Federal Register / Vol. 77, No. 73 / Monday, April 16, 2012 / Rules and Regulations 22483 

all of its T stock to FP. In Year 3, in a 

transaction unrelated to the issuance of the 

T stock in Year 1, T converts under state law 

to a limited liability company that is treated 

as a partnership for Federal income tax 

purposes. 

(b) Timing. Under paragraph (a)(2) of this 

section, P’s loss on the sale of its T stock is 

deferred. Under paragraph (c)(1)(iv) of this 

section, upon the conversion of T, to the 

extent P’s loss would be redetermined to be 

a noncapital, nondeductible amount under 

the principles of § 1.1502–13, P’s loss 

continues to be deferred. In determining 

whether the loss would be redetermined to 

be a noncapital, nondeductible amount, stock 

held by FS (which was acquired from T) and 

stock held by FP (the buyer of the T stock 

from P and a member of P’s controlled group) 

is taken into account. Accordingly, under the 

principles of § 1.1502–13 the deemed 

liquidation of T resulting from the 

conversion of T would be treated as a 

liquidation qualifying under section 332, and 

P’s loss would be redetermined to be a 

noncapital, nondeductible amount. Thus, 

under paragraph (c)(1)(iv), P’s loss continues 

to be deferred until P and FP are no longer 

in a controlled group relationship. 

* * * * * 

(l) * * * 

(3) Effective/applicability date. 

Paragraph (c)(1)(iv) of this section 

applies to a loss that continues to be 

deferred pursuant to that paragraph if 

the event that would cause the loss to 

be redetermined as a noncapital 

nondeductible amount under the 

principles of § 1.1502–13 occurs on or 

after April 16, 2012. 

* * * * * 

Steven T. Miller, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: April 9, 2012. 

Emily S. McMahon, 

Acting Assistant Secretary of the Treasury 

(Tax Policy). 

[FR Doc. 2012–9004 Filed 4–13–12; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9582] 

RIN 1545–BH66 

Guidance Under Sections 642 and 643 

(Income Ordering Rules) 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final Regulations. 

SUMMARY: This document contains final 

regulations under Internal Revenue 

Code (Code) section 642(c) with regard 

to the Federal tax consequences of an 

ordering provision in a trust, a will, or 

a provision of local law that attempts to 

determine the tax character of the 

amounts paid to a charitable beneficiary 

of the trust or estate. The final 

regulations also make conforming 

amendments to the regulations under 

section 643(a)(5). The final regulations 

affect estates, charitable lead trusts 

(CLTs), and other trusts making 

payments or permanently setting aside 

amounts for a charitable purpose. 

DATES: Effective Date: These regulations 

are effective on April 16, 2012. 

FOR FURTHER INFORMATION CONTACT: 

Melissa Liquerman, at (202) 622–3060 

(not a toll-free number). 

SUPPLEMENTARY INFORMATION: 

Background and Explanation of 

Provisions 

On June 18, 2008, proposed 

regulations (REG–101258–08) were 

published in the Federal Register [73 

FR 34670]. The proposed regulations 

contain proposed amendments to the 

Income Tax Regulations 26 CFR part 1, 

confirming that a provision in a trust, a 

will, or a provision of local law that 

specifically indicates the source out of 

which amounts are to be paid, 

permanently set aside, or used for a 

purpose specified in section 642(c) must 

have economic effect independent of 

income tax consequences in order to be 

respected for Federal tax purposes. If 

such provision does not have economic 

effect independent of income tax 

consequences, income distributed for a 

purpose specified in section 642(c) will 

consist of the same proportion of each 

class of the items of income as the total 

of each class bears to the total of all 

classes. The proposed regulations also 

make conforming changes in the 

corresponding language in the Income 

Tax Regulations under section 643(a)(5). 

The trusts and estates that are the 

subject of the proposed regulations 

include, without limitation, charitable 

lead trusts (CLTs) and trusts and estates 

making payments or permanently 

setting aside amounts for a charitable 

purpose. 

The proposed regulations are based 

on the structure and provisions of 

Subchapter J (of Chapter 1, Subtitle A, 

of the Code) as a whole, as well as on 

an analysis of the existing regulations 

with their interrelated cross-references. 

The IRS and Treasury Department 

believe that the current regulations 

under §§ 1.642(c)–3(b) and 1.643(a)–5(b) 

require that a specific provision of the 

governing instrument or a provision 

under local law have economic effect 

independent of income tax 

consequences in order to be respected 

for Federal income tax purposes. To 

make this clearer, the proposed 

regulations add the principle of 

economic effect directly to the 

regulations under sections 642(c) and 

643(a), rather than leaving this principle 

to be reached by cross-reference to other 

regulations. 

Finally, the proposed regulations 

remove § 1.642(c)–3(b)(4) because the 

provisions of section 116 referenced 

therein were repealed by the Tax 

Reform Act of 1986 (Pub. L. 99–514). 

Written comments were received on 

the proposed regulations. Because there 

were no requests to speak at the 

scheduled public hearing, the public 

hearing was cancelled. The proposed 

regulations, with certain changes made 

in response to the written comments 

received, are adopted as final 

regulations. 

Summary of Comments and 

Explanation of Provisions 

Specific Provisions Must Have 

Economic Effect Independent of Income 

Tax Consequences 

Commentators suggested that the 

clarification in the proposed 

regulations, that a specific provision in 

a governing instrument or in local law 

that identifies the source(s) of the 

amounts to be paid, permanently set 

aside, or used for a purpose specified in 

section 642(c) must have economic 

effect independent of income tax 

consequences in order for the specific 

provision in the governing instrument 

or in local law to be respected for 

Federal tax purposes, is an 

interpretation contrary to the clear 

language of section 642(c) and 643(a)(5) 

and the existing regulations. 

The IRS and Treasury Department 

have carefully considered these 

arguments and the analyses suggested 

by the commentators. The IRS and 

Treasury Department continue to 

believe that the position clarified in the 

proposed regulations, requiring that a 

specific provision of the governing 

instrument or a provision under local 

law have economic effect independent 

of income tax consequences in order to 

be respected for Federal tax purposes, is 

the proper interpretation of the relevant 

Code provisions and is a principle that 

applies throughout Subchapter J. 

The general rule provided in 

Subchapter J, which mandates that the 

tax character of distributions to 

beneficiaries consists of a pro rata 

portion of all types of a trust’s income, 

appears in section 652(b) and in several 

different sections of the regulations 

under the subchapter. The only 


emcdonald on DSK29S0YB1PROD with RULES
22484 Federal Register / Vol. 77, No. 73 / Monday, April 16, 2012 / Rules and Regulations 

regulatory exception to this pro rata rule 

is for a specific provision in a governing 

instrument or a provision under local 

law that provides as to the tax character 

of distributions to beneficiaries. This 

exception to the pro rata rule must have 

the same meaning throughout the 

Subchapter J regulations. The chain of 

regulatory references from §§ 1.642(c)– 

3(b) and 1.643(a)–5(b), detailed in the 

preamble to the proposed regulations, 

incorporates into each of those 

provisions, by cross-reference to 

§ 1.662(b)–2, ‘‘the principles contained’’ 

in § 1.652(b)–1 and, in turn, § 1.652(b)– 

2(a) and –2(b), which require a specific 

provision to have economic effect 

independent of income tax 

consequences in order to be respected. 

The proposed regulations confirm this 

uniform principle by inserting the terms 

of §§ 1.652(b)–1 and 1.652(b)–2(a) and 

–2(b) explicitly into §§ 1.642(c)–3(b) and 

1.643(a)–5(b). 

Moreover, section 643(a)(7) grants 

express regulatory authority to 

‘‘prescribe such regulations as may be 

necessary or appropriate to carry out the 

purposes of this part, including 

regulations to prevent avoidance of such 

purposes.’’ 

Income Ordering Provisions and 

Economic Effect Independent of Income 

Tax Consequences 

A commentator suggested that income 

ordering provisions in CLTs have 

economic effect independent of income 

tax consequences because disregarding 

an income ordering provision could 

increase a CLT’s tax liability, thereby 

reducing the value of the trust and in 

turn reducing the annual unitrust 

payments to the charitable beneficiaries 

and increasing the risk that the trust’s 

assets will be depleted before the end of 

the trust term. Although the general pro 

rata allocation rule may increase a 

trust’s tax liability and thereby reduce 

the value of the trust’s corpus, the effect 

of the payment of the trust’s income tax 

liability is not an economic effect 

independent of income tax 

consequences as described in these 

regulations. Any possible reduction in 

the unitrust amount subsequently paid 

to the charitable beneficiary would be 

the direct result of the payment of 

income taxes by the unitrust. The use of 

an income ordering rule in a CLT, 

directing the tax characteristics of the 

unitrust or annuity payments to the 

charity, is primarily, if not exclusively, 

an attempt to minimize the tax 

liabilities of the trust and its remainder 

beneficiaries. The only effects of the use 

of an ordering rule are in fact dependent 

solely upon tax consequences: 

specifically, the reduced amount of tax 

paid and the trust’s retention of the 

income tax savings. 

Ordering provisions in CLTs will 

never have economic effect independent 

of their tax consequences because the 

amount paid to the charity is not 

dependent upon the type of income it is 

allocated. An annuity payment is a fixed 

amount from year to year, and although 

a unitrust amount may fluctuate 

annually, the amount is based upon a 

predetermined percentage of the trust’s 

value. 

Permitting an ordering rule with no 

economic effect independent of income 

tax consequences to supersede the pro 

rata allocation rule generally applicable 

under Subchapter J would, in effect, 

permit taxpayers to deviate at will from 

the general rule imposed throughout 

Subchapter J in the case of all kinds of 

complex trusts. 

Encouragement of Charitable Gifts 

A commentator suggested that the 

proposed regulations are contrary to the 

Federal government’s long standing 

policy to encourage charitable gifts and 

to benefit and protect charities. 

The IRS and Treasury Department 

have carefully considered the merits 

and implications of this suggestion. The 

IRS and Treasury Department believe, 

however, that the proper interpretation 

of the relevant Code sections does not 

permit the creation of a special rule for 

CLTs. A CLT is treated and taxed in the 

same way as any other complex trust 

under Subchapter J. Subchapter J does 

not differentiate between a CLT and a 

different type of complex trust, and 

there is no provision of Subchapter J 

that applies exclusively and expressly to 

CLTs. Thus, any income tax rule 

applicable to a CLT will apply in the 

same way to every other complex trust. 

Principal/Income Ordering Rules 

A commentator requested that the 

proposed regulations be expanded to 

provide that trusts that make 

distributions to both charitable and 

noncharitable beneficiaries in the same 

taxable year must allocate the 

distributions equally to principal and 

income as between charitable and 

noncharitable beneficiaries, unless there 

is a provision that has economic effect 

independent of income tax 

consequences. 

This request is beyond the scope of 

the proposed regulations and might 

implicate other well settled income tax 

rules applicable to complex trusts. 

Section 662 and the regulations 

thereunder provide the rules for 

distributions by complex trusts with a 

charitable beneficiary, and sufficiently 

address the commentator’s concern. If 

the commentator believes that further 

guidance is needed or would be helpful 

to taxpayers, a request for additional 

guidance may be submitted for 

consideration to be added to the Priority 

Guidance Plan. 

Economic Effect Independent of Income 

Tax Consequences Example 

A commentator requested an example 

of a provision in a governing instrument 

that would have economic effect 

independent of income tax 

consequences. Such an example has 

been added to the final regulations as 

Example 2. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866, as 

supplemented by Executive Order 

13563. 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) 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. Therefore, a 

Regulatory Flexibility Analysis is not 

required. Pursuant to section 7805(f) of 

the Code, the notice of proposed 

rulemaking preceding this regulation 

was submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on its 

impact on small business, and no 

comments were received. 

Drafting Information 

The principal author of these 

proposed regulations is Melissa 

Liquerman, Office of the Associate Chief 

Counsel (Passthroughs and Special 

Industries). 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Adoption of Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

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 1.642(c)–3 is amended 

by: 

■ 1. Revising the heading of paragraph 

(b) and adding a heading for (b)(1). 


emcdonald on DSK29S0YB1PROD with RULES
Federal Register / Vol. 77, No. 73 / Monday, April 16, 2012 / Rules and Regulations 22485 

■ 2. Revising paragraph (b)(2). 

■ 3. Adding a heading to paragraph 

(b)(3). 

■ 4. Removing paragraph (b)(4). 

The revisions and addition read as 

follows: 

§ 1.642(c)–3 Adjustments and other 

special rules for determining unlimited 

charitable contributions deduction. 

* * * * * 

(b) Determination of amounts 

deductible under section 642(c) and the 

character of such amounts—(1) 

Reduction of charitable contributions 

deduction by amounts not included in 

gross income. * * * 

(2) Determination of the character of 

an amount deductible under section 

642(c). In determining whether the 

amounts of income so paid, 

permanently set aside, or used for a 

purpose specified in section 642(c)(1), 

(2), or (3) include particular items of 

income of an estate or trust, whether or 

not included in gross income, a 

provision in the governing instrument 

or in local law that specifically provides 

the source out of which amounts are to 

be paid, permanently set aside, or used 

for such a purpose controls for Federal 

tax purposes to the extent such 

provision has economic effect 

independent of income tax 

consequences. See § 1.652(b)–2(b). In 

the absence of such specific provisions 

in the governing instrument or in local 

law, the amount to which section 642(c) 

applies is deemed to consist of the same 

proportion of each class of the items of 

income of the estate or trust as the total 

of each class bears to the total of all 

classes. See § 1.643(a)–5(b) for the 

method of determining the allocable 

portion of exempt income and foreign 

income. This paragraph (b)(2) is 

illustrated by the following examples: 

Example 1. A charitable lead annuity trust 

has the calendar year as its taxable year, and 

is to pay an annuity of $10,000 annually to 

an organization described in section 170(c). 

A provision in the trust governing instrument 

provides that the $10,000 annuity should be 

deemed to come first from ordinary income, 

second from short-term capital gain, third 

from fifty percent of the unrelated business 

taxable income, fourth from long-term capital 

gain, fifth from the balance of unrelated 

business taxable income, sixth from taxexempt income, and seventh from principal. 

This provision in the governing instrument 

does not have economic effect independent 

of income tax consequences, because the 

amount to be paid to the charity is not 

dependent upon the type of income from 

which it is to be paid. Accordingly, the 

amount to which section 642(c) applies is 

deemed to consist of the same proportion of 

each class of the items of income of the trust 

as the total of each class bears to the total of 

all classes. 

Example 2. A trust instrument provides 

that 100 percent of the trust’s ordinary 

income must be distributed currently to an 

organization described in section 170(c) and 

that all remaining items of income must be 

distributed currently to B, a noncharitable 

beneficiary. This income ordering provision 

has economic effect independent of income 

tax consequences because the amount to be 

paid to the charitable organization each year 

is dependent upon the amount of ordinary 

income the trust earns within that taxable 

year. Accordingly, for purposes of section 

642(c), the full amount distributed to charity 

is deemed to consist of ordinary income. 

(3) Other examples. * * * 

* * * * * 

■ Par. 3. Section 1.643(a)–5 is amended 

by revising paragraph (b) to read as 

follows: 

§ 1.643(a)–5 Tax-exempt interest. 

* * * * * 

(b) If the estate or trust is allowed a 

charitable contributions deduction 

under section 642(c), the amounts 

specified in paragraph (a) of this section 

and § 1.643(a)–6 are reduced by the 

portion deemed to be included in 

income paid, permanently set aside, or 

to be used for the purposes specified in 

section 642(c). If the governing 

instrument or local law specifically 

provides as to the source out of which 

amounts are paid, permanently set 

aside, or to be used for such charitable 

purposes, the specific provision controls 

for Federal tax purposes to the extent 

such provision has economic effect 

independent of income tax 

consequences. See § 1.652(b)–2(b). In 

the absence of such specific provisions 

in the governing instrument or local 

law, an amount to which section 642(c) 

applies is deemed to consist of the same 

proportion of each class of the items of 

income of the estate or trust as the total 

of each class bears to the total of all 

classes. For illustrations showing the 

determination of the character of an 

amount deductible under section 642(c), 

see Examples 1 and 2 of § 1.662(b)–2 

and § 1.662(c)–4(e). 

Linda M. Kroening, 

(Acting) Deputy Commissioner for Services 

and Enforcement. 

Approved: April 9, 2012. 

Emily M. McMahon, 

(Acting) Assistant Secretary of the Treasury 

(Tax Policy). 

[FR Doc. 2012–8996 Filed 4–13–12; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Alcohol and Tobacco Tax and Trade 

Bureau 

27 CFR Parts 4, 5, and 7 

[Docket No. TTB–2010–0008; T.D. TTB–103; 

Ref: Notice No. 111] 

RIN 1513–AB79 

Disclosure of Cochineal Extract and 

Carmine in the Labeling of Wines, 

Distilled Spirits, and Malt Beverages 

AGENCY: Alcohol and Tobacco Tax and 

Trade Bureau, Treasury. 

ACTION: Final rule; Treasury decision. 

SUMMARY: The Alcohol and Tobacco Tax 

and Trade Bureau is revising its 

regulations to require the disclosure of 

the presence of cochineal extract and 

carmine on the labels of any alcohol 

beverage product containing one or both 

of these color additives. This rule 

responds to a final rule issued by the 

Food and Drug Administration. 

Consumers who are allergic to cochineal 

extract or carmine will now be able to 

identify and thus avoid alcohol beverage 

products that contain these color 

additives. 

DATES: Effective Date: May 16, 2012. 

Transitional rules are provided which 

will require compliance by April 16, 

2013. Voluntary compliance with this 

final rule, including making any 

required labeling changes, may begin 

immediately. 

FOR FURTHER INFORMATION CONTACT: Lisa 

M. Gesser, telephone 202–453–1039, 

ext. 292 or Joanne C. Brady, telephone 

202–453–1039, ext. 291; Regulations 

and Rulings Division, Alcohol and 

Tobacco Tax and Trade Bureau, 1310 

G Street NW., Box 12, Washington, DC 

20005. 

SUPPLEMENTARY INFORMATION: 

I. TTB’s Authority To Prescribe Alcohol 

Beverage Labeling Regulations 

Section 105(e) of the Federal Alcohol 

Administration Act (FAA Act), codified 

at 27 U.S.C. 205(e), sets forth standards 

for regulation of the labeling of wine 

(containing at least 7 percent alcohol by 

volume), distilled spirits, and malt 

beverages, generally referred to as 

‘‘alcohol beverage products’’ throughout 

this final rule. This section gives the 

Secretary of the Treasury the authority 

to issue regulations to prevent deception 

of the consumer, to provide the 

consumer with ‘‘adequate information’’ 

as to the identity and quality of the 

product, to prohibit false or misleading 

statements, and to provide information 

as to the alcohol content of the product. 


emcdonald on DSK29S0YB1PROD with RULES