[Federal Register Volume 61, Number 85 (Wednesday, May 1, 1996)]
[Rules and Regulations]
[Pages 19189-19192]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-10544]



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DEPARTMENT OF THE TREASURY
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.

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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 Sec. 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

[[Page 19190]]

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 
Sec. 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 Sec. 1.671-4(a) and Sec. 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.

[[Page 19191]]

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 to the end 
of paragraph (a) as follows:


Sec. 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 to the 
end of paragraph (d) as follows:


Sec. 1.677(a)-1  Income for benefit of grantor; general rule.

* * * * *
    (d) * * * See Sec. 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:


Sec. 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 
Sec. 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 Sec. 1.677(a)-1(d) of this chapter. Section 
677 and Sec. 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 Sec. 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 Sec. 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.

[[Page 19192]]

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.


Sec. 602.101  [Amended]

    Par. 7. In Sec. 602.101, paragraph (c) is amended by adding the 
entry ``301.7701-4 . . . . 1545-1465'' in numerical order to the table.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: April 5, 1996.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 96-10544 Filed 4-30-96; 8:45 am]
BILLING CODE 4830-01-P