shall not be taken into account as a purpose for entering into a transaction
if the origin of such financial accounting benefit is a reduction of Federal income tax.
7701(o)(5) DEFINITIONS AND SPECIAL RULES .— For purposes of this subsection—
7701(o)(5)(A) ECONOMIC SUBSTANCE DOCTRINE .— The term "economic substance doctrine" means
the common law doctrine under which tax benefits under subtitle A with respect to a transaction are
not allowable if the transaction does not have economic substance or lacks a business purpose.
7701(o)(5)(B) EXCEPTION FOR PERSONAL TRANSACTIONS OF INDIVIDUALS .— In the case of an

individual, paragraph (1) shall apply only to transactions entered into in connection with a trade or
business or an activity engaged in for the production of income.
7701(o)(5)(C) DETERMINATION OF APPLICATION OF DOCTRINE NOT AFFECTED .— The determination of

whether the economic substance doctrine is relevant to a transaction shall be made in the same
manner as if this subsection had never been enacted.
7701(o)(5)(D) TRANSACTION .— The term "transaction" includes a series of transactions.
7701(p) CROSS REFERENCES.—

7701(p)(1) OTHER DEFINITIONS.—
For other definitions, see the following sections of Title 1 of the United States Code:
7701(p)(1)(1) Singular as including plural, section 1.
7701(p)(1)(2) Plural as including singular, section 1.
7701(p)(1)(3) Masculine as including feminine, section 1.
7701(p)(1)(4) Officer, section 1.
7701(p)(1)(5) Oath as including affirmation, section 1.
7701(p)(1)(6) County as including parish, section 2.
7701(p)(1)(7) Vessel as including all means of water transportation, section 3.
7701(p)(1)(8) Vehicle as including all means of land transportation, section 4.
7701(p)(1)(9) Company or association as including successors and assigns, section 5.
7701(p)(2) EFFECT OF CROSS REFERENCES.—

For effect of cross references in this title, see section 7806(a).

56
TERMS DEFINED.
761(a) PARTNERSHIP.— For purposes of this subtitle, the term “partnership” includes a syndicate, group,
pool, joint venture or other unincorporated organization through or by means of which any business,
financial operation, or venture is carried on, and which is not, within the meaning of this title [subtitle], a
corporation or a trust or estate. Under regulations the Secretary may, at the election of all the members
of an unincorporated organization, exclude such organization from the application of all or part of this
subchapter, if it is availed of—
761(a)(1) for investment purposes only and not for the active conduct of a business,
761(a)(2) for the joint production, extraction, or use of property, but not for the purpose of selling
services or property produced or extracted, or
761(a)(3) by dealers in securities for a short period for the purpose of underwriting, selling, or
distributing a particular issue of securities,
if the income of the members of the organization may be adequately determined without the computation
of partnership taxable income.
761(b) PARTNER.— For purposes of this subtitle, the term “partner” means a member of a partnership.
761(c) PARTNERSHIP AGREEMENT.— For purposes of this subchapter, a partnership agreement includes
any modifications of the partnership agreement made prior to, or at, the time prescribed by law for the
filing of the partnership return for the taxable year (not including extensions) which are agreed to by
all the partners, or which are adopted in such other manner as may be provided by the partnership
agreement.
761(d) LIQUIDATION OF A PARTNER'S INTEREST.— For purposes of this subchapter, the term “liquidation of
a partner's interest” means the termination of a partner's entire interest in a partnership by means of a
distribution, or a series of distributions, to the partner by the partnership.
761(e) DISTRIBUTIONS OF PARTNERSHIP INTERESTS TREATED AS EXCHANGES.— Except as otherwise

provided in regulations, for purposes of—
761(e)(1) section 708 (relating to continuation of partnership),
761(e)(2) section 743 (relating to optional adjustment to basis of partnership property), and
761(e)(3) any other provision of this subchapter specified in regulations prescribed by the Secretary,
any distribution of an interest in a partnership (not otherwise treated as an exchange) shall be treated
as an exchange.
761(f) QUALIFIED JOINT VENTURE.—

761(f)(1) IN GENERAL.— In the case of a qualified joint venture conducted by a husband and wife who
file a joint return for the taxable year, for purposes of this title—
761(f)(1)(A) such joint venture shall not be treated as a partnership,
761(f)(1)(B) all items of income, gain, loss, deduction, and credit shall be divided between the
spouses in accordance with their respective interests in the venture, and
761(f)(1)(C) each spouse shall take into account such spouse’s respective share of such items as
if they were attributable to a trade or business conducted by such spouse as a sole proprietor.

57
761(f)(2) QUALIFIED JOINT VENTURE.— For purposes of paragraph (1), the term "qualified joint venture"
means any joint venture involving the conduct of a trade or business if—
761(f)(2)(A) the only members of such joint venture are a husband and wife,
761(f)(2)(B) both spouses materially participate (within the meaning of section 469(h) without
regard to paragraph (5) thereof) in such trade or business, and
761(f)(2)(C) both spouses elect the application of this subsection.
761(g) CROSS REFERENCE.—

For rules in the case of the sale, exchange, liquidation, or reduction of a partner's interest, see
sections 704(b) and 706(c)(2).

58
Federal Tax Regulations (TRC Version), Regulation, §1.701-2. , Internal
Revenue Service, Anti-abuse rule
Reg. §1.701-2 does not reflect P.L. 105–34.
(a) Intent of subchapter K.— Subchapter K is intended to permit taxpayers to conduct joint business
(including investment) activities through a flexible economic arrangement without incurring an entity-level
tax. Implicit in the intent of subchapter K are the following requirements—
(1) The partnership must be bona fide and each partnership transaction or series of related
transactions (individually or collectively, the transaction) must be entered into for a substantial
business purpose.
(2) The form of each partnership transaction must be respected under substance over form
principles.
(3) Except as otherwise provided in this paragraph (a)(3), the tax consequences under subchapter K
to each partner of partnership operations and of transactions between the partner and the partnership
must accurately reflect the partners' economic agreement and clearly reflect the partner's income
(collectively, proper reflection of income). However, certain provisions of subchapter K and the
regulations thereunder were adopted to promote administrative convenience and other policy
objectives, with the recognition that the application of those provisions to a transaction could, in some
circumstances, produce tax results that do not properly reflect income. Thus, the proper reflection
of income requirement of this paragraph (a)(3) is treated as satisfied with respect to a transaction
that satisfies paragraphs (a)(1) and (2) of this section to the extent that the application of such a
provision to the transaction and the ultimate tax results, taking into account all the relevant facts and
circumstances, are clearly contemplated by that provision. See, for example, paragraph (d) Example 6
of this section (relating to the value-equals-basis rule in §1.704-1(b)(2)(iii)(c)), paragraph (d) Example
9 of this section (relating to the election under section 754 to adjust basis in partnership property), and
paragraph (d) Examples 10 and 11 of this section (relating to the basis in property distributed by a
partnership under section 732). See also, for example, §§1.704-3(e)(1) and 1.752-2(e)(4) (providing
certain de minimis exceptions).
(b) Application of subchapter K rules.— The provisions of subchapter K and the regulations
thereunder must be applied in a manner that is consistent with the intent of subchapter K as set forth in
paragraph (a) of this section (intent of subchapter K). Accordingly, if a partnership is formed or availed
of in connection with a transaction a principal purpose of which is to reduce substantially the present
value of the partners' aggregate federal tax liability in a manner that is inconsistent with the intent of
subchapter K, the Commissioner can recast the transaction for federal tax purposes, as appropriate to
achieve tax results that are consistent with the intent of subchapter K, in light of the applicable statutory
and regulatory provisions and the pertinent facts and circumstances. Thus, even though the transaction
may fall within the literal words of a particular statutory or regulatory provision, the Commissioner can
determine, based on the particular facts and circumstances, that to achieve tax results that are consistent
with the intent of subchapter K—
(1) The purported partnership should be disregarded in whole or in part, and the partnership's assets
and activities should be considered, in whole or in part, to be owned and conducted, respectively, by
one or more of its purported partners;
(2) One or more of the purported partners of the partnership should not be treated as a partner;
(3) The methods of accounting used by the partnership or a partner should be adjusted to reflect
clearly the partnership's or the partner's income;

59
(4) The partnership's items of income, gain, loss, deduction, or credit should be reallocated; or
(5) The claimed tax treatment should otherwise be adjusted or modified.
(c) Facts and circumstances analysis; factors.— Whether a partnership was formed or availed of
with a principal purpose to reduce substantially the present value of the partners' aggregate federal tax
liability in a manner inconsistent with the intent of subchapter K is determined based on all of the facts
and circumstances, including a comparison of the purported business purpose for a transaction and the
claimed tax benefits resulting from the transaction. The factors set forth below may be indicative, but do
not necessarily establish, that a partnership was used in such a manner. These factors are illustrative
only, and therefore may not be the only factors taken into account in making the determination under
this section. Moreover, the weight given to any factor (whether specified in this paragraph or otherwise)
depends on all the facts and circumstances. The presence or absence of any factor described in this
paragraph does not create a presumption that a partnership was (or was not) used in such a manner.
Factors include:
(1) The present value of the partners' aggregate federal tax liability is substantially less than had the
partners owned the partnership's assets and conducted the partnership's activities directly;
(2) The present value of the partners' aggregate federal tax liability is substantially less than would be
the case if purportedly separate transactions that are designed to achieve a particular end result are
integrated and treated as steps in a single transaction. For example, this analysis may indicate that it
was contemplated that a partner who was necessary to achieve the intended tax results and whose
interest in the partnership was liquidated or disposed of (in whole or in part) would be a partner only
temporarily in order to provide the claimed tax benefits to the remaining partners;
(3) One or more partners who are necessary to achieve the claimed tax results either have
a nominal interest in the partnership, are substantially protected from any risk of loss from the
partnership's activities (through distribution preferences, indemnity or loss guaranty agreements, or
other arrangements), or have little or no participation in the profits from the partnership's activities
other than a preferred return that is in the nature of a payment for the use of capital;
(4) Substantially all of the partners (measured by number or interests in the partnership) are related
(directly or indirectly) to one another;
(5) Partnership items are allocated in compliance with the literal language of §§1.704-1 and 1.704-2
but with results that are inconsistent with the purpose of section 704(b) and those regulations. In this
regard, particular scrutiny will be paid to partnerships in which income or gain is specially allocated to
one or more partners that may be legally or effectively exempt from federal taxation (for example, a
foreign person, an exempt organization, an insolvent taxpayer, or a taxpayer with unused federal tax
attributes such as net operating losses, capital losses, or foreign tax credits);
(6) The benefits and burdens of ownership of property nominally contributed to the partnership are in
substantial part retained (directly or indirectly) by the contributing partner (or a related party); or
(7) The benefits and burdens of ownership of partnership property are in substantial part shifted
(directly or indirectly) to the distributee partner before or after the property is actually distributed to the
distributee partner (or a related party).
(d) Examples.— The following examples illustrate the principles of paragraphs (a), (b), and (c) of
this section. The examples set forth below do not delineate the boundaries of either permissible or
impermissible types of transactions. Further, the addition of any facts or circumstances that are not
specifically set forth in an example (or the deletion of any facts or circumstances) may alter the outcome
of the transaction described in the example. Unless otherwise indicated, parties to the transactions are
not related to one another.
Example 1. Choice of entity; avoidance of entity-level tax; use of partnership consistent with the intent of
subchapter K. (i) A and B form limited partnership PRS to conduct a bona fide business. A, the corporate

60
general partner, has a 1% partnership interest. B, the individual limited partner, has a 99% interest.
PRS is properly classified as a partnership under §§301.7701-2 and 301.7701-3. A and B chose limited
partnership form as a means to provide B with limited liability without subjecting the income from the
business operations to an entity-level tax.
(ii) Subchapter K is intended to permit taxpayers to conduct joint business activity through a flexible
economic arrangement without incurring an entity-level tax. See paragraph (a) of this section. Although
B has retained, indirectly, substantially all of the benefits and burdens of ownership of the money or
property B contributed to PRS (see paragraph (c)(6) of this section), the decision to organize and
conduct business through PRS under these circumstances is consistent with this intent. In addition, on
these facts, the requirements of paragraphs (a)(1), (2), and (3) of this section have been satisfied. The
Commissioner therefore cannot invoke paragraph (b) of this section to recast the transaction.
Example 2. Choice of entity; avoidance of subchapter S shareholder requirements; use of partnership
consistent with the intent of subchapter K. (i) A and B form partnership PRS to conduct a bona fide
business. A is a corporation that has elected to be treated as an S corporation under subchapter S. B
is a nonresident alien. PRS is properly classified as a partnership under §§301.7701-2 and 301.7701-3.
Because section 1361(b) prohibits B from being a shareholder in A, A and B chose partnership form,
rather than admit B as a shareholder in A, as a means to retain the benefits of subchapter S treatment for
A and its shareholders.
economic arrangement without incurring an entity-level tax. See paragraph (a) of this section. The
decision to organize and conduct business through PRS is consistent with this intent. In addition, on
these facts, the requirements of paragraphs (a)(1), (2), and (3) of this section have been satisfied.
Although it may be argued that the form of the partnership transaction should not be respected because
it does not reflect its substance (inasmuch as application of the substance over form doctrine arguably
could result in B being treated as a shareholder of A, thereby invalidating A's subchapter S election), the
facts indicate otherwise. The shareholders of A are subject to tax on their pro rata shares of A's income
(see section 1361 et. seq.), and B is subject to tax on B's distributive share of partnership income (see
sections 871 and 875). Thus, the form in which this arrangement is cast accurately reflects its substance
as a separate partnership and S corporation. The Commissioner therefore cannot invoke paragraph (b) of
this section to recast the transaction.
Example 3. Choice of entity; avoidance of more restrictive foreign tax credit limitation; use of partnership
consistent with the intent of subchapter K. (i) X, a domestic corporation, and Y, a foreign corporation,
form partnership PRS under the laws of foreign Country A to conduct a bona fide joint business. X and
Y each owns a 50% interest in PRS. PRS is properly classified as a partnership under §§301.7701-2
and 301.7701-3. PRS pays income taxes to Country A. X and Y chose partnership form to enable X to
qualify for a direct foreign tax credit under section 901, with look-through treatment under §1.904-5(h)(1).
Conversely, if PRS were a foreign corporation for U.S. tax purposes, X would be entitled only to indirect
foreign tax credits under section 902 with respect to dividend distributions from PRS. The look-through
rules, however, would not apply, and pursuant to section 904(d)(1)(E) and §1.904-4(g), the dividends and
associated taxes would be subject to a separate foreign tax credit limitation for dividends from PRS, a
noncontrolled section 902 corporation.
decision to organize and conduct business through PRS in order to take advantage of the look-through
rules for foreign tax credit purposes, thereby maximizing X's use of its proper share of foreign taxes paid
by PRS, is consistent with this intent. In addition, on these facts, the requirements of paragraphs (a)(1),
(2), and (3) of this section have been satisfied. The Commissioner therefore cannot invoke paragraph (b)
of this section to recast the transaction.
Example 4. Choice of entity; avoidance of gain recognition under sections 351(e) and 357(c); use of
partnership consistent with the intent of subchapter K. (i) X, ABC, and DEF form limited partnership PRS
to conduct a bona fide real estate management business. PRS is properly classified as a partnership
under §§301.7701-2 and 301.7701-3. X, the general partner, is a newly formed corporation that elects to

61
be treated as a real estate investment trust as defined in section 856. X offers its stock to the public and
contributes substantially all of the proceeds from the public offering to PRS. ABC and DEF, the limited
partners, are existing partnerships with substantial real estate holdings. ABC and DEF contribute all of
their real property assets to PRS, subject to liabilities that exceed their respective aggregate bases in
the real property contributed, and terminate under section 708(b)(1)(A). In addition, some of the former
partners of ABC and DEF each have the right, beginning two years after the formation of PRS, to require
the redemption of their limited partnership interests in PRS in exchange for cash or X stock (at X's option)
equal to the fair market value of their respective interests in PRS at the time of the redemption. These
partners are not compelled, as a legal or practical matter, to exercise their exchange rights at any time.
X, ABC, and DEF chose to form a partnership rather than have ABC and DEF invest directly in X to allow
ABC and DEF to avoid recognition of gain under sections 351(e) and 357(c). Because PRS would not
be treated as an investment company within the meaning of section 351(e) if PRS were incorporated (so
long as it did not elect under section 856), section 721(a) applies to the contribution of the real property to
PRS. See section 721(b).
decision to organize and conduct business through PRS, thereby avoiding the tax consequences that
would have resulted from contributing the existing partnerships' real estate assets to X (by applying the
rules of sections 721, 731, and 752 in lieu of the rules of sections 351(e) and 357(c)), is consistent with
this intent. In addition, on these facts, the requirements of paragraphs (a)(1), (2), and (3) of this section
have been satisfied. Although it may be argued that the form of the transaction should not be respected
because it does not reflect its substance (inasmuch as the present value of the partners' aggregate
federal tax liability is substantially less than would be the case if the transaction were integrated and
treated as a contribution of the encumbered assets by ABC and DEF directly to X, see paragraph (c)
(2) of this section), the facts indicate otherwise. For example, the right of some of the former ABC and
DEF partners after two years to exchange their PRS interests for cash or X stock (at X's option) equal
to the fair market value of their PRS interest at that time would not require that right to be considered
as exercised prior to its actual exercise. Moreover, X may make other real estate investments and other
business decisions, including the decision to raise additional capital for those purposes. Thus, although
it may be likely that some or all of the partners with the right to do so will, at some point, exercise their
exchange rights, and thereby receive either cash or X stock, the form of the transaction as a separate
partnership and real estate investment trust is respected under substance over form principles (see
paragraph (a)(2) of this section). The Commissioner therefore cannot invoke paragraph (b) of this section
to recast the transaction.
Example 5. Special allocations; dividends received deductions; use of partnership consistent with the
intent of subchapter K. (i) Corporations X and Y contribute equal amounts to PRS, a bona fide partnership
formed to make joint investments. PRS pays $100x for a share of common stock of Z, an unrelated
corporation, which has historically paid an annual dividend of $6x. PRS specially allocates the dividend
income on the Z stock to X to the extent of the London Inter-Bank Offered Rate (LIBOR) on the record
date, applied to X's contribution of $50x, and allocates the remainder of the dividend income to Y. All
other items of partnership income and loss are allocated equally between X and Y. The allocations under
the partnership agreement have substantial economic effect within the meaning of §1.704-1(b)(2). In
addition to avoiding an entity-level tax, a principal purpose for the formation of the partnership was to
invest in the Z common stock and to allocate the dividend income from the stock to provide X with a
floating-rate return based on LIBOR, while permitting X and Y to claim the dividends received deduction
under section 243 on the dividends allocated to each of them.
these facts, the requirements of paragraphs (a)(1), (2), and (3) of this section have been satisfied. Section
704(b) and §1.704-1(b)(2) permit income realized by the partnership to be allocated validly to the partners
separate from the partners' respective ownership of the capital to which the allocations relate, provided
that the allocations satisfy both the literal requirements of the statute and regulations and the purpose of

62
those provisions (see paragraph (c)(5) of this section). Section 704(e)(2) is not applicable to the facts of
this example (otherwise, the allocations would be required to be proportionate to the partners' ownership
of contributed capital). The Commissioner therefore cannot invoke paragraph (b) of this section to recast
the transaction.
Example 6. Special allocations; nonrecourse financing; low-income housing credit; use of partnership
consistent with the intent of subchapter K. (i) A and B, high-bracket taxpayers, and X, a corporation
with net operating loss carryforwards, form general partnership PRS to own and operate a building that
qualifies for the low-income housing credit provided by section 42. The project is financed with both cash
contributions from the partners and nonrecourse indebtedness. The partnership agreement provides
for special allocations of income and deductions, including the allocation of all depreciation deductions
attributable to the building to A and B equally in a manner that is reasonably consistent with allocations
that have substantial economic effect of some other significant partnership item attributable to the
building. The section 42 credits are allocated to A and B in accordance with the allocation of depreciation
deductions. PRS's allocations comply with all applicable regulations, including the requirements of
§§1.704-1(b)(2)(ii) (pertaining to economic effect) and 1.704-2(e) (requirements for allocations of
nonrecourse deductions). The nonrecourse indebtedness is validly allocated to the partners under the
rules of §1.752-3, thereby increasing the basis of the partners' respective partnership interests. The basis
increase created by the nonrecourse indebtedness enables A and B to deduct their distributive share of
losses from the partnership (subject to all other applicable limitations under the Internal Revenue Code)
against their nonpartnership income and to apply the credits against their tax liability.
(ii) At a time when the depreciation deductions attributable to the building are not treated as nonrecourse
deductions under §1.704-2(c) (because there is no net increase in partnership minimum gain during
the year), the special allocation of depreciation deductions to A and B has substantial economic effect
because of the value-equals-basis safe harbor contained in §1.704-1(b)(2)(iii)(c) and the fact that A
and B would bear the economic burden of any decline in the value of the building (to the extent of
the partnership's investment in the building), notwithstanding that A and B believe it is unlikely that
the building will decline in value (and, accordingly, they anticipate significant timing benefits through
the special allocation). Moreover, in later years, when the depreciation deductions attributable to the
building are treated as nonrecourse deductions under §1.704-2(c), the special allocation of depreciation
deductions to A and B is considered to be consistent with the partners' interests in the partnership under
§1.704-2(e).
(iii) Subchapter K is intended to permit taxpayers to conduct joint business activity through a flexible
these facts, the requirements of paragraphs (a)(1), (2), and (3) of this section have been satisfied. Section
704(b), §1.704-1(b)(2), and §1.704-2(e) allow partnership items of income, gain, loss, deduction, and
credit to be allocated validly to the partners separate from the partners' respective ownership of the
capital to which the allocations relate, provided that the allocations satisfy both the literal requirements
of the statute and regulations and the purpose of those provisions (see paragraph (c)(5) of this section).
Moreover, the application of the value-equals-basis safe harbor and the provisions of §1.704-2(e) with
respect to the allocations to A and B, and the tax results of the application of those provisions, taking into
account all the facts and circumstances, are clearly contemplated. Accordingly, even if the allocations
would not otherwise be considered to satisfy the proper reflection of income standard in paragraph (a)
(3) of this section, that requirement will be treated as satisfied under these facts. Thus, even though
the partners' aggregate federal tax liability may be substantially less than had the partners owned the
partnership's assets directly (due to X's inability to use its allocable share of the partnership's losses
and credits) (see paragraph (c)(1) of this section), the transaction is not inconsistent with the intent of
subchapter K. The Commissioner therefore cannot invoke paragraph (b) of this section to recast the
transaction.
Example 7. Partner with nominal interest; temporary partner; use of partnership not consistent with the
intent of subchapter K. (i) Pursuant to a plan a principal purpose of which is to generate artificial losses
and thereby shelter from federal taxation a substantial amount of income, X (a foreign corporation), Y
(a domestic corporation), and Z (a promoter) form partnership PRS by contributing $9,000x, $990x,

63
and $10x, respectively, for proportionate interests (90.0%, 9.9%, and 0.1%, respectively) in the capital
and profits of PRS. PRS purchases offshore equipment for $10,000x and validly leases the equipment
offshore for a term representing most of its projected useful life. Shortly thereafter, PRS sells its rights
to receive income under the lease to a third party for $9,000x, and allocates the resulting $9,000x of
income $8,100x to X, $891x to Y, and $9x to Z. PRS thereafter makes a distribution of $9,000x to X
in complete liquidation of its interest. Under §1.704-1(b)(2)(iv)(f), PRS restates the partners' capital
accounts immediately before making the liquidating distribution to X to reflect its assets consisting of the
offshore equipment worth $1,000x and $9,000x in cash. Thus, because the capital accounts immediately
before the distribution reflect assets of $19,000x (that is, the initial capital contributions of $10,000x plus
the $9,000x of income realized from the sale of the lease), PRS allocates a $9,000x book loss among
the partners (for capital account purposes only), resulting in restated capital accounts for X, Y, and
Z of $9,000x, $990x, and $10x, respectively. Thereafter, PRS purchases real property by borrowing
the $8,000x purchase price on a recourse basis, which increases Y's and Z's bases in their respective
partnership interests from $1,881x and $19x, to $9,801x and $99x, respectively (reflecting Y's and Z's
adjusted interests in the partnership of 99% and 1%, respectively). PRS subsequently sells the offshore
equipment, subject to the lease, for $1,000x and allocates the $9,000x tax loss $8,910x to Y and $90x to
Z. Y's and Z's bases in their partnership interests are therefore reduced to $891x and $9x, respectively.
(ii) On these facts, any purported business purpose for the transaction is insignificant in comparison to the
tax benefits that would result if the transaction were respected for federal tax purposes (see paragraph
(c) of this section). Accordingly, the transaction lacks a substantial business purpose (see paragraph
(a)(1) of this section). In addition, factors (1), (2), (3), and (5) of paragraph (c) of this section indicate
that PRS was used with a principal purpose to reduce substantially the partners' tax liability in a manner
inconsistent with the intent of subchapter K. On these facts, PRS is not bona fide (see paragraph (a)(1)
of this section), and the transaction is not respected under applicable substance over form principles
(see paragraph (a)(2) of this section) and does not properly reflect the income of Y (see paragraph (a)
(3) of this section). Thus, PRS has been formed and availed of with a principal purpose of reducing
substantially the present value of the partners' aggregate federal tax liability in a manner inconsistent with
the intent of subchapter K. Therefore (in addition to possibly challenging the transaction under judicial
principles or the validity of the allocations under §1.704-1(b)(2) (see paragraph (h) of this section)), the
Commissioner can recast the transaction as appropriate under paragraph (b) of this section.
Example 8. Plan to duplicate losses through absence of section 754 election; use of partnership not
consistent with the intent of subchapter K. (i) A owns land with a basis of $100x and a fair market value
of $60x. A would like to sell the land to B. A and B devise a plan a principal purpose of which is to permit
the duplication, for a substantial period of time, of the tax benefit of A's built-in loss in the land. To effect
this plan, A, C (A's brother), and W (C's wife) form partnership PRS, to which A contributes the land, and
C and W each contribute $30x. All partnership items are shared in proportion to the partners' respective
contributions to PRS. PRS invests the cash in an investment asset (that is not a marketable security
within the meaning of section 731(c)). PRS also leases the land to B under a three-year lease pursuant
to which B has the option to purchase the land from PRS upon the expiration of the lease for an amount
equal to its fair market value at that time. All lease proceeds received are immediately distributed to the
partners. In year 3, at a time when the values of the partnership's assets have not materially changed,
PRS agrees with A to liquidate A's interest in exchange for the investment asset held by PRS. Under
section 732(b), A's basis in the asset distributed equals $100x, A's basis in A's partnership interest
immediately before the distribution. Shortly thereafter, A sells the investment asset to X, an unrelated
party, recognizing a $40x loss.
(ii) PRS does not make an election under section 754. Accordingly, PRS's basis in the land contributed
by A remains $100x. At the end of year 3, pursuant to the lease option, PRS sells the land to B for $60x
(its fair market value). Thus, PRS recognizes a $40x loss on the sale, which is allocated equally between
C and W. C's and W's bases in their partnership interests are reduced to $10x each pursuant to section
705. Their respective interests are worth $30x each. Thus, upon liquidation of PRS (or their interests
therein), each of C and W will recognize $20x of gain. However, PRS's continued existence defers
recognition of that gain indefinitely. Thus, if this arrangement is respected, C and W duplicate for their
benefit A's built-in loss in the land prior to its contribution to PRS.

64
(iii) On these facts, any purported business purpose for the transaction is insignificant in comparison
to the tax benefits that would result if the transaction were respected for federal tax purposes (see
paragraph (c) of this section). Accordingly, the transaction lacks a substantial business purpose (see
paragraph (a)(1) of this section). In addition, factors (1), (2), and (4) of paragraph (c) of this section
indicate that PRS was used with a principal purpose to reduce substantially the partners' tax liability
in a manner inconsistent with the intent of subchapter K. On these facts, PRS is not bona fide (see
paragraph (a)(1) of this section), and the transaction is not respected under applicable substance over
form principles (see paragraph (a)(2) of this section). Further, the tax consequences to the partners do
not properly reflect the partners' income; and Congress did not contemplate application of section 754 to
partnerships such as PRS, which was formed for a principal purpose of producing a double tax benefit
from a single economic loss (see paragraph (a)(3) of this section). Thus, PRS has been formed and
availed of with a principal purpose of reducing substantially the present value of the partners' aggregate
federal tax liability in a manner inconsistent with the intent of subchapter K. Therefore (in addition to
possibly challenging the transaction under judicial principles or other statutory authorities, such as the
substance over form doctrine or the disguised sale rules under section 707 (see paragraph (h) of this
section)), the Commissioner can recast the transaction as appropriate under paragraph (b) of this section.
Example 9. Absence of section 754 election; use of partnership consistent with the intent of subchapter
K. (i) PRS is a bona fide partnership formed to engage in investment activities with contributions of cash
from each partner. Several years after joining PRS, A, a partner with a capital account balance and basis
in its partnership interest of $100x, wishes to withdraw from PRS. The partnership agreement entitles A to
receive the balance of A's capital account in cash or securities owned by PRS at the time of withdrawal,
as mutually agreed to by A and the managing general partner, P. P and A agree to distribute to A $100x
worth of non-marketable securities (see section 731(c)) in which PRS has an aggregate basis of $20x.
Upon distribution, A's aggregate basis in the securities is $100x under section 732(b). PRS does not
make an election to adjust the basis in its remaining assets under section 754. Thus, PRS's basis in
its remaining assets is unaffected by the distribution. In contrast, if a section 754 election had been in
effect for the year of the distribution, under these facts section 734(b) would have required PRS to adjust
the basis in its remaining assets downward by the amount of the untaxed appreciation in the distributed
property, thus reflecting that gain in PRS's retained assets. In selecting the assets to be distributed, A
and P had a principal purpose to take advantage of the facts that (i) A's basis in the securities will be
determined by reference to A's basis in its partnership interest under section 732(b), and (ii) because
PRS will not make an election under section 754, the remaining partners of PRS will likely enjoy a federal
tax timing advantage (i.e., from the $80x of additional basis in its assets that would have been eliminated
if the section 754 election had been made) that is inconsistent with proper reflection of income under
paragraph (a)(3) of this section.
these facts, the requirements of paragraphs (a)(1) and (2) of this section have been satisfied. The validity
of the tax treatment of this transaction is therefore dependent upon whether the transaction satisfies (or
is treated as satisfying) the proper reflection of income standard under paragraph (a)(3) of this section.
A's basis in the distributed securities is properly determined under section 732(b). The benefit to the
remaining partners is a result of PRS not having made an election under section 754. Subchapter K is
generally intended to produce tax consequences that achieve proper reflection of income. However,
paragraph (a)(3) of this section provides that if the application of a provision of subchapter K produces
tax results that do not properly reflect income, but application of that provision to the transaction and the
ultimate tax results, taking into account all the relevant facts and circumstances, are clearly contemplated
by that provision (and the transaction satisfies the requirements of paragraphs (a)(1) and (2) of this
section), then the application of that provision to the transaction will be treated as satisfying the proper
reflection of income standard.
(iii) In general, the adjustments that would be made if an election under section 754 were in effect are
necessary to minimize distortions between the partners' bases in their partnership interests and the
partnership's basis in its assets following, for example, a distribution to a partner. The electivity of section

65
754 is intended to provide administrative convenience for bona fide partnerships that are engaged
in transactions for a substantial business purpose, by providing those partnerships the option of not
adjusting their bases in their remaining assets following a distribution to a partner. Congress clearly
recognized that if the section 754 election were not made, basis distortions may result. Taking into
account all the facts and circumstances of the transaction, the electivity of section 754 in the context of
the distribution from PRS to A, and the ultimate tax consequences that follow from the failure to make
the election with respect to the transaction, are clearly contemplated by section 754. Thus, the tax
consequences of this transaction will be treated as satisfying the proper reflection of income standard
under paragraph (a)(3) of this section. The Commissioner therefore cannot invoke paragraph (b) of this
section to recast the transaction.
Example 10. Basis adjustments under section 732; use of partnership consistent with the intent of
subchapter K. (i) A, B, and C are partners in partnership PRS, which has for several years been engaged
in substantial bona fide business activities. For valid business reasons, the partners agree that A's
interest in PRS, which has a value and basis of $100x, will be liquidated with the following assets of PRS:
a nondepreciable asset with a value of $60x and a basis to PRS of $40x, and related equipment with
two years of cost recovery remaining and a value and basis to PRS of $40x. Neither asset is described
in section 751 and the transaction is not described in section 732(d). Under section 732(b) and (c),
A's $100x basis in A's partnership interest will be allocated between the nondepreciable asset and the
equipment received in the liquidating distribution in proportion to PRS's bases in those assets, or $50x
to the nondepreciable asset and $50x to the equipment. Thus, A will have a $10x built-in gain in the
nondepreciable asset ($60x value less $50x basis) and a $10x built-in loss in the equipment ($50x basis
less $40x value), which it expects to recover rapidly through cost recovery deductions. In selecting the
assets to be distributed to A, the partners had a principal purpose to take advantage of the fact that A's
basis in the assets will be determined by reference to A's basis in A's partnership interest, thus, in effect,
shifting a portion of A's basis from the nondepreciable asset to the equipment, which in turn would allow
A to recover that portion of its basis more rapidly. This shift provides a federal tax timing advantage to A,
with no offsetting detriment to B or C.
these facts, the requirements of paragraphs (a)(1) and (2) of this section have been satisfied. The
validity of the tax treatment of this transaction is therefore dependent upon whether the transaction
satisfies (or is treated as satisfying) the proper reflection of income standard under paragraph (a)(3)
of this section. Subchapter K is generally intended to produce tax consequences that achieve proper
reflection of income. However, paragraph (a)(3) of this section provides that if the application of a
provision of subchapter K produces tax results that do not properly reflect income, but the application of
that provision to the transaction and the ultimate tax results, taking into account all the relevant facts and
circumstances, are clearly contemplated by that provision (and the transaction satisfies the requirements
of paragraphs (a)(1) and (2) of this section), then the application of that provision to the transaction will be
treated as satisfying the proper reflection of income standard.
(iii) A's basis in the assets distributed to it was determined under section 732(b) and (c). The transaction
does not properly reflect A's income due to the basis distortions caused by the distribution and the shifting
of basis from a nondepreciable to a depreciable asset. However, the basis rules under section 732,
which in some situations can produce tax results that are inconsistent with the proper reflection of income
standard (see paragraph (a)(3) of this section), are intended to provide simplifying administrative rules
for bona fide partnerships that are engaged in transactions with a substantial business purpose. Taking
into account all the facts and circumstances of the transaction, the application of the basis rules under
section 732 to the distribution from PRS to A, and the ultimate tax consequences of the application of
that provision of subchapter K, are clearly contemplated. Thus, the application of section 732 to this
transaction will be treated as satisfying the proper reflection of income standard under paragraph (a)(3)
of this section. The Commissioner therefore cannot invoke paragraph (b) of this section to recast the
transaction.

66
Example 11. Basis adjustments under section 732; plan or arrangement to distort basis allocations
artificially; use of partnership not consistent with the intent of subchapter K. (i) Partnership PRS has for
several years been engaged in the development and management of commercial real estate projects.
X, an unrelated party, desires to acquire undeveloped land owned by PRS, which has a value of $95x
and a basis of $5x. X expects to hold the land indefinitely after its acquisition. Pursuant to a plan a
principal purpose of which is to permit X to acquire and hold the land but nevertheless to recover for
tax purposes a substantial portion of the purchase price for the land, X contributes $100x to PRS for an
interest therein. Subsequently (at a time when the value of the partnership's assets have not materially
changed), PRS distributes to X in liquidation of its interest in PRS the land and another asset with a
value and basis to PRS of $5x. The second asset is an insignificant part of the economic transaction
but is important to achieve the desired tax results. Under section 732(b) and (c), X's $100x basis in
its partnership interest is allocated between the assets distributed to it in proportion to their bases to
PRS, or $50x each. Thereafter, X plans to sell the second asset for its value of $5x, recognizing a loss
of $45x. In this manner, X will, in effect, recover a substantial portion of the purchase price of the land
almost immediately. In selecting the assets to be distributed to X, the partners had a principal purpose to
take advantage of the fact that X's basis in the assets will be determined under section 732(b) and (c),
thus, in effect, shifting a portion of X's basis economically allocable to the land that X intends to retain
to an inconsequential asset that X intends to dispose of quickly. This shift provides a federal tax timing
advantage to X, with no offsetting detriment to any of PRS's other partners.
(ii) Although section 732 recognizes that basis distortions can occur in certain situations, which may
produce tax results that do not satisfy the proper reflection of income standard of paragraph (a)(3)
of this section, the provision is intended only to provide ancillary, simplifying tax results for bona fide
partnership transactions that are engaged in for substantial business purposes. Section 732 is not
intended to serve as the basis for plans or arrangements in which inconsequential or immaterial assets
are included in the distribution with a principal purpose of obtaining substantially favorable tax results by
virtue of the statute's simplifying rules. The transaction does not properly reflect X's income due to the
basis distortions caused by the distribution that result in shifting a significant portion of X's basis to this
inconsequential asset. Moreover, the proper reflection of income standard contained in paragraph (a)(3)
of this section is not treated as satisfied, because, taking into account all the facts and circumstances,
the application of section 732 to this arrangement, and the ultimate tax consequences that would thereby
result, were not clearly contemplated by that provision of subchapter K. In addition, by using a partnership
(if respected), the partners' aggregate federal tax liability would be substantially less than had they owned
the partnership's assets directly (see paragraph (c)(1) of this section). On these facts, PRS has been
formed and availed of with a principal purpose to reduce the taxpayers' aggregate federal tax liability in a
manner that is inconsistent with the intent of subchapter K. Therefore (in addition to possibly challenging
the transaction under applicable judicial principles and statutory authorities, such as the disguised sale
rules under section 707, see paragraph (h) of this section), the Commissioner can recast the transaction
as appropriate under paragraph (b) of this section.
(e) Abuse of entity treatment.

(1) General rule.— The Commissioner can treat a partnership as an aggregate of its partners in whole
or in part as appropriate to carry out the purpose of any provision of the Internal Revenue Code or the
regulations promulgated thereunder.
(2) Clearly contemplated entity treatment.— Paragraph (e)(1) of this section does not apply to the
extent that—
(i) A provision of the Internal Revenue Code or the regulations promulgated thereunder prescribes
the treatment of a partnership as an entity, in whole or in part, and
(ii) That treatment and the ultimate tax results, taking into account all the relevant facts and
circumstances, are clearly contemplated by that provision.
(f) Examples.— The following examples illustrate the principles of paragraph (e) of this section. The
examples set forth below do not delineate the boundaries of either permissible or impermissible types

67
of transactions. Further, the addition of any facts or circumstances that are not specifically set forth in
an example (or the deletion of any facts or circumstances) may alter the outcome of the transaction
described in the example. Unless otherwise indicated, parties to the transactions are not related to one
another.
Example 1. Aggregate treatment of partnership appropriate to carry out purpose of section 163(e)
(5). (i) Corporations X and Y are partners in partnership PRS, which for several years has engaged
in substantial bona fide business activities. As part of these business activities, PRS issues certain
high yield discount obligations to an unrelated third party. Section 163(e)(5) defers (and in certain
circumstances disallows) the interest deductions on this type of obligation if issued by a corporation. PRS,
X, and Y take the position that, because PRS is a partnership and not a corporation, section 163(e)(5) is
not applicable.
(ii) Section 163(e)(5) does not prescribe the treatment of a partnership as an entity for purposes of
that section. The purpose of section 163(e)(5) is to limit corporate-level interest deductions on certain
obligations. The treatment of PRS as an entity could result in a partnership with corporate partners
issuing those obligations and thereby circumventing the purpose of section 163(e)(5), because the
corporate partner would deduct its distributive share of the interest on obligations that would have
been deferred until paid or disallowed had the corporation issued its share of the obligation directly.
Thus, under paragraph (e)(1) of this section, PRS is properly treated as an aggregate of its partners for
purposes of applying section 163(e)(5) (regardless of whether any party had a tax avoidance purpose
in having PRS issue the obligation). Each partner of PRS will therefore be treated as issuing its share of
the obligations for purposes of determining the deductibility of its distributive share of any interest on the
obligations. See also section 163(i)(5)(B).
Example 2. Aggregate treatment of partnership appropriate to carry out purpose of section 1059.
(i) Corporations X and Y are partners in partnership PRS, which for several years has engaged in
substantial bona fide business activities. As part of these business activities, PRS purchases 50 shares
of Corporation Z common stock. Six months later, Corporation Z announces an extraordinary dividend
(within the meaning of section 1059). Section 1059(a) generally provides that if any corporation receives
an extraordinary dividend with respect to any share of stock and the corporation has not held the stock
for more than two years before the dividend announcement date, the basis in the stock held by the
corporation is reduced by the nontaxed portion of the dividend. PRS, X, and Y take the position that
section 1059(a) is not applicable because PRS is a partnership and not a corporation.
(ii) Section 1059(a) does not prescribe the treatment of a partnership as an entity for purposes of that
section. The purpose of section 1059(a) is to limit the benefits of the dividends received deduction with
respect to extraordinary dividends. The treatment of PRS as an entity could result in corporate partners
in the partnership receiving dividends through partnerships in circumvention of the intent of section 1059.
Thus, under paragraph (e)(1) of this section, PRS is properly treated as an aggregate of its partners
for purposes of applying section 1059 (regardless of whether any party had a tax avoidance purpose in
acquiring the Z stock through PRS). Each partner of PRS will therefore be treated as owning its share of
the stock. Accordingly, PRS must make appropriate adjustments to the basis of the Corporation Z stock,
and the partners must also make adjustments to the basis in their respective interests in PRS under
section 705(a)(2)(B). See also section 1059(g)(1).
Example 3. Prescribed entity treatment of partnership; determination of CFC status clearly contemplated.
(i) X, a domestic corporation, and Y, a foreign corporation, intend to conduct a joint venture in foreign
Country A. They form PRS, a bona fide domestic general partnership in which X owns a 40% interest and
Y owns a 60% interest. PRS is properly classified as a partnership under §§301.7701-2 and 301.7701-3.
PRS holds 100% of the voting stock of Z, a Country A entity that is classified as an association taxable as
a corporation for federal tax purposes under §301.7701-2. Z conducts its business operations in Country
A. By investing in Z through a domestic partnership, X seeks to obtain the benefit of the look-through
rules of section 904(d)(3) and, as a result, maximize its ability to claim credits for its proper share of
Country A taxes expected to be incurred by Z.
(ii) Pursuant to sections 957(c) and 7701(a)(30), PRS is a United States person. Therefore, because
it owns 10% or more of the voting stock of Z, PRS satisfies the definition of a U.S. shareholder under

68
section 951(b). Under section 957(a), Z is a controlled foreign corporation (CFC) because more than
50% of the voting power or value of its stock is owned by PRS. Consequently, under section 904(d)(3),
X qualifies for look-through treatment in computing its credit for foreign taxes paid or accrued by Z. In
contrast, if X and Y owned their interests in Z directly, Z would not be a CFC because only 40% of its
stock would be owned by U.S. shareholders. X's credit for foreign taxes paid or accrued by Z in that case
would be subject to a separate foreign tax credit limitation for dividends from Z, a noncontrolled section
902 corporation. See section 904(d)(1)(E) and §1.904-4(g).
(iii) Sections 957(c) and 7701(a)(30) prescribe the treatment of a domestic partnership as an entity
for purposes of defining a U.S. shareholder, and thus, for purposes of determining whether a foreign
corporation is a CFC. The CFC rules prevent the deferral by U.S. shareholders of U.S. taxation of
certain earnings of the CFC and reduce disparities that otherwise might occur between the amount of
income subject to a particular foreign tax credit limitation when a taxpayer earns income abroad directly
rather than indirectly through a CFC. The application of the look-through rules for foreign tax credit
purposes is appropriately tied to CFC status. See sections 904(d)(2)(E) and 904(d)(3). This analysis
confirms that Congress clearly contemplated that taxpayers could use a bona fide domestic partnership
to subject themselves to the CFC regime, and the resulting application of the look-through rules of section
904(d)(3). Accordingly, under paragraph (e) of this section, the Commissioner cannot treat PRS as an
aggregate of its partners for purposes of determining X's foreign tax credit limitation.
(g) Effective date.— Paragraphs (a), (b), (c), and (d) of this section are effective for all transactions
involving a partnership that occur on or after May 12, 1994. Paragraphs (e) and (f) of this section are
effective for all transactions involving a partnership that occur on or after December 29, 1994.
(h) Scope and application.— This section applies solely with respect to taxes under subtitle A of the
Internal Revenue Code, and for purposes of this section, any reference to a federal tax is limited to any
tax imposed under subtitle A of the Internal Revenue Code.
(i) Application of nonstatutory principles and other statutory authorities.— The Commissioner can
continue to assert and to rely upon applicable nonstatutory principles and other statutory and regulatory
authorities to challenge transactions. This section does not limit the applicability of those principles and
authorities. [Reg. §1.701-2.]
# [T.D. 8588, 12-29-94. Amended by T.D. 8592, 4-12-95.]
Federal Tax Service Explanations:

1.701-2
PART:45,100

69
PARTNERS, NOT PARTNERSHIP, SUBJECT TO TAX.
A partnership as such shall not be subject to the income tax imposed by this chapter. Persons carrying on
business as partners shall be liable for income tax only in their separate or individual capacities.

70

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United States Tax Cases (1913-1999), [49-1 USTC ¶9323], Commissioner

of Internal Revenue, Petitioner, v. W. O. Culbertson, Sr., and Gladys

©2011 Wolters Kluwer. All rights reserved.

Gifts from respondent ............. 21,744

One-half of a loan procured by

Culbertson & Sons partnership ..... 30,000

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

(c) Certain investment trusts

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

(e) Environmental remediation trusts

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

(b) Classification of eligible entities that do not file an election

(i) A partnership if it has two or more members; or

(2) Foreign eligible entities

(B) An association if all members have limited liability; or

(3) Existing eligible entities

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

(v) Deemed elections

©2011 Wolters Kluwer. All rights reserved.

(2) Authorized signatures

(d) Special rules for foreign eligible entities

(ii) Deemed relevance

©2011 Wolters Kluwer. All rights reserved.

(f) Changes in number of members of an entity

©2011 Wolters Kluwer. All rights reserved.

(g) Elective changes in classification

(ii) Association to partnership.— If an eligible entity classified as an association elects under

(iii) Association to disregarded entity.— If an eligible entity classified as an association elects

(iv) Disregarded entity to an association.— If an eligible entity that is disregarded as an entity

(2) Effect of elective chanqes

©2011 Wolters Kluwer. All rights reserved.

(3) Timing of election

(h) Effective date

©2011 Wolters Kluwer. All rights reserved.

Federal Tax Service Explanations:

©2011 Wolters Kluwer. All rights reserved.

(2) An association (as determined under §301.7701-3);

(4) An insurance company;

(8) Certain foreign entities

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

(ii) Clarification of list of corporations in paragraph (b)(8)(i) of this

©2011 Wolters Kluwer. All rights reserved.

(3) With regard to Malaysia, a Sendirian Berhad.

(9) Business entities with multiple charters

©2011 Wolters Kluwer. All rights reserved.

©2011 Wolters Kluwer. All rights reserved.

(2) Wholly owned entities

(iii) [Reserved].— For further guidance, see §301.7701-2T(c)(2)(iii).