\[4830-01-p\]

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

\[REG-121122-03\]

RIN 1545-BC11

Notarized Statements of Purchase Under Section 1042

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed amendments to the temporary
regulations under section 1042 of the Internal Revenue Code of 1986. The
proposed regulations would affect taxpayers making an election to defer
the recognition of gain under section 1042 on the sale of stock to an
employee stock ownership plan. The proposed regulations provide guidance
on the notarization requirements of the temporary regulations.

DATES: Written and electronic comments and requests for a public hearing
must be received by October 7, 2003.

ADDRESSES: Send submissions to: CC:ITA:RU (REG-121122-03), room 5226,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered Monday through Friday between
the hours of 8 a.m. and 4 p.m. to: CC:PA:RU (REG-121122-03), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically directly to the IRS Internet site at
[www.irs.gov/regs]{.underline}.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, John T.
Ricotta at (202) 622-6060 (not a toll-free number); concerning
submissions or hearing requests, Sonya Cruse, (202) 622-7180 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

**Background**

This document contains proposed amendments to the requirement of
§1.1042-1T, A-3(b) of the Temporary Income Tax regulations that a
statement of purchase for qualified replacement property be notarized
within 30 days of the date of purchase of the property (30-day
notarization requirement).

The temporary regulations under section 1042 were published in TD 8073
on February 4, 1986 (EE-63-84) (51 FR 4312) as part of a package of
temporary regulations addressing effective dates and other issues under
the Tax Reform Act of 1984. The text of the temporary regulations also
served as a notice of proposed rulemaking (EE-96-85) (51 FR 4391). A
public hearing was held on June 26, 1986, concerning the proposed
regulations.

**Explanation of Provisions**

[Overview]{.underline}

Section 1042(a) provides that a taxpayer or executor may elect in
certain cases not to recognize long-term capital gain on the sale of
[qualified securities]{.underline} to an employee stock ownership plan
(ESOP) (as defined in section 4975(e)(7)) or eligible worker owned
cooperative (as defined in section 1042(c)(2)) if the taxpayer purchases
[qualified replacement property]{.underline} (as defined in section
1042(c)(4)) within the replacement period of section 1042(c)(3) and the
requirements of section 1042(b) and §1.1042-1T of the Temporary Income
Tax Regulations are satisfied.

Section 1042(c)(1) provides that the term [qualified
securities]{.underline} means employer securities (as defined in section
409(l)) which are issued by a domestic C corporation that has no stock
outstanding that is readily tradable on an established securities market
and which were not received by the taxpayer in a distribution from a
plan described in section 401(a) or in a transfer pursuant to an option
or other right to acquire stock to which section 83, 422, or 423
applied.

A sale of [qualified securities]{.underline} meets the requirements of
section 1042(b) if: (1) the qualified securities are sold to an ESOP (as
defined in section 4975(e)(7)), or an eligible worker owned cooperative;
(2) the plan or cooperative owns (after application of section
318(a)(4)), immediately after the sale, at least 30 percent of (a) each
class of outstanding stock of the corporation (other than stock
described in section 1504(a)(4)) which issued the securities or (b) the
total value of all outstanding stock of the corporation (other than
stock described in section 1504(a)(4)); (3) the taxpayer files with the
Secretary a verified written statement of the employer whose employees
are covered by the ESOP or an authorized officer of the cooperative
consenting to the application of sections 4978 and 4979A (which provide
for excise taxes on certain dispositions or allocations of securities
acquired in a sale to which section 1042 applies) with respect to such
employer or cooperative; and (4) the taxpayer\'s holding period with
respect to the qualified securities is at least three years (determined
as of the time of the sale).

The taxpayer must purchase [qualified replacement property]{.underline}
within the [replacement period]{.underline}, which is defined in section
1042(c)(3) as the period which begins three months before the date on
which the sale of qualified securities occurs and ends 12 months after
the date of such sale.

Section 1042(c)(4)(A) defines [qualified replacement
property]{.underline} as any security issued by a domestic operating
corporation which did not, for the taxable year preceding the taxable
year in which such security was purchased, have passive investment
income (as defined in section 1362(d)(3)(C)) in excess of 25 percent of
the gross receipts of such corporation for such preceding taxable year,
and is not the corporation which issued the qualified securities which
such security is replacing or a member of the same controlled group of
corporations (within the meaning of section 1563(a)(1)) as such
corporation.

Section 1042(c)(4)(B) defines an [operating corporation]{.underline} as
a corporation more than 50 percent of the assets of which, at the time
the security was purchased or before the close of the replacement
period, were used in the active conduct of a trade or business.

Section 1.1042-1T A-3(a) of the Temporary Income Tax Regulations states
that the election is to be made in a [statement of election]{.underline}
attached to the taxpayer\'s income tax return filed on or before the due
date (including extensions of time) for the taxable year in which the
sale occurs.

Section 1.1042-1T A-3(b) states that the [statement of
election]{.underline} must provide that the taxpayer elects to treat the
sale of securities as a sale of qualified securities under section
1042(a) and must contain the following information: (1) A description of
the qualified securities sold, including the type and number of shares;
(2) The date of the sale of the qualified securities; (3) The adjusted
basis of the qualified securities; (4) The amount realized upon the sale
of the qualified securities; (5) The identity of the ESOP or eligible
worker-owned cooperative to which the qualified securities were sold;
and (6) If the sale was part of a single interrelated transaction under
a prearranged agreement between taxpayers involving other sales of
qualified securities, the names and taxpayer identification numbers of
the other taxpayers under the agreement and the number of shares sold by
the other taxpayers.

Section 1.1042-1T, A-3(b) further provides that, if the taxpayer has
purchased qualified replacement property at the time of the election,
the taxpayer must attach as part of the statement of election a
[statement of purchase]{.underline} describing the qualified replacement
property, the date of the purchase, and the cost of the property, and
declaring such property to be qualified replacement property with
respect to the sale of qualified securities.

The statement of purchase must be notarized no later than 30 days after
the purchase. The purpose of the statement of purchase is to identify
qualified replacement property with respect to a sale of qualified
securities. The qualified replacement property will have its cost basis
reduced under section 1042(d) to reflect the gain on the sale of
qualified securities that is being deferred by the taxpayer. Upon
subsequent disposition of the qualified replacement property by the
taxpayer, the deferred gain will be recognized by the taxpayer under
section 1042(e). Under section 1042(f), the filing of the statement of
purchase of qualified replacement property (or a statement of the
taxpayer\'s intention not to purchase replacement property) will begin
the statutory period for assessment of any deficiency with respect to
gain arising from the sale of the qualified securities. The purpose of
the 30-day notarization requirement is to provide a contemporaneous
identification of replacement property.

However, the 30-day notarization requirement leads to frequent mistakes
by taxpayers and their advisors. Taxpayers are often unaware of this
requirement and become aware of it only when they prepare their tax
returns for the year of sale to the ESOP. By this time, the 30-day
period is typically past because purchases of replacement property may
have been made up to one year before. A number of private letter rulings
have been issued granting relief to taxpayers in these situations as
long as the statements were notarized shortly after the taxpayer became
aware of the requirement and it was represented that the property listed
was the only replacement property purchased for this sale.

A number of commentators on the temporary and proposed regulations
criticized this requirement as without statutory authority, a trap for
the unwary, and inconsistent with the definition of the qualified
replacement period in section 1042(c)(3).

[Proposed Amendment to the Regulations]{.underline}

In order to facilitate taxpayer compliance with the temporary
regulations concerning identification of qualified replacement property
through notarization of the statements of purchase, the proposed
amendment to the temporary regulations would modify §1.1042-1T, A-3(b)
to provide that the notarization requirements for the [statement of
purchase]{.underline} are satisfied if the taxpayer\'s statement of
purchase is notarized not later than the time the taxpayer files the
income tax return for the taxable year in which the sale of qualified
securities occurred in any case in which any qualified replacement
property was purchased by such time and during the qualified replacement
period. If qualified replacement property was purchased after such
filing date and during the qualified replacement period, the statement
of purchase must be notarized not later than the time the taxpayer's
income tax return is filed for the taxable year following the year for
which the election under section 1042(a) was made.

**Proposed Effective Date**

The proposed amendments to the temporary regulations would apply to
taxable years of sellers ending on or after the date of publication of
the Treasury decision adopting these amendments as final regulations in
the **Federal Register**. However, taxpayers may rely upon these
proposed regulations for guidance with respect to all open taxable years
pending the issuance of final regulations. If, and to the extent, future
guidance is more restrictive than the guidance in these proposed
regulations, the future guidance will be applied without retroactive
effect.

**Special Analyses**

It has been determined that this notice of proposed rulemaking is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because these
regulations do not impose a collection of information on small entities,
the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal Revenue Code, these proposed
regulations will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.

**Comments and Public Hearing**

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written (a signed original and 8
copies) or electronic comments that are submitted timely to the IRS. The
IRS and Treasury Department request comments on the clarity of the
proposed rules and how they can be made easier to understand. All
comments will be available for public inspection and copying. A public
hearing will be scheduled if requested in writing by any person that
timely submits written comments. If a public hearing is scheduled,
notice of the date, time, and place for the public hearing will be
published in the **Federal Register**.

**Drafting Information**

The principal author of these regulations is John T. Ricotta of the
Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from The IRS and Treasury
participated in their development.

**List of Subjects in 26 CFR Part 1**

Income taxes, Reporting and recordkeeping requirements.

**Proposed Amendments to The Regulations**

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

PART 1\--INCOME TAXES

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

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

Par. 2. In §1.1042-1T, A-3, in the undesignated paragraph following
paragraph (b)(6), the penultimate sentence is removed and three
sentences added in its place to read as follows:

[§1.1042-1T Questions and Answers relating to the sales of stock to
employee stock ownership plans or certain cooperatives
(temporary)]{.underline}.

\* \* \* \* \*

Q-3. \* \* \*

A-3. \* \* \* Such statement of purchase must be notarized not later
than the time the taxpayer files the income tax return for the taxable
year in which the sale of qualified securities occurred in any case in
which any qualified replacement property was purchased by such time and
during the qualified replacement period. If qualified replacement
property is purchased after such filing date but during the qualified
replacement period, the statement of purchase must be notarized not
later than the time the taxpayer's income tax return is filed for the
taxable year following the year for which the election under section
1042(a) was made. The previous two sentences apply to taxable years of
sellers ending on or after the date final regulations are published in
the **Federal Register**. \* \* \*

\* \* \* \* \*

Robert E. Wenzel,

Deputy Commissioner for Services and Enforcement.