[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 301, and 602
[TD 8668]
RIN  1545-AT02
Environmental Settlement Funds-Classification
AGENCY:  Internal Revenue Service (IRS), Treasury.
ACTION:  Final Regulations.
SUMMARY:  This document contains final regulations relating to the
classification of certain organizations as trusts for federal tax purposes.
The final regulations provide guidance to taxpayers on the proper
classification of trusts formed to collect and disburse amounts for
environmental remediation of an existing waste site to discharge taxpayers'
liability or potential liability under applicable environmental laws.
DATES:  These regulations are effective May 1, 1996.
     For dates of applicability, see 301.7701-4(e)(5).
FOR FURTHER INFORMATION CONTACT:  James A. Quinn, (202) 622-3060 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
     The collection of information contained in these final regulations has
been reviewed and approved by the Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control
number 1545-1465.  This information is required by the IRS to ensure the
proper reporting of items of income and expense of an environmental
remediation trust in which a portion of the trust is treated as owned by a
grantor.
     An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless the collection of information
displays a valid control number.
     The estimated annual burden per respondent is 4 hours.
     Comments concerning the accuracy of this burden estimate and suggestions
for reducing this burden should be sent to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, T:FP, Washington, DC 20224, and to the Office
of Management and Budget, Attn: Desk Officer for the Department of the
Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.
     Books or records relating to this collection of information must be
retained as long as their contents may become material in the administration
of any internal revenue law.  Generally, tax returns and tax return
information are confidential, as required by 26 U.S.C. 6103.
Background
     On August 4, 1995, the IRS published in the Federal Register a notice of
proposed rulemaking (60 FR 39903) to provide guidance on the classification of
certain organizations as trusts for federal tax purposes.  Written comments
responding to the notice were received, and a public hearing was held on
October 26, 1995.  After consideration of the comments received, the proposed
regulations are adopted as revised by this Treasury decision.
Summary of Significant Comments and Revisions
     The proposed regulations provide that an environmental remediation trust
is considered a trust for purposes of the Internal Revenue Code.  Under the
proposed regulations, a trust is an environmental remediation trust if the
primary purpose of the trust is collecting and disbursing amounts for
environmental remediation of an existing waste site.  One commentator
suggested that "response costs" should be considered amounts incurred for
environmental remediation.  To address this concern, the final regulations
clarify that environmental remediation includes the costs of remedying and
removing environmental contamination.  One commentator also suggested that the
final regulations define the term existing waste site.  The final regulations
do not adopt this comment.  The term existing waste site should be
sufficiently specific to allow taxpayers to establish an environmental
remediation trust for any contaminated site that currently requires
remediation under environmental laws.
     The proposed regulations provide that all contributors to an
environmental remediation trust must have potential liability or a reasonable
expectation of liability under federal, state, or local environmental laws for
environmental remediation of the waste site.  A commentator suggested that the
final regulations be clarified to provide that eligible contributors include
contributors with "actual" as well as potential liability and contributors who
are released from liability upon their contribution to the trust.  The final
regulations clarify that contributors having "actual" liability are eligible
contributors.  The final regulations do not address the treatment of
contributors that are released from liability by the governmental authority
upon contribution to the trust; the regulations are intended only to address
the tax treatment of environmental remediation trusts in which contributors
continue to have actual or potential liability (and thus are treated as owners
of the trust under section 677).  In situations where one or more contributors
are released from liability by the governmental authority upon contribution to
the trust, the rules for qualified settlement funds may apply to the entire
trust.  See 1.468B-1(c) and (h)(2).  If such contributors contribute amounts
to a trust that is separate from the environmental remediation trust, however,
the classification of the environmental remediation trust as a trust will not
be affected.
     One commentator suggested that a cross-reference to these regulations be
inserted in 1.671-4(a) and 1.677(a)-1(d) because the proposed regulations
address reporting and grantor trust issues.  The final regulations include the
suggested cross-references.
     Other commentators suggested that the final regulations address the
timing of deductions for contributions to the trust, the treatment of interest
earned by the trust, and other federal tax consequences of the trust.  The
final regulations do not adopt these suggestions.  The regulations are limited
to the classification of an environmental remediation trust as a trust for
purposes of section 7701 and do not address or affect the timing or amount of
a deduction for environmental remediation costs.  Amounts contributed to an
environmental remediation trust and interest earned on those amounts must be
taken into account under the appropriate federal tax accounting rules,
including the economic performance rules of section 461(h).  Under those
rules, taxpayers generally cannot deduct contributions to the trust at the
time of contribution or deduct earnings at the time they are received by the
trust.
     The proposed regulations provide that the regulations will apply to
trusts formed on or after the date of publication of final regulations.  One
commentator suggested that the final regulations should be effective, at the
trustee's option, to trusts meeting the requirements of an environmental
remediation trust established prior to such date, effective as of any date
designated by the trustee.  The commentator further suggested that, with
respect to amounts held in a fund, account, or trust meeting the requirements
of an environmental remediation trust prior to the date of publication of the
final regulations, the IRS should not challenge the classification of the
fund, account, or trust as a trust for federal tax purposes.
     The final regulations are effective for trusts meeting the definition of
an environmental remediation trust that are formed on or after May 1, 1996.
The final regulations may be relied on by trusts formed before May 1, 1996, if
the trust has at all times met all requirements of the final regulations and
the grantors reported items of income and deduction consistent with the final
regulations on original or amended returns.  This provision allows a trust and
grantors that have met all of the requirements of the final regulations
throughout the existence of the trust to treat the trust as an environmental
remediation trust.  The final regulations also provide that, for trusts formed
before May 1, 1996, that are not described by the preceding rule, the
Commissioner may permit by letter ruling, in appropriate circumstances, the
final regulations to be applied subject to appropriate terms and conditions.
Special Analyses
     It has been determined that this Treasury decision is not a significant
regulatory action as defined in EO 12866.  Therefore, a regulatory assessment
is not required.  It has also been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and,
therefore, a Regulatory Flexibility Analysis is not required.  Pursuant to
section 7805(f) of the Code, the notice of proposed rulemaking preceding these
regulations was submitted to the Small Business Administration for comment on
its impact on small business.
Drafting Information
     The principal author of these regulations is James A. Quinn of the
Office of Assistant Chief Counsel (Passthroughs and Special Industries).
However, other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects
26 CFR Part 1
     Income taxes, Reporting and recordkeeping requirements.      26 CFR Part
301
     Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes,
Penalties, Reporting and recordkeeping requirements.
26 CFR Part 602
     Reporting and recordkeeping requirements.
Amendments to the Regulations
     Accordingly, 26 CFR parts 1, 301, and 602 are 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.  Section 1.671-4 is amended by adding a sentence at the end of
paragraph (a) to read as follows:
1.671-4  Method of reporting.
     (a) * * *  Section 301.7701-4(e)(2) of this chapter provides guidance on
how these reporting rules apply to an environmental remediation trust.
* * * * *
     Par. 3.  Section 1.677(a)-1 is amended by adding a sentence at the end
of paragraph (d) to read as follows:
1.677(a)-1  Income for benefit of grantor; general rule.
* * * * *
     (d) * * *  See 301.7701-4(e) of this chapter for rules on the
classification of and application of section 677 to an environmental
remediation trust.
* * * * *
PART 301--PROCEDURE AND ADMINISTRATION
     Par. 4.  The authority citation for part 301 continues to read as
follows:
     Authority:  26 U.S.C. 7805 * * *
     Par. 5.  Section 301.7701-4(e) is added to read as follows:
301.7701-4 Trusts.
* * * * *
     (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 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.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
     Par. 6.  The authority citation for part 602 continues to read as
follows:
     Authority:  26 U.S.C. 7805.
Par. 7.  In 602.101, paragraph (c) is amended by adding the entry "301.7701-
4(e) . . . . 1545-1465" in numerical order to the table.
                              Margaret Milner Richardson
                              Commissioner of Internal Revenue
Approved:  April 5, 1996
          Assistant Secretary of the Treasury
          Leslie Samuels