Rules and Regulations. Final rule; delay of compliance dates

29,551 words·~134 min read·/register/2008/02/15/08-706

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BILLING CODE 4910-13-M DEPARTMENT OF TRANSPORTATION Federal Aviation Administration 14 CFR Part 135 [Docket No. FAA-1999-6717; Amendment No. 135-112] RIN 2120-AI03 Extended Operations (ETOPS) of Multi Engine Airplanes AGENCY: Federal Aviation Administration, DOT. ACTION: Final rule; delay of compliance dates. SUMMARY: The Federal Aviation Administration

(FAA)is delaying the compliance date for certain sections of a final rule, published January 16, 2007, that established regulations governing the design, operation, and maintenance of certain airplanes operated on flights that fly over 180 minutes from an adequate airport. The extension of the compliance date is necessary to give operators additional time to gain a comprehensive understanding of Extended Operations (ETOPS) requirements, develop training and procedures, and implement safety measures established in the final rule. In addition, the regulatory text for certain sections is amended to reflect this delay of compliance dates. DATES: *Effective Dates:* The effective date for the amendments in this final rule is February 15, 2008. *Compliance Dates:* The compliance date contained in the Final Rule (72 FR 1808), for §§ 135.98, 135.345(a)(9), and 135.364, section G135.2.1 of appendix G to part 135, and section G135.2.9 of appendix G to part 135 is delayed by 180 days, from February 16, 2008, to August 13, 2008. The delay of compliance dates for these specific sections of the Final Rule does not affect any other compliance date established in Table 2 of Section VI of the preamble to the Final Rule. FOR FURTHER INFORMATION CONTACT: Jim Ryan, Air Carrier Operations Branch (AFS-220), Air Transportation Division, Flight Standards Service, Federal Aviation Administration, 800 Independence Ave., SW., Washington, DC 20591, Telephone (202-267-7493), E-Mail *jim.ryan@faa.gov.* SUPPLEMENTARY INFORMATION: Availability of Rulemaking Documents You can get an electronic copy of rulemaking documents using the Internet by— 1. Searching the Federal eRulemaking Portal ( *http://www.regulations.gov* ); 2. Visiting the FAA's Regulations and Policies Web page at *http://www.faa.gov/regulations_policies/* ; or 3. Accessing the Government Printing Office's Web page at *http://www.gpoaccess.gov/fr/index.html.* You can also get a copy by sending a request to the Federal Aviation Administration, Office of Rulemaking, ARM-1, 800 Independence Avenue, SW., Washington, DC 20591, or by calling

(202)267-9680. Make sure to identify the amendment number or docket number of this rulemaking. Anyone is able to search the electronic form of all comments received into any of our dockets by the name of the individual submitting the comment (or signing the comment, if submitted on behalf of an association, business, labor union, etc.). You may review DOT's complete Privacy Act statement in the **Federal Register** published on April 11, 2000 (Volume 65, Number 70; Pages 19477-78), or you may visit *http://DocketInfo.dot.gov.* Small Business Regulatory Enforcement Fairness Act The Small Business Regulatory Enforcement Fairness Act (SBREFA) of 1996 requires FAA to comply with small entity requests for information or advice about compliance with statutes and regulations within its jurisdiction. If you are a small entity and you have a question regarding this document, you may contact your local FAA official, or the person listed under FOR FURTHER INFORMATION CONTACT . You can find out more about SBREFA on the Internet at *http://www.faa.gov/ regulations_policies/rulemaking/ sbre_act/* . Authority for This Rulemaking The FAA's authority to issue rules regarding aviation safety is found in Title 49 of the United States Code. Subtitle I, Section 106 describes the authority of the FAA Administrator. Subtitle VII, Aviation Programs, describes in more detail the scope of the agency's authority. This rulemaking is promulgated under the authority described in Subtitle VII, Part A, subpart I, 49 U.S.C. 44701. Under that section, the FAA is charged with regulating air commerce in a way that best promotes safety. Background The Extended Operations of Multi Engine Airplanes (ETOPS) Final Rule (72 FR 1808) established regulations governing the design, operation, and maintenance of certain airplanes operated on flights that fly long distances from an adequate airport. The final rule affected aircraft operators under 14 CFR parts 121 and 135, as well as manufacturers under 14 CFR parts 21, 25, and 33. The Final Rule, published January 16, 2007, establishes a compliance schedule for affected operators and manufacturers that was designed to ease the burden of compliance and make the rule less costly. The FAA established a compliance date of 1 year for part 135 operators to meet the operational and training requirements of the final rule. For cargo fire suppression, the final rule allows 8 years for currently approved part 135 ETOPS operators to comply. In that final rule, the FAA published commenters' observations that “There is no FAA guidance for, and FAA Inspectors have not approved, any part 135 ETOPS flights” (72 FR 1849). Previous FAA guidance has addressed ETOPS operations for 121 operators. In December 1998, the FAA published Advisory Circular

(AC)120-42A, Extended Range Operation with Two-Engine Airplanes. This AC contained guidance for operators under part 121 who wished to engage in ETOPS operations. Based on this guidance, part 121 operators have been conducting safe and successful ETOPS flights for over 20 years. Until the final rule was published on January 16, 2007, part 135 operators did not need FAA approval for ETOPS flights. Because the final rule establishes new requirements for part 135 operations, the FAA intends to support successful implementation of the operational and training requirements in the final rule for part 135 operations by publishing an AC that addresses the requirements for part 135 operators. On September 17, 2007, the FAA published and invited comment on two draft ACs, draft AC 120-42B for part 121 operators and draft AC 135-42 for part 135 operators (FAA-2002-6717, *http://dms.dot.gov* ). The FAA has determined that the current guidance available for part 121 operators regarding ETOPS flights is sufficient for part 121 operators to meet the compliance schedule in the final rule. However, because the ETOPS requirements in the final rule are new for part 135 operators, the FAA has determined that it is appropriate to delay compliance for certain part 135 operational and training requirements (i.e. §§ 135.98, 135.345(a)(9), 135.364, section G135.2.1 of appendix G to part 135, and section G135.2.9 of appendix G to part 135) until after the guidance in AC 135-42 is published. The delay of the compliance date is necessary to give part 135 operators additional time to gain a comprehensive understanding of ETOPS requirements, develop training and procedures, and implement the safety measures established in the Final Rule. Good Cause for Foregoing Public Notice and Comment Section 553(b)(3)(B) of the Administrative Procedure Act, 5 U.S.C. 553(b)(3)(B), authorizes agencies to dispense with certain notice procedures for rules when they find “good cause” to do so. Under section 553(b)(3)(B), the requirements of notice and opportunity for comment do not apply when the agency for good cause finds that those procedures are “impracticable, unnecessary, or contrary to the public interest.” In this case, the FAA finds that notice and public comment are unnecessary and contrary to the public interest. This action delays the compliance date for several sections of the final rule published January 16, 2007. We issued those regulations using the public notice and comment procedure. In that final rule, we published commenters' observations that “There is no FAA guidance for, and FAA inspectors have not approved, any part 135 ETOPS flights” (72 FR 1849). The FAA intends to support successful implementation of the operational and training requirements in the final rule for part 135 operations by publishing an Advisory Circular that addresses these requirements. On September 17, 2007, the FAA published and invited comment on draft AC 135-42 for part 135 operators (FAA-1999-6717, *http://www.regulations.gov* ). The FAA has determined that it is contrary to the public interest to require part 135 operators to comply with the requirements of the final rule until AC 135-42 is published. The FAA has determined that notice and public comment are unnecessary because the public has already commented that FAA guidance is necessary for part 135 operators. The public is best served by delaying the compliance date for the part 135 operational and training requirements in the rule to allow time for publication of the AC, which will provide part 135 operators with a comprehensive understanding of ETOPS requirements. Good Cause for Immediate Adoption Since the delay in the compliance date of the final rule does not impose any new requirements or any additional burden on the regulated public, the FAA finds that good cause exists for immediate adoption of the compliance date without a 30-day notice period. The Effect of Our Decision Our decision delays the compliance date of certain sections of the final rule (72 FR 1809, January 15, 2007), §§ 135.98, 135.345(a)(9), and 135.364, section G135.2.1 of appendix G to part 135, and section G135.2.9 of appendix G to part 135, from February 16, 2008, to August 13, 2008. List of Subjects in 14 CFR Part 135 Air taxis, Aircraft, Airmen, Alcohol abuse, Aviation safety, Drug abuse, Drug testing, Reporting and recordkeeping requirements. The Amendment In consideration of the foregoing, the Federal Aviation Administration amends Chapter I of Title 14, Code of Federal Regulations as follows: PART 135—OPERATING REQUIREMENTS; COMMUTER AND ON DEMAND OPERATION AND RULES GOVERNING PERSONS ON BOARD SUCH AIRCRAFT 1. The authority citation for part 135 continues to read as follows: Authority: 49 U.S.C. 106(g), 41706, 44113, 44701-44702, 44705, 44709, 44711-44713, 44715-44717, 44722. 2. Amend § 135.98 by revising the introductory text to read as follows: § 135.98 Operations in the North Polar Area. After August 13, 2008, no certificate holder may operate an aircraft in the region north of 78° N latitude (“North Polar Area”), other than intrastate operations wholly within the state of Alaska, unless authorized by the FAA. The certificate holder's operation specifications must include the following: 3. Amend § 135.345 by revising paragraph (a)(9) to read as follows: § 135.345 Pilots: Initial, transition, and upgrade ground training.

(a)* * *

(9)After August 13, 2008, passenger recovery plan for any passenger-carrying operation (other than intrastate operations wholly within the state of Alaska) in the North Polar area; and 4. Revise § 135.364 to read as follows: § 135.364 Maximum flying time outside the United States. After August 13, 2008, no certificate holder may operate an airplane, other than an all-cargo airplane with more than two engines, on a planned route that exceeds 180 minutes flying time (at the one-engine-inoperative cruise speed under standard conditions in still air) from an Adequate Airport outside the continental United States unless the operation is approved by the FAA in accordance with Appendix G of this part, Extended Operations (ETOPS). 5. Revise the introductory text of section G135.2.1, and section G135.2.9, of appendix G to part 135 to read as follows: Appendix G to Part 135—Extended Operations (ETOPS) G135.2 *Requirements.* G135.2.1 *General.* After August 13, 2008, no certificate holder may operate an airplane, other than an all-cargo airplane with more than two engines, outside the continental United States more than 180 minutes flying time (at the one-engine-inoperative cruise speed under standard conditions in still air) from an airport described in § 135.364 unless— G135.2.9 *Delayed compliance date for all airplanes.* A certificate holder need not comply with this appendix for any airplane until August 13, 2008. Issued in Washington, DC, on February 11, 2008. Rebecca Byers MacPherson, Assistant Chief Counsel for Regulations. [FR Doc. E8-2879 Filed 2-14-08; 8:45 am] BILLING CODE 4910-13-P DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9381] RIN 1545-BF79 TIPRA Amendments to Section 199 AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final regulations. SUMMARY: This document contains final regulations concerning the amendments made by the Tax Increase Prevention and Reconciliation Act of 2005 to section 199 of the Internal Revenue Code. The final regulations also contain a rule concerning the use of losses incurred by members of an expanded affiliated group. Section 199 provides a deduction for income attributable to domestic production activities. The final regulations affect taxpayers engaged in certain domestic production activities. DATES: *Effective Date:* These regulations are effective February 15, 2008. *Applicability Date:* For dates of applicability, see § 1.199-8(i)(5) and (6). FOR FURTHER INFORMATION CONTACT: Concerning §§ 1.199-2(e)(2) and 1.199-8(i)(5), Paul Handleman or David McDonnell,

(202)622-3040; concerning §§ 1.199-3(i)(7) and (8), and 1.199-5, William Kostak,

(202)622-3060; and concerning §§ 1.199-7(b)(4) and 1.199-8(i)(6), Ken Cohen,

(202)622-7790 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Background This document provides rules relating to the deduction for income attributable to domestic production activities under section 199 of the Internal Revenue Code (Code). Section 199 was added to the Code by section 102 of the American Jobs Creation Act of 2004 (Pub. L. 108-357, 118 Stat. 1418), and amended by section 403(a) of the Gulf Opportunity Zone Act of 2005 (Pub. L. 109-135, 119 Stat. 25), section 514 of the Tax Increase Prevention and Reconciliation Act of 2005 (Pub. L. 109-222, 120 Stat. 345) (TIPRA), and section 401 of the Tax Relief and Health Care Act of 2006 (Pub. L. 109-432, 120 Stat. 2922). On June 1, 2006, the IRS and Treasury Department published final regulations under section 199 (TD 9263, 71 FR 31268). On October 19, 2006, the IRS and Treasury Department published final and temporary regulations on the TIPRA amendments to section 199 (TD 9293, 71 FR 61662) and cross-referencing proposed regulations (REG-127819-06, 71 FR 61692). No public hearing was requested or held on the proposed regulations. One comment responding to the proposed regulations was received. After consideration of the comment, the proposed regulations are adopted as amended by this Treasury decision and the corresponding temporary regulations are removed. General Overview Section 199(a)(1) allows a deduction equal to 9 percent (3 percent in the case of taxable years beginning in 2005 or 2006, and 6 percent in the case of taxable years beginning in 2007, 2008, or 2009) of the lesser of

(A)the qualified production activities income

(QPAI)of the taxpayer for the taxable year, or

(B)taxable income (determined without regard to section 199) for the taxable year (or, in the case of an individual, adjusted gross income (AGI)). Section 199(b)(1) limits the deduction for a taxable year to 50 percent of the W-2 wages paid by the taxpayer during the calendar year that ends in such taxable year. For this purpose, section 199(b)(2)(A) defines the term *W-2 wages* to mean, with respect to any person for any taxable year of such person, the sum of the amounts described in section 6051(a)(3) and

(8)paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year. Section 514(a) of TIPRA added new section 199(b)(2)(B), which provides that the term *W-2 wages* does not include any amount which is not properly allocable to domestic production gross receipts

(DPGR)for purposes of section 199(c)(1). Section 199(b)(2)(C) provides that the term *W-2 wages* does not include any amount that is not properly included in a return filed with the Social Security Administration on or before the 60th day after the due date (including extensions) for the return. Pass-thru Entities Section 199(d)(1)(A) provides that, in the case of a partnership or S corporation,

(i)section 199 shall be applied at the partner or shareholder level,

(ii)each partner or shareholder shall take into account such person's allocable share of each item described in section 199(c)(1)(A) or

(B)(determined without regard to whether the items described in section 199(c)(1)(A) exceed the items described in section 199(c)(1)(B)), and

(iii)each partner or shareholder shall be treated for purposes of section 199(b) as having W-2 wages for the taxable year in an amount equal to such person's allocable share of the W-2 wages of the partnership or S corporation for the taxable year (as determined under regulations prescribed by the Secretary). Section 199(d)(1)(B) provides that, in the case of a trust or estate,

(i)the items referred to in section 199(d)(1)(A)(ii) (as determined therein) and the W-2 wages of the trust or estate for the taxable year shall be apportioned between the beneficiaries and the fiduciary (and among the beneficiaries) under regulations prescribed by the Secretary, and

(ii)for purposes of section 199(d)(2), AGI of the trust or estate shall be determined as provided in section 67(e) with the adjustments described in such section. Section 199(d)(1)(C) provides that the Secretary may prescribe rules requiring or restricting the allocation of items and wages under section 199(d)(1) and may prescribe such reporting requirements as the Secretary determines appropriate. Expanded Affiliated Groups Section 199(d)(4)(A) provides that all members of an expanded affiliated group

(EAG)are treated as a single corporation for purposes of section 199. Section 199(d)(4)(B) provides that an EAG is an affiliated group as defined in section 1504(a), determined by substituting “more than 50 percent” for “at least 80 percent” each place it appears and without regard to section 1504(b)(2) and (4). Authority to Prescribe Regulations Section 199(d)(9) authorizes the Secretary to prescribe such regulations as are necessary to carry out the purposes of section 199, including regulations that prevent more than one taxpayer from being allowed a deduction under section 199 with respect to any activity described in section 199(c)(4)(A)(i). Summary of Comments For taxable years beginning after May 17, 2006, § 1.199-2T(e)(2)(i) provides that the term *W-2 wages* includes only amounts described in § 1.199-2(e)(1) (paragraph (e)(1) wages) that are properly allocable to DPGR (as defined in § 1.199-3) for purposes of section 199(c)(1). A taxpayer may determine the amount of paragraph (e)(1) wages that is properly allocable to DPGR using any reasonable method that is satisfactory to the Secretary based on all of the facts and circumstances. Section 1.199-2T(e)(2)(ii) and

(iii)provide safe harbors for determining the amount of paragraph (e)(1) wages that is properly allocable to DPGR. Under the wage expense safe harbor in § 1.199-2T(e)(2)(ii)(A) for taxpayers using either the section 861 method of cost allocation under § 1.199-4(d) or the simplified deduction method under § 1.199-4(e), a taxpayer may determine the amount of paragraph (e)(1) wages that is properly allocable to DPGR by multiplying the amount of paragraph (e)(1) wages by the ratio of the taxpayer's wage expense included in calculating QPAI for the taxable year to the taxpayer's total wage expense used in calculating the taxpayer's taxable income (or AGI, if applicable) for the taxable year. For purposes of determining the amount of wage expense included in cost of goods sold

(CGS)for this safe harbor, § 1.199-2T(e)(2)(ii)(B) provides that a taxpayer may determine its wage expense included in CGS using any reasonable method that is satisfactory to the Secretary based on all of the facts and circumstances. Under the wage expense safe harbor in § 1.199-2T(e)(2)(ii)(A), a taxpayer uses its wage expense, not W-2 wages, to determine the amount of W-2 wages that are properly allocable to DPGR. Section 1.199-2T(e)(2)(ii)(A) defines the term *wage expense* as wages (that is, compensation paid by the employer in the active conduct of a trade or business to its employees) that are properly taken into account under the taxpayer's method of accounting. The commentator suggested that, in certain circumstances, it should not be necessary for W-2 wages to be paid by a taxpayer in order for those wages to be properly allocable to DPGR. Specifically, the commentator suggested that W-2 wages should be treated as properly allocable to DPGR if the wages are paid to employees that are performing services in connection with an activity attributable to DPGR. Thus, in the case of partnership-shared services, if the employees of one partnership perform services that give rise to DPGR for another partnership and both partnerships have common ownership, then some or all of the W-2 wages should be treated as properly allocable to DPGR. The commentator further suggested that W-2 wages should be properly allocable to DPGR as long as the owner of the pass-thru entity includes in its taxable income DPGR (as a distributive share of another pass-thru entity's DPGR) and deducts from its taxable income wages paid to employees (those employed by the pass-thru entity) whose services created that DPGR. As an alternative, the commentator suggested that owners of certain pass-thru entities be permitted to treat non-DPGR as DPGR for purposes of determining whether W-2 wages are properly allocable to DPGR. The commentator suggested that the activity attribution rules for qualifying in-kind partnerships in § 1.199-3T(i)(7)(i), EAG partnerships in § 1.199-3T(i)(8)(ii), and EAGs in § 1.199-7(a)(3) be extended to pass-thru entities with respect to gross receipts attributable to services performed by employees of a pass-thru entity if such gross receipts are taken into account as an item of income on a tax return in which the DPGR attributable to those services also is reported. The commentator believes the result of such a rule would be to recharacterize non-DPGR as DPGR if the activities giving rise to the employee wages contribute to generating DPGR that is reported on the same tax return as the wage deduction. Therefore, the pass-thru entity with the employees would be treated as engaged in a qualifying production activity to the extent of the W-2 wages and the W-2 wages would be treated as properly allocable to DPGR. The interplay between the TIPRA amendment to section 199(b)(2) and the rules for qualifying in-kind partnerships under § 1.199-3T(i)(7), EAG partnerships under § 1.199-3T(i)(8), and EAGs under § 1.199-7 may reduce or eliminate the section 199 deduction for EAGs and partners in qualifying in-kind partnerships if one entity uses employees of another entity to perform activities giving rise to DPGR. In addition, even though § 1.199-3(f) provides rules for contract manufacturing and certain government contracts, the TIPRA amendment to section 199(b)(2) may reduce or eliminate the section 199 deduction for taxpayers entering into such contracts because the contract manufacturer's W-2 wages are not attributed to the taxpayer. The commentator's suggestions would treat pass-thru entities more favorably than non-consolidated EAGs. In general, § 1.199-7(a) and

(b)provides that each member of an EAG calculates its own taxable income or loss, QPAI, and W-2 wages, which are then aggregated in determining the EAG's section 199 deduction. After the TIPRA amendment to section 199(b)(2), to qualify as W-2 wages within the meaning of § 1.199-2T(e)(2), paragraph (e)(1) wages must be properly allocable to DPGR. Because each member of an EAG separately calculates its own items before they are aggregated by the EAG, the member having the paragraph (e)(1) wages must itself have DPGR to which the wages are properly allocable in order to qualify those wages as W-2 wages. Paragraph (e)(1) wages that are not properly allocable to DPGR of the member having the paragraph (e)(1) wages do not qualify as W-2 wages, even if the paragraph (e)(1) wages were paid in connection with another member's DPGR activities. *Example 5* in § 1.199-2T(e)(2)(iv) illustrates this point. Section 514(b) of TIPRA amended section 199(d)(1)(A)(iii) regarding a partner's or shareholder's share of W-2 wages from a partnership or S corporation for taxable years beginning after May 17, 2006. After TIPRA, the section 199(d)(1)(A)(iii) rule for determining a partner's or shareholder's share of W-2 wages from a pass-thru entity no longer includes the second prong of the former two-prong standard, by which a partner's or shareholder's share of W-2 wages from the partnership or S corporation was limited to the lesser of that person's allocable share of W-2 wages from the entity or a specified percentage of the person's QPAI, computed by taking into account only the items of the entity allocated to that person for the taxable year of the entity. Before TIPRA, if the employees of a partnership performed services that gave rise to DPGR for another entity, but the partnership had no DPGR, then under the section 199(d)(1)(A)(iii) wage limitation, a partner could not take into account any W-2 wages from the partnership. After TIPRA, if the partner uses the section 861 method of cost allocation under § 1.199-4(d), the partner cannot take into account any W-2 wages from the partnership because the W-2 wages do not generate DPGR in the partnership. Thus, in the case of partnership-shared services where the partner uses the section 861 method, the TIPRA amendment to section 199(b)(2) retains the result that the partner cannot take into account any W-2 wages from the partnership in applying the wage limitation under section 199(b)(1). Moreover, the TIPRA amendment modified the W-2 wage limitation to narrow the availability of the section 199 deduction. The commentator's suggestions would allow more taxpayers to claim the section 199 deduction and increase the amount of the deduction for some taxpayers, which conflicts with the changes made by TIPRA. Accordingly, the final regulations do not adopt the commentator's suggestions. In finalizing § 1.199-5, certain clarifying changes have been made and conforming clarifications have been made to § 1.199-9. As described in the preamble to the final and temporary regulations on the TIPRA amendments to section 199, published on October 19, 2006 (TD 9293, 71 FR 61662), the combination of the aggregation rules for determining the taxable income of an EAG in § 1.199-7(b)(1) of the June 1, 2006 final regulations (TD 9263, 71 FR 31268) and the rules of section 172 for net operating loss deductions could cause the unintended result of the same loss being used twice in determining the taxable income limitation under section 199(a)(1)(B). To eliminate this unintended result, § 1.199-7T(b)(4) was promulgated to prevent a loss that was used in the year it was sustained in determining any EAG's taxable income for purposes of the taxable income limitation under section 199(a)(1)(B) from being used again as either a carryover or carryback to any taxable year in determining the taxable income limitation under section 199(a)(1)(B). No comments were received on the provisions of § 1.199-7T(b)(4) and those provisions are finalized without change. Effective/Applicability Dates Section 199 applies to taxable years beginning after December 31, 2004. Sections 1.199-2(e)(2), 1.199-3(i)(7) and (8), and 1.199-5 are applicable for taxable years beginning on or after October 19, 2006 (the effective date of the temporary regulations). A taxpayer may apply §§ 1.199-2(e)(2), 1.199-3(i)(7) and (8), and 1.199-5 to taxable years beginning after May 17, 2006, and before October 19, 2006, regardless of whether the taxpayer otherwise relied upon Notice 2005-14 (2005-1 CB 498) (see § 601.601(d)(2)(ii)( *b* )), the provisions of REG-105847-05 (2005-2 CB 987), or §§ 1.199-1 through 1.199-8. Section 1.199-7(b)(4) is applicable for taxable years beginning on or after February 15, 2008. Special Analyses It has been determined that this Treasury decision 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 this regulation, and because the regulation does 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 Code, the notice of proposed rulemaking preceding this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Drafting Information The principal authors of these regulations are Paul Handleman and Lauren Ross Taylor, Office of the Associate Chief Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the IRS and Treasury Department participated in their development. 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 1.199-0 is amended by adding new entries for §§ 1.199-2(e)(2), 1.199-3(i)(7), 1.199-3(i)(8), 1.199-5, and 1.199-7(b)(4) to read as follows: § 1.199-0 Table of contents. § 1.199-2 Wage limitation.

(e)* * *

(2)Limitation on W-2 wages for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005.

(i)In general.

(ii)Wage expense safe harbor.

(A)In general.

(B)Wage expense included in cost of goods sold.

(iii)Small business simplified overall method safe harbor.

(iv)Examples. § 1.199-3 Domestic production gross receipts.

(i)* * *

(7)Qualifying in-kind partnership for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005.

(i)In general.

(ii)Definition of qualifying in-kind partnership.

(iii)Other rules.

(iv)Example.

(8)Partnerships owned by members of a single expanded affiliated group for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005.

(i)In general.

(ii)Attribution of activities.

(A)In general.

(B)Attribution between EAG partnerships.

(C)Exceptions to attribution.

(iii)Other rules.

(iv)Examples. § 1.199-5 Application of section 199 to pass-thru entities for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005.

(a)In general.

(b)Partnerships.

(1)In general.

(i)Determination at partner level.

(ii)Determination at entity level.

(2)Disallowed losses or deductions.

(3)Partner's share of paragraph (e)(1) wages.

(4)Transition rule for definition of W-2 wages and for W-2 wage limitation.

(5)Partnerships electing out of subchapter K.

(6)Examples.

(c)S corporations.

(1)In general.

(i)Determination at shareholder level.

(ii)Determination at entity level.

(2)Disallowed losses and deductions.

(3)Shareholder's share of paragraph (e)(1) wages.

(4)Transition rule for definition of W-2 wages and for W-2 wage limitation.

(d)Grantor trusts.

(e)Non-grantor trusts and estates.

(1)Allocation of costs.

(2)Allocation among trust or estate and beneficiaries.

(i)In general.

(ii)Treatment of items from a trust or estate reporting qualified production activities income.

(3)Transition rule for definition of W-2 wages and for W-2 wage limitation.

(4)Example.

(f)Gain or loss from the disposition of an interest in a pass-thru entity.

(g)No attribution of qualified activities. § 1.199-7 Expanded affiliated groups.

(b)* * *

(4)Losses used to reduce taxable income of expanded affiliated group.

(i)In general.

(ii)Examples. § 1.199-8 Other rules.

(i)* * *

(5)Tax Increase Prevention and Reconciliation Act of 2005.

(6)Losses used to reduce taxable income of expanded affiliated group. § 1.199-1 [Amended] **Par. 3.** Section 1.199-1 is amended by removing the language “§ 1.199-9(d)” in paragraphs (d)(3)(i) and

(ii)and adding the language “§ 1.199-5(d) or § 1.199-9(d)” in its place. **Par. 4.** Section 1.199-2 is amended by revising paragraph (e)(2) to read as follows: § 1.199-2 Wage limitation.

(e)* * *

(2)*Limitation on W-2 wages for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005* —(i) *In general.* The term *W-2 wages* includes only amounts described in paragraph (e)(1) of this section (paragraph (e)(1) wages) that are properly allocable to domestic production gross receipts

(DPGR)(as defined in § 1.199-3) for purposes of section 199(c)(1). A taxpayer may determine the amount of paragraph (e)(1) wages that is properly allocable to DPGR using any reasonable method that is satisfactory to the Secretary based on all of the facts and circumstances.

(ii)*Wage expense safe harbor* —(A) *In general.* A taxpayer using either the section 861 method of cost allocation under § 1.199-4(d) or the simplified deduction method under § 1.199-4(e) may determine the amount of paragraph (e)(1) wages that is properly allocable to DPGR for a taxable year by multiplying the amount of paragraph (e)(1) wages for the taxable year by the ratio of the taxpayer's wage expense included in calculating qualified production activities income

(QPAI)(as defined in § 1.199-1(c)) for the taxable year to the taxpayer's total wage expense used in calculating the taxpayer's taxable income (or adjusted gross income, if applicable) for the taxable year, without regard to any wage expense disallowed by section 465, 469, 704(d), or 1366(d). A taxpayer that uses the section 861 method of cost allocation under § 1.199-4(d) or the simplified deduction method under § 1.199-4(e) to determine QPAI must use the same expense allocation and apportionment methods that it uses to determine QPAI to allocate and apportion wage expense for purposes of this safe harbor. For purposes of this paragraph (e)(2)(ii), the term *wage expense* means wages (that is, compensation paid by the employer in the active conduct of a trade or business to its employees) that are properly taken into account under the taxpayer's method of accounting.

(B)*Wage expense included in cost of goods sold.* For purposes of paragraph (e)(2)(ii)(A) of this section, a taxpayer may determine its wage expense included in cost of goods sold

(CGS)using any reasonable method that is satisfactory to the Secretary based on all of the facts and circumstances, such as using the amount of direct labor included in CGS or using section 263A labor costs (as defined in § 1.263A-1(h)(4)(ii)) included in CGS.

(iii)*Small business simplified overall method safe harbor.* A taxpayer that uses the small business simplified overall method under § 1.199-4(f) may use the small business simplified overall method safe harbor for determining the amount of paragraph (e)(1) wages that is properly allocable to DPGR. Under this safe harbor, the amount of paragraph (e)(1) wages that is properly allocable to DPGR is equal to the same proportion of paragraph (e)(1) wages that the amount of DPGR bears to the taxpayer's total gross receipts.

(iv)*Examples.* The following examples illustrate the application of this paragraph (e)(2). See § 1.199-5(e)(4) for an example of the application of paragraph (e)(2)(ii) of this section to a trust or estate. The examples read as follows: Example 1. *Section 861 method and no EAG.*

(i)*Facts.* X, a United States corporation that is not a member of an expanded affiliated group

(EAG)(as defined in § 1.199-7) or an affiliated group as defined in the regulations under section 861, engages in activities that generate both DPGR and non-DPGR. X's taxable year ends on April 30, 2011. For X's taxable year ending April 30, 2011, X has $3,000 of paragraph (e)(1) wages reported on 2010 Forms W-2. All of X's production activities that generate DPGR are within Standard Industrial Classification

(SIC)Industry Group AAA (SIC AAA). All of X's production activities that generate non-DPGR are within SIC Industry Group BBB (SIC BBB). X is able to specifically identify CGS allocable to DPGR and to non-DPGR. X incurs $900 of research and experimentation expenses (R&E) that are deductible under section 174, $300 of which are performed with respect to SIC AAA and $600 of which are performed with respect to SIC BBB. None of the R&E is legally mandated R&E as described in § 1.861-17(a)(4) and none of the R&E is included in CGS. X incurs section 162 selling expenses that are not includible in CGS and are definitely related to all of X's gross income. For X's taxable year ending April 30, 2011, the adjusted basis of X's assets is $50,000, $40,000 of which generate gross income attributable to DPGR and $10,000 of which generate gross income attributable to non-DPGR. For X's taxable year ending April 30, 2011, the total square footage of X's headquarters is 8,000 square feet, of which 2,000 square feet is set aside for domestic production activities. For its taxable year ending April 30, 2011, X's taxable income is $1,380 based on the following Federal income tax items: DPGR (all from sales of products within SIC AAA) $3,000 Non-DPGR (all from sales of products within SIC BBB) 3,000 CGS allocable to DPGR (includes $200 of wage expense)

(600)CGS allocable to non-DPGR (includes $600 of wage expense) (1,800) Section 162 selling expenses (includes $600 of wage expense)

(840)Section 174 R&E-SIC AAA (includes $100 of wage expense)

(300)Section 174 R&E-SIC BBB (includes $200 of wage expense)

(600)Interest expense (not included in CGS)

(300)Headquarters overhead expense (includes $100 of wage expense)

(180)X's taxable income 1,380

(ii)*X's QPAI.* X allocates and apportions its deductions to gross income attributable to DPGR under the section 861 method in § 1.199-4(d). In this case, the section 162 selling expenses and overhead expense are definitely related to all of X's gross income. Based on the facts and circumstances of this specific case, apportionment of the section 162 selling expenses between DPGR and non-DPGR on the basis of X's gross receipts is appropriate. In addition, based on the facts and circumstances of this specific case, apportionment of the headquarters overhead expense between DPGR and non-DPGR on the basis of the square footage of X's headquarters is appropriate. For purposes of apportioning R&E, X elects to use the sales method as described in § 1.861-17(c). X elects to apportion interest expense under the tax book value method of § 1.861-9T(g). X has $2,400 of gross income attributable to DPGR (DPGR of $3,000 − CGS of $600 allocated based on X's books and records). X's QPAI for its taxable year ending April 30, 2011, is $1,395, as shown in the following table: DPGR (all from sales of products within SIC AAA) $3,000 CGS allocable to DPGR

(600)Section 162 selling expenses ($840 × ($3,000 DPGR/$6,000 total gross receipts))

(420)Section 174 R&E-SIC AAA

(300)Interest expense (not included in CGS) ($300 × ($40,000 (X's DPGR assets)/$50,000 (X's total assets)))

(240)Headquarters overhead expense ($180 × (2,000 square feet attributable to DPGR activity/total 8,000 square feet))

(45)X's QPAI 1,395

(iii)*W-2 wages.* X chooses to use the wage expense safe harbor under paragraph (e)(2)(ii) of this section to determine its W-2 wages, as shown in the following steps:

(A)*Step one.* X determines that $625 of wage expense were taken into account in determining its QPAI in paragraph

(ii)of this *Example 1,* as shown in the following table: CGS wage expense $200 Section 162 selling expenses wage expense ($600 × ($3,000 DPGR/$6,000 total gross receipts)) 300 Section 174 R&E-SIC AAA wage expense 100 Headquarters overhead wage expense ($100 × (2,000 square feet attributable to DPGR activity/8,000 total square feet)) 25 Total wage expense taken into account 625

(B)*Step two.* X determines that $1,042 of the $3,000 in paragraph (e)(1) wages are properly allocable to DPGR, and are therefore W-2 wages, as shown in the following calculation: Step one wage expense/X's total wage expense for taxable year ending April 30, 2011 × X's paragraph (e)(1) wages $625/$1,800 × $3,000 = $1,042

(iv)*Section 199 deduction determination.* X's tentative deduction under § 1.199-1(a) (section 199 deduction) is $124 (.09 × (lesser of QPAI of $1,395 or taxable income of $1,380)) subject to the wage limitation under section 199(b)(1) (W-2 wage limitation) of $521 (50% × $1,042). Accordingly, X's section 199 deduction for its taxable year ending April 30, 2011, is $124. Example 2. *Section 861 method and EAG.*

(i)*Facts.* The facts are the same as in *Example 1* except that X owns stock in Y, a United States corporation, equal to 75% of the total voting power of the stock of Y and 80% of the total value of the stock of Y. X and Y are not members of an affiliated group as defined in section 1504(a). Accordingly, the rules of § 1.861-14T do not apply to X's and Y's selling expenses, R&E, and charitable contributions. X and Y are, however, members of an affiliated group for purposes of allocating and apportioning interest expense (see § 1.861-11T(d)(6)) and are also members of an EAG. Y's taxable year ends April 30, 2011. For Y's taxable year ending April 30, 2011, Y has $2,000 of paragraph (e)(1) wages reported on 2010 Forms W-2. For Y's taxable year ending April 30, 2011, the adjusted basis of Y's assets is $50,000, $20,000 of which generate gross income attributable to DPGR and $30,000 of which generate gross income attributable to non-DPGR. All of Y's activities that generate DPGR are within SIC Industry Group AAA (SIC AAA). All of Y's activities that generate non-DPGR are within SIC Industry Group BBB (SIC BBB). None of X's and Y's sales are to each other. Y is not able to specifically identify CGS allocable to DPGR and non-DPGR. In this case, because CGS is definitely related under the facts and circumstances to all of Y's gross receipts, apportionment of CGS between DPGR and non-DPGR based on gross receipts is appropriate. For Y's taxable year ending April 30, 2011, the total square footage of Y's headquarters is 8,000 square feet, of which 2,000 square feet is set aside for domestic production activities. Y incurs section 162 selling expenses that are not includible in CGS and are definitely related to all of Y's gross income. For Y's taxable year ending April 30, 2011, Y's taxable income is $1,710 based on the following Federal income tax items: DPGR (all from sales of products within SIC AAA) $3,000 Non-DPGR (all from sales of products within SIC BBB) 3,000 CGS allocated to DPGR (includes $300 of wage expense) (1,200) CGS allocated to non-DPGR (includes $300 of wage expense) (1,200) Section 162 selling expenses (includes $300 of wage expense)

(840)Section 174 R&E-SIC AAA (includes $20 of wage expense)

(100)Section 174 R&E-SIC BBB (includes $60 of wage expense)

(200)Interest expense (not included in CGS and not subject to § 1.861-10T)

(500)Charitable contributions

(50)Headquarters overhead expense (includes $40 of wage expense)

(200)Y's taxable income 1,710

(ii)*QPAI.*

(A)*X's QPAI.* Determination of X's QPAI is the same as in *Example 1* except that interest is apportioned to gross income attributable to DPGR based on the combined adjusted bases of X's and Y's assets. See § 1.861-11T(c). Accordingly, X's QPAI for its taxable year ending April 30, 2011, is $1,455, as shown in the following table: DPGR (all from sales of products within SIC AAA) $3,000 CGS allocated to DPGR

(600)Section 162 selling expenses ($840 × ($3,000 DPGR/$6,000 total gross receipts))

(420)Section 174 R&E-SIC AAA

(300)Interest expense (not included in CGS and not subject to § 1.861-10T) ($300 × ($60,000 (tax book value of X's and Y's DPGR assets)/$100,000 (tax book value of X's and Y's total assets)))

(180)Headquarters overhead expense ($180 × (2,000 square feet attributable to DPGR activity/total 8,000 square feet))

(45)X's QPAI 1,455

(B)*Y's QPAI.* Y makes the same elections under the section 861 method as does X. Y has $1,800 of gross income attributable to DPGR (DPGR of $3,000−CGS of $1,200 allocated based on Y's gross receipts). Y's QPAI for its taxable year ending April 30, 2011, is $905, as shown in the following table: DPGR (all from sales of products within SIC AAA) $3,000 CGS allocated to DPGR (1,200) Section 162 selling expenses ($840 × ($3,000 DPGR/$6,000 total gross receipts))

(420)Section 174 R&E-SIC AAA

(100)Interest expense (not included in CGS and not subject to § 1.861-10T) ($500 × ($60,000 (tax book value of X's and Y's DPGR assets)/$100,000 (tax book value of X's and Y's total assets)))

(300)Charitable contributions (not included in CGS) ($50 × ($1,800 gross income attributable to DPGR/$3,600 total gross income))

(25)Headquarters overhead expense ($200 × (2,000 square feet attributable to DPGR activity/total 8,000 square feet))

(50)Y's QPAI 905

(iii)*W-2 wages.*

(A)*X's W-2 wages.* X's W-2 wages are $1,042, the same as in *Example 1.*

(B)*Y's W-2 wages.* Y chooses to use the wage expense safe harbor under paragraph (e)(2)(ii) of this section to determine its W-2 wages, as shown in the following steps: ( *1* ) *Step one.* Y determines that $480 of wage expense were taken into account in determining its QPAI in paragraph (ii)(B) of this *Example 2* , as shown in the following table: CGS wage expense $300 Section 162 selling expenses wage expense ($300 × ($3,000 DPGR/$6,000 total gross receipts)) 150 Section 174 R&E-SIC AAA wage expense 20 Headquarters overhead wage expense ($40 × (2,000 square feet attributable to DPGR activity/8,000 total square feet)) 10 Total wage expense taken into account 480 ( *2* ) *Step two.* Y determines that $941 of the $2,000 paragraph (e)(1) wages are properly allocable to DPGR, and are therefore W-2 wages, as shown in the following calculation: Step one wage expense/Y's total wage expense for taxable year ending April 30, 2011 × Y's paragraph (e)(1) wages $480/$1,020 × $2,000 = $941

(iv)*Section 199 deduction determination.* The section 199 deduction of the X and Y EAG is determined by aggregating the separately determined taxable income, QPAI, and W-2 wages of X and Y. See § 1.199-7(b). Accordingly, the X and Y EAG's tentative section 199 deduction is $212 (.09 × (lesser of combined QPAI of X and Y of $2,360 (X's QPAI of $1,455 plus Y's QPAI of $905) or combined taxable incomes of X and Y of $3,090 (X's taxable income of $1,380 plus Y's taxable income of $1,710)) subject to the combined W-2 wage limitation of X and Y of $992 (50% × ($1,042 (X's W-2 wages) + $941 (Y's W-2 wages)))). Accordingly, the X and Y EAG's section 199 deduction is $212. The $212 is allocated to X and Y in proportion to their QPAI. See § 1.199-7(c). Example 3. *Simplified deduction method.*

(i)*Facts.* Z, a corporation that is not a member of an EAG, engages in activities that generate both DPGR and non-DPGR. Z is able to specifically identify CGS allocable to DPGR and to non-DPGR. Z's taxable year ends on April 30, 2011. For Z's taxable year ending April 30, 2011, Z has $3,000 of paragraph (e)(1) wages reported on 2010 Forms W-2, and Z's taxable income is $1,380 based on the following Federal income tax items: DPGR $3,000 Non-DPGR 3,000 CGS allocable to DPGR (includes $200 of wage expense)

(600)CGS allocable to non-DPGR (includes $600 of wage expense) (1,800) Expenses, losses, or deductions (deductions) (includes $1,000 of wage expense) (2,220) Z's taxable income 1,380

(ii)*Z's QPAI.* Z uses the simplified deduction method under § 1.199-4(e) to apportion deductions between DPGR and non-DPGR. Z's QPAI for its taxable year ending April 30, 2011, is $1,290, as shown in the following table: DPGR $3,000 CGS allocable to DPGR

(600)Deductions apportioned to DPGR ($2,220 × ($3,000 DPGR/$6,000 total gross receipts)) (1,110) Z's QPAI 1,290

(iii)*W-2 wages.* Z chooses to use the wage expense safe harbor under paragraph (e)(2)(ii) of this section to determine its W-2 wages, as shown in the following steps:

(A)*Step one.* Z determines that $700 of wage expense were taken into account in determining its QPAI in paragraph

(ii)of this *Example 3,* as shown in the following table: Wage expense included in CGS allocable to DPGR $200 Wage expense included in deductions ($1,000 in wage expense × ($3,000 DPGR/$6,000 total gross receipts)) 500 Wage expense allocable to DPGR 700

(B)*Step two.* Z determines that $1,167 of the $3,000 paragraph (e)(1) wages are properly allocable to DPGR, and are therefore W-2 wages, as shown in the following calculation: *Step one wage expense* / Z's total wage expense for taxable year ending April 30, 2011 × Z's paragraph (e)(1) wages $700 / $1,800 × $3,000 = $1,167

(iv)*Section 199 deduction determination.* Z's tentative section 199 deduction is $116 (.09 × (lesser of QPAI of $1,290 or taxable income of $1,380)) subject to the W-2 wage limitation of $584 (50% × $1,167). Accordingly, Z's section 199 deduction for its taxable year ending April 30, 2011, is $116. Example 4. *Small business simplified overall method.*

(i)*Facts.* Z, a corporation that is not a member of an EAG, engages in activities that generate both DPGR and non-DPGR. Z's taxable year ends on April 30, 2011. For Z's taxable year ending April 30, 2011, Z has $3,000 of paragraph (e)(1) wages reported on 2010 Forms W-2, and Z's taxable income is $1,380 based on the following Federal income tax items: DPGR $3,000 Non-DPGR 3,000 CGS and deductions (4,620) Z's taxable income 1,380

(ii)*Z's QPAI.* Z uses the small business simplified overall method under § 1.199-4(f) to apportion CGS and deductions between DPGR and non-DPGR. Z's QPAI for its taxable year ending April 30, 2011, is $690, as shown in the following table: DPGR $3,000 CGS and deductions apportioned to DPGR ($4,620 × ($3,000 DPGR/$6,000 total gross receipts)) (2,310) Z's QPAI 690

(iii)*W-2 wages.* Z's W-2 wages under paragraph (e)(2)(iii) of this section are $1,500, as shown in the following calculation: $3,000 in paragraph (e)(1) wages × ($3,000 DPGR/$6,000 total gross receipts) $1,500

(iv)*Section 199 deduction determination.* Z's tentative section 199 deduction is $62 (.09 × (lesser of QPAI of $690 or taxable income of $1,380)) subject to the W-2 wage limitation of $750 (50% × $1,500). Accordingly, Z's section 199 deduction for its taxable year ending April 30, 2011, is $62. Example 5. *Corporation uses employees of non-consolidated EAG member.*

(i)*Facts.* Corporations S and B are the only members of a single EAG but are not members of a consolidated group. S and B are both calendar year taxpayers. All the activities described in this *Example 5* take place during the same taxable year and they are the only activities of S and B. S and B each use the section 861 method described in § 1.199-4(d) for allocating and apportioning their deductions. B is a manufacturer but has only three employees of its own. S employs the remainder of the personnel who perform the manufacturing activities for B. S's only receipts are from supplying employees to B. In 2010, B manufactures qualifying production property

(QPP)(as defined in § 1.199-3(j)(1)), using its three employees and S's employees, and sells the QPP for $10,000,000. B's total CGS and other deductions are $6,000,000, including $1,000,000 paid to S for the use of S's employees and $100,000 paid to its own employees. B reports the $100,000 paid to its employees on the 2010 Forms W-2 issued to its employees. S pays its employees $800,000 that is reported on the 2010 Forms W-2 issued to the employees.

(ii)*B's W-2 wages.* In determining its W-2 wages, B utilizes the wage expense safe harbor described in paragraph (e)(2)(ii) of this section. The entire $100,000 paid by B to its employees is included in B's wage expense included in calculating its QPAI and is the only wage expense used in calculating B's taxable income. Thus, under the wage expense safe harbor described in paragraph (e)(2)(ii) of this section, B's W-2 wages are $100,000 ($100,000 (paragraph (e)(1) wages) × ($100,000 (wage expense used in calculating B's QPAI)/$100,000 (wage expense used in calculating B's taxable income))).

(iii)*S's W-2 wages.* In determining its W-2 wages, S utilizes the wage expense safe harbor described in paragraph (e)(2)(ii) of this section. Because S's $1,000,000 in receipts from B do not qualify as DPGR and are S's only gross receipts, none of the $800,000 paid by S to its employees is included in S's wage expense included in calculating its QPAI. However, the entire $800,000 is included in calculating S's taxable income. Thus, under the wage expense safe harbor described in paragraph (e)(2)(ii)(A) of this section, S's W-2 wages are $0 ($800,000 (paragraph (e)(1) wages) × ($0 (wage expense used in calculating S's QPAI)/$800,000 (wage expense used in calculating S's taxable income))).

(iv)*Determination of EAG's section 199 deduction.* The section 199 deduction of the S and B EAG is determined by aggregating the separately determined taxable income or loss, QPAI, and W-2 wages of S and B. See § 1.199-7(b). B's taxable income and QPAI are each $4,000,000 ($10,000,000 DPGR − $6,000,000 CGS and other deductions). S's taxable income is $200,000 ($1,000,000 gross receipts − $800,000 total deductions). S's QPAI is $0 ($0 DPGR − $0 CGS and other deductions). B's W-2 wages (as calculated in paragraph

(ii)of this *Example 5* ) are $100,000 and S's W-2 wages (as calculated in paragraph

(iii)of this *Example 5* ) are $0. The EAG's tentative section 199 deduction is $360,000 (.09 × (lesser of combined QPAI of $4,000,000 (B's QPAI of $4,000,000 + S's QPAI of $0) or combined taxable income of $4,200,000 (B's taxable income of $4,000,000 + S's taxable income of $200,000))) subject to the W-2 wage limitation of $50,000 (50% × ($100,000 (B's W-2 wages) + $0 (S's W-2 wages))). Accordingly, the S and B EAG's section 199 deduction for 2010 is $50,000. The $50,000 is allocated to S and B in proportion to their QPAI. See § 1.199-7(c). Because S has no QPAI, the entire $50,000 is allocated to B. *Example 6.* *Corporation using employees of consolidated EAG member.* The facts are the same as in *Example 5* except that B and S are members of the same consolidated group. Ordinarily, as demonstrated in *Example 5,* S's $1,000,000 of receipts would not be DPGR and its $800,000 paid to its employees would not be W-2 wages (because the $800,000 would not be properly allocable to DPGR). However, because S and B are members of the same consolidated group, § 1.1502-13(c)(1)(i) provides that the separate entity attributes of S's intercompany items or B's corresponding items, or both, may be redetermined in order to produce the same effect as if S and B were divisions of a single corporation. If S and B were divisions of a single corporation, S and B would have QPAI and taxable income of $4,200,000 ($10,000,000 DPGR received from the sale of the QPP − $5,800,000 CGS and other deductions) and, under the wage expense safe harbor described in paragraph (e)(2)(ii) of this section, would have $900,000 of W-2 wages ($900,000 (combined paragraph (e)(1) wages of S and B) × ($900,000 (wage expense used in calculating QPAI)/$900,000 (wage expense used in calculating taxable income))). The single corporation would have a tentative section 199 deduction equal to 9% of $4,200,000, or $378,000, subject to the W-2 wage limitation of 50% of $900,000, or $450,000. Thus, the single corporation would have a section 199 deduction of $378,000. To obtain this same result for the consolidated group, S's $1,000,000 of receipts from the intercompany transaction are redetermined as DPGR. Thus, S's $800,000 paid to its employees are costs properly allocable to DPGR and S's W-2 wages are $800,000. Accordingly, the consolidated group has QPAI and taxable income of $4,200,000 ($11,000,000 DPGR (from the sale of the QPP and the redetermined intercompany transaction) − $6,800,000 CGS and other deductions) and W-2 wages of $900,000. The consolidated group's section 199 deduction is $378,000, the same as the single corporation. However, for purposes of allocating the section 199 deduction between S and B, the redetermination of S's income as DPGR under § 1.1502-13(c)(1)(i) is not taken into account. See § 1.199-7(d)(5). Accordingly, the consolidated group's entire section 199 deduction of $378,000 is allocated to B. § 1.199-2T [Removed] **Par. 5.** Section 1.199-2T is removed. **Par. 6.** Section 1.199-3 is amended by: 1. Revising the first sentence of paragraph (f)(1). 2. Adding the language “paragraph (i)(8) of this section and” before the language “§ 1.199-9(j)” in paragraph (g)(4)(ii)(B). 3. Adding the language “paragraph (i)(7) of this section and” before the language “§ 1.199-9(i)” in paragraph (g)(4)(ii)(D). 4. Revising paragraphs (i)(7) and (8). 5. Removing the language “§ 1.199-9(e)” in the last sentence of paragraph (m)(6)(iv)(B) and adding the language “§§ 1.199-5(e) and 1.199-9(e)” in its place. 6. Revising the second and third sentences in paragraph (p). The revisions read as follows: § 1.199-3 Domestic production gross receipts.

(f)* * *

(1)*In general.* With the exception of the rules applicable to an expanded affiliated group

(EAG)under § 1.199-7, qualifying in-kind partnerships under paragraph (i)(7) of this section and § 1.199-9(i), EAG partnerships under paragraph (i)(8) of this section and § 1.199-9(j), and government contracts under paragraph (f)(2) of this section, only one taxpayer may claim the deduction under § 1.199-1(a) with respect to any qualifying activity under paragraphs (e)(1), (k)(1), and (l)(1) of this section performed in connection with the same QPP, or the production of a qualified film or utilities. * * *

(i)* * *

(7)*Qualifying in-kind partnership for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005—(i) In general.* If a partnership is a qualifying in-kind partnership described in paragraph (i)(7)(ii) of this section, then each partner is treated as having MPGE or produced the property MPGE or produced by the partnership that is distributed to that partner. If a partner of a qualifying in-kind partnership derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of the property that was MPGE or produced by the qualifying in-kind partnership and distributed to that partner, then, provided such partner is a partner of the qualifying in-kind partnership at the time the partner disposes of the property, the partner is treated as conducting the MPGE or production activities previously conducted by the qualifying in-kind partnership with respect to that property. With respect to a lease, rental, or license, the partner is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts derived from the lease, rental, or license under its method of accounting. With respect to a sale, exchange, or other disposition, the partner is treated as having disposed of the property on the date it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account.

(ii)*Definition of qualifying in-kind partnership.* For purposes of this paragraph (i)(7), *a qualifying in-kind partnership* is a partnership engaged solely in—

(A)The extraction, refining, or processing of oil, natural gas (as described in paragraph (l)(2) of this section), petrochemicals, or products derived from oil, natural gas, or petrochemicals in whole or in significant part within the United States;

(B)The production or generation of electricity in the United States; or

(C)An activity or industry designated by the Secretary by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter).

(iii)*Other rules.* Except as provided in this paragraph (i)(7), a qualifying in-kind partnership is treated the same as other partnerships for purposes of section 199. Accordingly, a qualifying in-kind partnership is subject to the rules of this section regarding the application of section 199 to pass-thru entities, including application of the section 199(d)(1)(A)(iii) rule for determining a partner's share of the amounts described in § 1.199-2(e)(1) (paragraph (e)(1) wages) from the partnership under § 1.199-5(b)(3). In determining whether a qualifying in-kind partnership or its partners MPGE QPP in whole or in significant part within the United States, see paragraphs (g)(2) and

(3)of this section.

(iv)*Example.* The following example illustrates the application of this paragraph (i)(7). Assume that PRS and X are calendar year taxpayers. The example reads as follows: Example. X, Y, and Z are partners in PRS, a qualifying in-kind partnership described in paragraph (i)(7)(ii) of this section. X, Y, and Z are corporations. In 2007, PRS distributes oil to X that PRS derived from its oil extraction. PRS incurred $600 of CGS extracting the oil distributed to X, and X's adjusted basis in the distributed oil is $600. X incurs $200 of CGS in refining the oil within the United States. In 2007, X, while it is a partner in PRS, sells the oil to a customer for $1,500. X is treated as having disposed of the property on the date it ceases to own the property for Federal income tax purposes. Under paragraph (i)(7)(i) of this section, X is treated as having extracted the oil. The extraction and refining of the oil each qualify as an MPGE activity under paragraph (e)(1) of this section. Therefore, X's $1,500 of gross receipts qualify as DPGR. X subtracts from the $1,500 of DPGR the $600 of CGS incurred by PRS and the $200 of refining costs it incurred. Thus, X's QPAI is $700 for 2007.

(8)*Partnerships owned by members of a single expanded affiliated group for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005* —(i) *In general.* For purposes of this section, if all of the interests in the capital and profits of a partnership are owned by members of a single EAG at all times during the taxable year of the partnership (EAG partnership), then the EAG partnership and all members of that EAG are treated as a single taxpayer for purposes of section 199(c)(4) during that taxable year.

(ii)Attribution of activities—(A) *In general.* If a member of an EAG (disposing member) derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of property that was MPGE or produced by an EAG partnership, all the partners of which are members of the same EAG to which the disposing member belongs at the time that the disposing member disposes of such property, then the disposing member is treated as conducting the MPGE or production activities previously conducted by the EAG partnership with respect to that property. The previous sentence applies only for those taxable years in which the disposing member is a member of the EAG of which all the partners of the EAG partnership are members for the entire taxable year of the EAG partnership. With respect to a lease, rental, or license, the disposing member is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts from the lease, rental, or license under its method of accounting. With respect to a sale, exchange, or other disposition, the disposing member is treated as having disposed of the property on the date it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account. Likewise, if an EAG partnership derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of property that was MPGE or produced by a member (or members) of the same EAG (the producing member) to which all the partners of the EAG partnership belong at the time that the EAG partnership disposes of such property, then the EAG partnership is treated as conducting the MPGE or production activities previously conducted by the producing member with respect to that property. The previous sentence applies only for those taxable years in which the producing member is a member of the EAG of which all the partners of the EAG partnership are members for the entire taxable year of the EAG partnership. With respect to a lease, rental, or license, the EAG partnership is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts derived from the lease, rental, or license under its method of accounting. With respect to a sale, exchange, or other disposition, the EAG partnership is treated as having disposed of the property on the date it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account. See paragraph (i)(8)(iv) *Example 3* of this section.

(B)*Attribution between EAG partnerships.* If an EAG partnership (disposing partnership) derives gross receipts from the lease, rental, license, sale, exchange, or other disposition of property that was MPGE or produced by another EAG partnership (producing partnership), then the disposing partnership is treated as conducting the MPGE or production activities previously conducted by the producing partnership with respect to that property, provided that each of these partnerships (the producing partnership and the disposing partnership) is owned for its entire taxable year in which the disposing partnership disposes of such property by members of the same EAG. With respect to a lease, rental, or license, the disposing partnership is treated as having disposed of the property on the date or dates on which it takes into account its gross receipts from the lease, rental, or license under its method of accounting. With respect to a sale, exchange, or other disposition, the disposing partnership is treated as having disposed of the property on the date it ceases to own the property for Federal income tax purposes, even if no gain or loss is taken into account.

(C)*Exceptions to attribution.* Attribution of activities does not apply for purposes of the construction of real property under paragraph (m)(1) of this section and the performance of engineering and architectural services under paragraphs (n)(2) and

(3)of this section, respectively.

(iii)*Other rules.* Except as provided in this paragraph (i)(8), an EAG partnership is treated the same as other partnerships for purposes of section 199. Accordingly, an EAG partnership is subject to the rules of this section regarding the application of section 199 to pass-thru entities, including the section 199(d)(1)(A)(iii) rule under § 1.199-5(b)(3). In determining whether a member of an EAG or an EAG partnership MPGE QPP in whole or in significant part within the United States or produced a qualified film or produced utilities within the United States, see paragraphs (g)(2) and

(3)of this section and *Example 5* of paragraph (i)(8)(iv) of this section.

(iv)*Examples.* The following examples illustrate the rules of this paragraph (i)(8). Assume that PRS, X, Y, and Z all are calendar year taxpayers. The examples read as follows: Example 1. *Contribution.* X and Y are the only partners in PRS, a partnership, for PRS's entire 2007 taxable year. X and Y are both members of a single EAG for the entire 2007 year. In 2007, X MPGE QPP within the United States and contributes the QPP to PRS. In 2007, PRS sells the QPP for $1,000. Under this paragraph (i)(8), PRS is treated as having MPGE the QPP within the United States, and PRS's $1,000 gross receipts constitute DPGR. PRS, X, and Y must apply the rules of this section regarding the application of section 199 to pass-thru entities with respect to the activity of PRS, including the section 199(d)(1)(A)(iii) rule for determining a partner's share of the paragraph (e)(1) wages from the partnership under § 1.199-5(b)(3). Example 2. *Sale.* X, Y, and Z are the only members of a single EAG for the entire 2007 year. X and Y each own 50% of the capital and profits interests in PRS, a partnership, for PRS's entire 2007 taxable year. In 2007, PRS MPGE QPP within the United States and then sells the QPP to X for $6,000, its fair market value at the time of the sale. PRS's gross receipts of $6,000 qualify as DPGR. In 2007, X sells the QPP to customers for $10,000, incurring selling expenses of $2,000. Under paragraph (i)(8)(ii)(A) of this section, X is treated as having MPGE the QPP within the United States, and X's $10,000 of gross receipts qualify as DPGR. PRS, X and Y must apply the rules of this section regarding the application of section 199 to pass-thru entities with respect to the activity of PRS, including application of the section 199(d)(1)(A)(iii) rule for determining a partner's share of the paragraph (e)(1) wages from the partnership under § 1.199-5(b)(3). The results would be the same if PRS sold the QPP to Z rather than to X. However, if PRS did sell the QPP to Z, and Z was not a member of the EAG for PRS's entire taxable year, the activities previously conducted by PRS with respect to the QPP would not be attributed to Z, and none of Z's $10,000 of gross receipts would qualify as DPGR. Example 3. *Lease.* X, Y, and Z are the only members of a single EAG for the entire 2007 year. X and Y each own 50% of the capital and profits interests in PRS, a partnership, for PRS's entire 2007 taxable year. In 2007, PRS MPGE QPP within the United States and then sells the QPP to X for $6,000, its fair market value at the time of the sale. PRS's gross receipts of $6,000 qualify as DPGR. In 2007, X rents the QPP it acquired from PRS to customers unrelated to X. X takes the gross receipts attributable to the rental of the QPP into account under its method of accounting in 2007 and 2008. On July 1, 2008, X ceases to be a member of the same EAG to which Y, the other partner in PRS, belongs. For 2007, X is treated as having MPGE the QPP within the United States under paragraph (i)(8)(ii)(A) of this section, and its gross receipts derived from the rental of the QPP qualify as DPGR. For 2008, however, because X and Y, partners in PRS, are no longer members of the same EAG for the entire year, the gross rental receipts X takes into account in 2008 do not qualify as DPGR. Example 4. *Distribution.* X and Y are the only partners in PRS, a partnership, for PRS's entire 2007 taxable year. X and Y are both members of a single EAG for the entire 2007 year. In 2007, PRS MPGE QPP within the United States, incurring $600 of CGS, and then distributes the QPP to X. X's adjusted basis in the QPP is $600. X incurs $200 of CGS to further MPGE the QPP within the United States. In 2007, X sells the QPP for $1,500 to an unrelated customer. X is treated as having disposed of the QPP on the date it ceases to own the QPP for Federal income tax purposes. Under paragraph (i)(8)(ii)(A) of this section, X is treated as having MPGE the QPP within the United States, and X's $1,500 of gross receipts qualify as DPGR. Example 5. *Multiple sales.*

(i)Facts. X and Y are the only partners in PRS, a partnership, for PRS's entire 2007 taxable year. X and Y are both non-consolidated members of a single EAG for the entire 2007 year. PRS produces in bulk form in the United States the active ingredient for a drug. Assume that PRS's own MPGE activity with respect to the active ingredient is not substantial in nature, taking into account all of the facts and circumstances, and PRS's direct labor and overhead to MPGE the active ingredient within the United States are $15 and account for 15% of PRS's $100 CGS of the active ingredient. In 2007, PRS sells the active ingredient in bulk form to X. X uses the active ingredient to produce the finished dosage form drug. Assume that X's own MPGE activity with respect to the finished dosage form drug is not substantial in nature, taking into account all of the facts and circumstances, and X's direct labor and overhead to MPGE the finished dosage form drug within the United States are $12 and account for 10% of X's $120 CGS of the drug. In 2007, X sells the finished dosage form drug to Y and Y sells the finished dosage form drug to customers. Assume that Y's own MPGE activity with respect to the finished dosage form drug is not substantial in nature, taking into account all of the facts and circumstances, and Y incurs $2 of direct labor and overhead and Y's CGS in selling the finished dosage form drug to customers is $130.

(ii)*Analysis.* PRS's gross receipts from the sale of the active ingredient to X are non-DPGR because PRS's MPGE activity is not substantial in nature and PRS does not satisfy the safe harbor described in paragraph (g)(3) of this section because PRS's direct labor and overhead account for less than 20% of PRS's CGS of the active ingredient. X's gross receipts from the sale of the finished dosage form drug to Y are DPGR because X is considered to have MPGE the finished dosage form drug in significant part in the United States pursuant to the safe harbor described in paragraph (g)(3) of this section because the $27 ($15 + $12) of direct labor and overhead incurred by PRS and X equals or exceeds 20% of X's total CGS ($120) of the finished dosage form drug at the time X disposes of the finished dosage form drug to Y. Similarly, Y's gross receipts from the sale of the finished dosage form drug to customers are DPGR because Y is considered to have MPGE the finished dosage form drug in significant part in the United States pursuant to the safe harbor described in paragraph (g)(3) of this section because the $29 ($15 + $12 + $2) of direct labor and overhead incurred by PRS, X, and Y equals or exceeds 20% of Y's total CGS ($130) of the finished dosage form drug at the time Y disposes of the finished dosage form drug to Y's customers.

(p)* * * Thus, partners, including partners in partnerships described in paragraphs (i)(7) and

(8)of this section and § 1.199-9(i) and (j), may not treat guaranteed payments as DPGR. See §§ 1.199-5(b)(6) *Example 5* and 1.199-9(b)(6) *Example 5.* § 1.199-3T [Removed] **Par. 7.** Section 1.199-3T is removed. **Par. 8.** Section 1.199-4 is amended by: 1. Revising paragraph (d)(5). 2. Removing the language “§ 1.199-9(d)” in paragraph (e)(1) and adding the language “§ 1.199-5(d) or § 1.199-9(d)” in its place. 3. Revising paragraph (f)(5). The revisions read as follows: § 1.199-4 Costs allocable to domestic production gross receipts.

(d)* * *

(5)*Treatment of items from a pass-thru entity reporting qualified production activities income.* If, pursuant to § 1.199-5(e)(2) or § 1.199-9(e)(2), or to the authority granted in § 1.199-5(b)(1)(ii) or (c)(1)(ii), or § 1.199-9(b)(1)(ii) or (c)(1)(ii), a taxpayer must combine QPAI and W-2 wages from a partnership, S corporation, trust (to the extent not described in § 1.199-5(d) or § 1.199-9(d)) or estate with the taxpayer's total QPAI and W-2 wages from other sources, then for purposes of apportioning the taxpayer's interest expense under this paragraph (d), the taxpayer's interest in such partnership (and, where relevant in apportioning the taxpayer's interest expense, the partnership's assets), the taxpayer's shares in such S corporation, or the taxpayer's interest in such trust shall be disregarded.

(f)* * *

(5)*Trusts and estates.* Trusts and estates under §§ 1.199-5(e) and 1.199-9(e) may not use the small business simplified overall method. **Par. 9.** Section 1.199-5 is added to read as follows: § 1.199-5 Application of section 199 to pass-thru entities for taxable years beginning after May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2005.

(a)*In general.* The provisions of this section apply solely for purposes of section 199 of the Internal Revenue Code (Code).

(b)*Partnerships* —(1) *In general* —(i) *Determination at partner level.* The deduction with respect to the qualified production activities of the partnership allowable under § 1.199-1(a) (section 199 deduction) is determined at the partner level. As a result, each partner must compute its deduction separately. The section 199 deduction has no effect on the adjusted basis of the partner's interest in the partnership. Except as provided by publication pursuant to paragraph (b)(1)(ii) of this section, for purposes of this section, each partner is allocated, in accordance with sections 702 and 704, its share of partnership items (including items of income, gain, loss, and deduction), cost of goods sold

(CGS)allocated to such items of income, and gross receipts that are included in such items of income, even if the partner's share of CGS and other deductions and losses exceeds domestic production gross receipts

(DPGR)(as defined in § 1.199-3(a)). A partnership may specially allocate items of income, gain, loss, or deduction to its partners, subject to the rules of section 704(b) and the supporting regulations. Guaranteed payments under section 707(c) are not considered allocations of partnership income for purposes of this section. Guaranteed payments under section 707(c) are deductions by the partnership that must be taken into account under the rules of § 1.199-4. See § 1.199-3(p) and paragraph (b)(6) *Example 5* of this section. Except as provided in paragraph (b)(1)(ii) of this section, to determine its section 199 deduction for the taxable year, a partner aggregates its distributive share of such items, to the extent they are not otherwise disallowed by the Code, with those items it incurs outside the partnership (whether directly or indirectly) for purposes of allocating and apportioning deductions to DPGR and computing its qualified production activities income

(QPAI)(as defined in § 1.199-1(c)).

(ii)*Determination at entity level.* The Secretary may, by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter), permit a partnership to calculate a partner's share of QPAI and W-2 wages as defined in § 1.199-2(e)(2) (W-2 wages) at the entity level, instead of allocating to the partner, in accordance with sections 702 and 704, the partner's share of partnership items (including items of income, gain, loss, and deduction) and amounts described in § 1.199-2(e)(1) (paragraph (e)(1) wages). If a partnership does calculate QPAI at the entity level—

(A)Each partner is allocated its share of QPAI (subject to the limitations of paragraph (b)(2) of this section) and W-2 wages from the partnership, which are combined with the partner's QPAI and W-2 wages from other sources, if any;

(B)For purposes of computing the partner's QPAI under §§ 1.199-1 through 1.199-8, a partner does not take into account the items from the partnership (for example, a partner does not take into account items from the partnership in determining whether a threshold or *de minimis* rule applies or in allocating and apportioning deductions) in calculating its QPAI from other sources;

(C)A partner generally does not recompute its share of QPAI from the partnership using another method; however, the partner might have to adjust its share of QPAI from the partnership to take into account certain disallowed losses or deductions, or the allowance of suspended losses or deductions; and

(D)A partner's distributive share of QPAI from a partnership may be less than zero.

(2)*Disallowed losses or deductions.* Except as provided by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter), losses or deductions of a partnership are taken into account in computing the partner's QPAI for a taxable year only if, and to the extent that, the partner's distributive share of those losses or deductions from all of the partnership's activities is not disallowed by section 465, 469, or 704(d), or any other provision of the Code. If only a portion of the partner's distributive share of the losses or deductions from a partnership is allowed for a taxable year, a proportionate share of those allowed losses or deductions that are allocated to the partnership's qualified production activities, determined in a manner consistent with sections 465, 469, and 704(d), and any other applicable provision of the Code, is taken into account in computing QPAI for that taxable year. To the extent that any of the disallowed losses or deductions are allowed in a later taxable year under section 465, 469, or 704(d), or any other provision of the Code, the partner takes into account a proportionate share of those allowed losses or deductions that are allocated to the partnership's qualified production activities in computing the partner's QPAI for that later taxable year. Losses or deductions of the partnership that are disallowed for taxable years beginning on or before December 31, 2004, however, are not taken into account in a later taxable year for purposes of computing the partner's QPAI for that later taxable year, whether or not the losses or deductions are allowed for other purposes.

(3)*Partner's share of paragraph (e)(1) wages.* Under section 199(d)(1)(A)(iii), a partner's share of paragraph (e)(1) wages of a partnership for purposes of determining the partner's wage limitation under section 199(b)(1) (W-2 wage limitation) equals the partner's allocable share of those wages. Except as provided by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter), the partnership must allocate the amount of paragraph (e)(1) wages among the partners in the same manner it allocates wage expense among those partners. The partner must add its share of the paragraph (e)(1) wages from the partnership to the partner's paragraph (e)(1) wages from other sources, if any. The partner (other than a partner that itself is a partnership or S corporation) then must calculate its W-2 wages by determining the amount of the partner's total paragraph (e)(1) wages properly allocable to DPGR. If the partner is a partnership or S corporation, the partner must allocate its paragraph (e)(1) wages (including the paragraph (e)(1) wages from a lower-tier partnership) among its partners or shareholders in the same manner it allocates wage expense among those partners or shareholders. See § 1.199-2(e)(2) for the computation of W-2 wages and for the proper allocation of any such wages to DPGR.

(4)*Transition rule for definition of W-2 wages and for W-2 wage limitation.* If a partnership and any partner in that partnership have different taxable years, only one of which begins after May 17, 2006, the definition of W-2 wages of the partnership and the section 199(d)(1)(A)(iii) rule for determining a partner's share of wages from that partnership is determined under the law applicable to partnerships based on the beginning date of the partnership's taxable year. Thus, for example, for the taxable year of a partnership beginning on or before May 17, 2006, a partner's share of W-2 wages from the partnership is determined under section 199(d)(1)(A)(iii) as in effect for taxable years beginning on or before May 17, 2006, even if the taxable year of that partner in which those wages are taken into account begins after May 17, 2006.

(5)*Partnerships electing out of subchapter K.* For purposes of §§ 1.199-1 through 1.199-8, the rules of this paragraph

(b)apply to all partnerships, including those partnerships electing under section 761(a) to be excluded, in whole or in part, from the application of subchapter K of chapter 1 of the Code.

(6)*Examples.* The following examples illustrate the application of this paragraph (b). Assume that each partner has sufficient adjusted gross income or taxable income so that the section 199 deduction is not limited under section 199(a)(1)(B). Assume also that the partnership and each of its partners (whether individual or corporate) are calendar year taxpayers. The examples read as follows: Example 1. *Section 861 method with interest expense.*

(i)*Partnership Federal income tax items.* X and Y, unrelated United States corporations, are each 50% partners in PRS, a partnership that engages in production activities that generate both DPGR and non-DPGR. X and Y share all items of income, gain, loss, deduction, and credit equally. Both X and Y are engaged in a trade or business. PRS is not able to identify from its books and records CGS allocable to DPGR and non-DPGR. In this case, because CGS is definitely related under the facts and circumstances to all of PRS's gross receipts, apportionment of CGS between DPGR and non-DPGR based on gross receipts is appropriate. For 2010, the adjusted basis of PRS's business assets is $5,000, $4,000 of which generate gross income attributable to DPGR and $1,000 of which generate gross income attributable to non-DPGR. For 2010, PRS has the following Federal income tax items: DPGR $3,000 Non-DPGR 3,000 CGS 3,240 Section 162 selling expenses 1,200 Interest expense (not included in CGS) 300

(ii)*Allocation of PRS's Federal income tax items.* X and Y each receive the following distributive share of PRS's Federal income tax items, as determined under the principles of § 1.704-1(b)(1)(vii): Gross income attributable to DPGR ($1,500

(DPGR)− $810 (allocable CGS)) $690 Gross income attributable to non-DPGR ($1,500 (non-DPGR) − $810 (allocable CGS)) 690 Section 162 selling expenses 600 Interest expense (not included in CGS) 150

(iii)*Determination of QPAI.*

(A)*X's QPAI.* Because the section 199 deduction is determined at the partner level, X determines its QPAI by aggregating its distributive share of PRS's Federal income tax items with all other such items from all other, non-PRS-related activities. For 2010, X does not have any other such items. For 2010, the adjusted basis of X's non-PRS assets, all of which are investment assets, is $10,000. X's only gross receipts for 2010 are those attributable to the allocation of gross income from PRS. X allocates and apportions its deductible items to gross income attributable to DPGR under the section 861 method of § 1.199-4(d). In this case, the section 162 selling expenses are not included in CGS and are definitely related to all of PRS's gross income. Based on the facts and circumstances of this specific case, apportionment of those expenses between DPGR and non-DPGR on the basis of PRS's gross receipts is appropriate. X elects to apportion its distributive share of interest expense under the tax book value method of § 1.861-9T(g). X's QPAI for 2010 is $366, as shown in the following table: DPGR $1,500 CGS allocable to DPGR

(810)Section 162 selling expenses ($600 × ($1,500 DPGR/$3,000 total gross receipts))

(300)Interest expense (not included in CGS) ($150 × ($2,000 (X's share of PRS's DPGR assets)/$12,500 (X's non-PRS assets ($10,000) + X's share of PRS assets ($2,500))))

(24)X's QPAI 366

(B)*Y's QPAI.* ( *1* ) For 2010, in addition to the activities of PRS, Y engages in production activities that generate both DPGR and non-DPGR. Y is able to identify from its books and records CGS allocable to DPGR and to non-DPGR. For 2010, the adjusted basis of Y's non-PRS assets attributable to its production activities that generate DPGR is $8,000 and to other production activities that generate non-DPGR is $2,000. Y has no other assets. Y has the following Federal income tax items relating to its non-PRS activities: Gross income attributable to DPGR ($1,500

(DPGR)− $900 (allocable CGS)) $600 Gross income attributable to non-DPGR ($3,000 (other gross receipts) −$1,620 (allocable CGS)) 1,380 Section 162 selling expenses 540 Interest expense (not included in CGS) 90 ( *2* ) Y determines its QPAI in the same general manner as X. However, because Y has other trade or business activities outside of PRS, Y must aggregate its distributive share of PRS's Federal income tax items with its own such items. Y allocates and apportions its deductible items to gross income attributable to DPGR under the section 861 method of § 1.199-4(d). In this case, Y's distributive share of PRS's section 162 selling expenses, as well as those selling expenses from Y's non-PRS activities, are definitely related to all of its gross income. Based on the facts and circumstances of this specific case, apportionment of those expenses between DPGR and non-DPGR on the basis of Y's gross receipts (including Y's share of PRS's gross receipts) is appropriate. Y elects to apportion its distributive share of interest expense under the tax book value method of § 1.861-9T(g). Y has $1,290 of gross income attributable to DPGR ($3,000 DPGR ($1,500 from PRS and $1,500 from non-PRS activities)—$1,710 CGS ($810 from PRS and $900 from non-PRS activities)). Y's QPAI for 2010 is $642, as shown in the following table: DPGR ($1,500 from PRS and $1,500 from non-PRS activities) $3,000 CGS allocable to DPGR ($810 from PRS and $900 from non-PRS activities) (1,710) Section 162 selling expenses ($1,140 ($600 from PRS and $540 from non-PRS activities) × $3,000 ($1,500 PRS DPGR + $1,500 non-PRS DPGR)/$7,500 ($3,000 PRS total gross receipts + $4,500 non-PRS total gross receipts))

(456)Interest expense (not included in CGS) ($240 ($150 from PRS and $90 from non-PRS activities) × $10,000 (Y's non-PRS DPGR assets ($8,000) + Y's share of PRS DPGR assets ($2,000))/$12,500 (Y's non-PRS assets ($10,000) + Y's share of PRS assets ($2,500)))

(192)Y's QPAI 642

(iv)*Determination of section 199 deduction.* X's tentative section 199 deduction is $33 (.09 × $366, that is, QPAI determined at the partner level) subject to the W-2 wage limitation (50% of W-2 wages). Y's tentative section 199 deduction is $58 (.09 × $642) subject to the W-2 wage limitation. Example 2. *Section 861 method with R&E expense.*

(i)*Partnership Federal income tax items.* X and Y, unrelated United States corporations each of which is engaged in a trade or business, are partners in PRS, a partnership that engages in production activities that generate both DPGR and non-DPGR. Neither X nor Y is a member of an affiliated group. X and Y share all items of income, gain, loss, deduction, and credit equally. All of PRS's domestic production activities that generate DPGR are within Standard Industrial Classification

(SIC)Industry Group AAA (SIC AAA). All of PRS's production activities that generate non-DPGR are within SIC Industry Group BBB (SIC BBB). PRS is not able to identify from its books and records CGS allocable to DPGR and to non-DPGR. In this case, because CGS is definitely related under the facts and circumstances to all of PRS's gross receipts, apportionment of CGS between DPGR and non-DPGR based on gross receipts is appropriate. PRS incurs $900 of research and experimentation expenses (R&E) that are deductible under section 174, $300 of which are performed with respect to SIC AAA and $600 of which are performed with respect to SIC BBB. None of the R&E is legally mandated R&E as described in § 1.861-17(a)(4) and none is included in CGS. For 2010, PRS has the following Federal income tax items: DPGR (all from sales of products within SIC AAA) $3,000 Non-DPGR (all from sales of products within SIC BBB) 3,000 CGS 2,400 Section 162 selling expenses 840 Section 174 R&E-SIC AAA 300 Section 174 R&E-SIC BBB 600

(DPGR)− $600 (CGS)) $900 Gross income attributable to non-DPGR ($1,500 (other gross receipts) − $600 (CGS)) 900 Section 162 selling expenses 420 Section 174 R&E-SIC AAA 150 Section 174 R&E-SIC BBB 300

(iii)*Determination of QPAI.*

(A)*X's QPAI.* Because the section 199 deduction is determined at the partner level, X determines its QPAI by aggregating its distributive share of PRS's Federal income tax items with all other such items from all other, non-PRS-related activities. For 2010, X does not have any other such tax items. X's only gross receipts for 2010 are those attributable to the allocation of gross income from PRS. As stated, all of PRS's domestic production activities that generate DPGR are within SIC AAA. X allocates and apportions its deductible items to gross income attributable to DPGR under the section 861 method of § 1.199-4(d). In this case, the section 162 selling expenses are definitely related to all of PRS's gross income. Based on the facts and circumstances of this specific case, apportionment of those expenses between DPGR and non-DPGR on the basis of PRS's gross receipts is appropriate. For purposes of apportioning R&E, X elects to use the sales method as described in § 1.861-17(c). Because X has no direct sales of products, and because all of PRS's SIC AAA sales attributable to X's share of PRS's gross income generate DPGR, all of X's share of PRS's section 174 R&E attributable to SIC AAA is taken into account for purposes of determining X's QPAI. Thus, X's total QPAI for 2010 is $540, as shown in the following table: DPGR (all from sales of products within SIC AAA) $1,500 CGS

(600)Section 162 selling expenses ($420) × ($1,500 DPGR/$3,000 total gross receipts))

(210)Section 174 R&E-SIC AAA

(150)X's QPAI 540

(B)*Y's QPAI.* ( *1* ) For 2010, in addition to the activities of PRS, Y engages in domestic production activities that generate both DPGR and non-DPGR. With respect to those non-PRS activities, Y is not able to identify from its books and records CGS allocable to DPGR and to non-DPGR. In this case, because non-PRS CGS is definitely related under the facts and circumstances to all of Y's non-PRS gross receipts, apportionment of non-PRS CGS between DPGR and non-DPGR based on Y's non-PRS gross receipts is appropriate. For 2010, Y has the following non-PRS Federal income tax items: DPGR (from sales of products within SIC AAA) $1,500 DPGR (from sales of products within SIC BBB) 1,500 Non-DPGR (from sales of products within SIC BBB) 3,000 CGS (allocated to DPGR within SIC AAA) 750 CGS (allocated to DPGR within SIC BBB) 750 CGS (allocated to non-DPGR within SIC BBB) 1,500 Section 162 selling expenses 540 Section 174 R&E-SIC AAA 300 Section 174 R&E-SIC BBB 450 ( *2* ) Because Y has DPGR as a result of activities outside PRS, Y must aggregate its distributive share of PRS's Federal income tax items with such items from all its other, non-PRS-related activities. Y allocates and apportions its deductible items to gross income attributable to DPGR under the section 861 method of § 1.199-4(d). In this case, the section 162 selling expenses are definitely related to all of Y's gross income. Based on the facts and circumstances of the specific case, apportionment of such expenses between DPGR and non-DPGR on the basis of Y's gross receipts (including Y's share of PRS's gross receipts) is appropriate. For purposes of apportioning R&E, Y elects to use the sales method as described in § 1.861-17(c). ( *3* ) With respect to sales that generate DPGR, Y has gross income of $2,400 ($4,500 DPGR ($1,500 from PRS and $3,000 from non-PRS activities) − $2,100 CGS ($600 from sales of products by PRS and $1,500 from non-PRS activities)). Because all of the sales in SIC AAA generate DPGR, all of Y's share of PRS's section 174 R&E attributable to SIC AAA and the section 174 R&E attributable to SIC AAA that Y incurs in its non-PRS activities are taken into account for purposes of determining Y's QPAI. Because only a portion of the sales within SIC BBB generate DPGR, only a portion of the section 174 R&E attributable to SIC BBB is taken into account in determining Y's QPAI. Thus, Y's QPAI for 2010 is $1,282, as shown in the following table: DPGR ($4,500 DPGR ($1,500 from PRS and $3,000 from non-PRS activities)) $4,500 CGS ($600 from sales of products by PRS and $1,500 from non-PRS activities) (2,100) Section 162 selling expenses ($960 ($420 from PRS + $540 from non-PRS activities) × ($4,500 DPGR/$9,000 total gross receipts))

(480)Section 174 R&E-SIC AAA ($150 from PRS and $300 from non-PRS activities)

(450)Section 174 R&E-SIC BBB ($750 ($300 from PRS + $450 from non-PRS activities) × ($1,500 DPGR/$6,000 total gross receipts allocated to SIC BBB ($1,500 from PRS + $4,500 from non-PRS activities))

(188)Y's QPAI 1,282

(iv)*Determination of section 199 deduction* . X's tentative section 199 deduction is $49 (.09 × $540, that is, QPAI determined at the partner level) subject to the W-2 wage limitation (50% of W-2 wages). Y's tentative section 199 deduction is $115 (.09 × $1,282) subject to the W-2 wage limitation. Example 3. *Partnership with special allocations* .

(i)*In general* . X and Y are unrelated corporate partners in PRS and each is engaged in a trade or business. PRS is a partnership that engages in a domestic production activity and other activities. In general, X and Y share all partnership items of income, gain, loss, deduction, and credit equally, except that 80% of the wage expense of PRS and 20% of PRS's other expenses are specially allocated to X. Under all the facts and circumstances, these special allocations have substantial economic effect under section 704(b). In the 2010 taxable year, PRS's only wage expense is $2,000 for marketing, which is not included in CGS. PRS has $8,000 of gross receipts ($6,000 of which is DPGR), $4,000 of CGS ($3,500 of which is allocable to DPGR), and $3,000 of deductions (comprised of $2,000 of wage expense for marketing and $1,000 of other expenses). X qualifies for and uses the simplified deduction method under § 1.199-4(e). Y does not qualify to use that method and, therefore, must use the section 861 method under § 1.199-4(d). In the 2010 taxable year, X has gross receipts attributable to non-partnership trade or business activities of $1,000 and wage expense of $200. None of X's non-PRS gross receipts is DPGR. For purposes of this *Example 3* , with regard to both X and PRS, paragraph (e)(1) wages equal wage expense for the 2010 taxable year.

(ii)*Allocation and apportionment of costs* . Under the partnership agreement, X's distributive share of the Federal income tax items of PRS is $1,250 of gross income attributable to DPGR ($3,000 DPGR−$1,750 allocable CGS), $750 of gross income attributable to non-DPGR ($1,000 non-DPGR−$250 allocable CGS), and $1,800 of deductions (comprised of X's special allocations of $1,600 of wage expense ($2,000 × 80%) for marketing and $200 of other expenses ($1,000 x 20%)). Under the simplified deduction method, X apportions $1,200 of other deductions to DPGR ($2,000 ($1,800 from the partnership and $200 from non-partnership activities) × ($3,000 DPGR/$5,000 total gross receipts)). Accordingly, X's QPAI is $50 ($3,000 DPGR − $1,750 CGS−$1,200 of deductions). X has $1,800 of paragraph (e)(1) wages ($1,600 (X's 80% share) from PRS + $200 (X's own non-PRS paragraph (e)(1) wages)). To calculate its W-2 wages, X must determine how much of this $1,800 is properly allocable under § 1.199-2(e)(2) to X's total DPGR (including X's share of DPGR from PRS). Thus, X's tentative section 199 deduction for the 2010 taxable year is $5 (.09 × $50), subject to the W-2 wage limitation (50% of X's W-2 wages). Example 4. *Partnership with no paragraph (e)(1) wages* .

(i)*Facts* . A and B, both individuals, are partners in PRS. PRS is a partnership that engages in manufacturing activities that generate both DPGR and non-DPGR. A and B share all items of income, gain, loss, deduction, and credit equally. For the 2010 taxable year, PRS has total gross receipts of $2,000 ($1,000 of which is DPGR), CGS of $400 and deductions of $800. PRS has no paragraph (e)(1) wages. Each partner's distributive share of PRS's Federal income tax items is $500 DPGR, $500 non-DPGR, $200 CGS, and $400 of deductions. A has trade or business activities outside of PRS (non-PRS activities). With respect to those activities, A has total gross receipts of $1,000 ($500 of which is DPGR), CGS of $400 (including $50 of paragraph (e)(1) wages), and deductions of $200 for the 2010 taxable year. B has no trade or business activities outside of PRS. A and B each use the small business simplified overall method under § 1.199-4(f).

(ii)*A's QPAI* . A's total CGS and deductions apportioned to DPGR equal $600 (($1,200 ($200 PRS CGS + $400 non-PRS CGS + $400 PRS deductions + $200 non-PRS trade or business deductions)) × ($1,000 total DPGR ($500 from PRS + $500 from non-PRS activities)/$2,000 total gross receipts ($1,000 from PRS + $1,000 from non-PRS activities))). Accordingly, A's QPAI is $400 ($1,000 DPGR ($500 from PRS + $500 from non-PRS activities) − $600 CGS and deductions).

(iii)*A's W-2 wages and section 199 deduction* . A has $50 of paragraph (e)(1) wages ($0 from PRS + $50 from A's non-PRS activities). To calculate A's W-2 wages, A determines, under a reasonable method satisfactory to the Secretary, that $40 of this $50 is properly allocable under § 1.199-2(e)(2) to A's DPGR from PRS and non-PRS activities. A's tentative section 199 deduction is $36 (.09 × $400), subject to the W-2 wage limitation of $20 (50% of W-2 wages of $40). Thus, A's section 199 deduction is $20.

(iv)*B's QPAI and section 199 deduction* . B's CGS and deductions apportioned to DPGR equal $300 (($200 PRS CGS + $400 PRS deductions) × ($500 DPGR from PRS /$1,000 total gross receipts from PRS)). Accordingly, B's QPAI is $200 ($500 DPGR − $300 CGS and deductions). B's tentative section 199 deduction is $18 (.09 × $200), subject to the W-2 wage limitation. In this case, however, the limitation is $0, because B has no paragraph (e)(1) wages. Thus, B's section 199 deduction is $0. Example 5. *Guaranteed payment* .

(i)*Facts* . The facts are the same as in *Example 4* , except that in 2010 PRS also makes a guaranteed payment of $200 to A for services rendered by A (see section 707(c)), and PRS incurs $200 of wage expense for employees' salary, which is included within the $400 of CGS (in this case the wage expense of $200 equals PRS's paragraph (e)(1) wages). The guaranteed payment is taxable to A as ordinary income and is properly deducted by PRS under section 162. Pursuant to § 1.199-3(p), A may not treat any part of this payment as DPGR. Accordingly, PRS has total gross receipts of $2,000 ($1,000 of which is DPGR), CGS of $400 (including $200 of wage expense) and deductions of $1,000 (including the $200 guaranteed payment) for the 2010 taxable year. Each partner's distributive share of the items of the partnership is $500 DPGR, $500 non-DPGR, $200 CGS (including $100 of wage expense), and $500 of deductions.

(ii)*A's QPAI and W-2 wages* . A's total CGS and deductions apportioned to DPGR equal $591 ($1,300 ($200 PRS CGS + $400 non-PRS CGS + $500 PRS deductions + $200 non-PRS trade or business deductions) × ($1,000 total DPGR ($500 from PRS + $500 from non-PRS activities)/$2,200 total gross receipts ($1,000 from PRS + $200 guaranteed payment + $1,000 from non-PRS activities))). Accordingly, A's QPAI is $409 ($1,000 DPGR−$591 CGS and other deductions). A's total paragraph (e)(1) wages are $150 ($100 from PRS + $50 from non-PRS activities). To calculate its W-2 wages, A must determine how much of this $150 is properly allocable under § 1.199-2(e)(2) to A's total DPGR from PRS and non-PRS activities. A's tentative section 199 deduction is $37 (.09 × $409), subject to the W-2 wage limitation (50% of W-2 wages).

(iii)*B's QPAI and W-2 wages* . B's QPAI is $150 ($500 DPGR−$350 CGS and other deductions). B has $100 of paragraph (e)(1) wages (all from PRS). To calculate its W-2 wages, B must determine how much of this $100 is properly allocable under § 1.199-2(e)(2) to B's total DPGR. B's tentative section 199 deduction is $14 (.09 × $150), subject to the W-2 wage limitation (50% of B's W-2 wages).

(c)*S corporations* —(1) *In general* —(i) *Determination at shareholder level* . The section 199 deduction with respect to the qualified production activities of an S corporation is determined at the shareholder level. As a result, each shareholder must compute its deduction separately. The section 199 deduction has no effect on the adjusted basis of a shareholder's stock in an S corporation. Except as provided by publication pursuant to paragraph (c)(1)(ii) of this section, for purposes of this section, each shareholder is allocated, in accordance with section 1366, its pro rata share of S corporation items (including items of income, gain, loss, and deduction), CGS allocated to such items of income, and gross receipts included in such items of income, even if the shareholder's share of CGS and other deductions and losses exceeds DPGR. Except as provided by publication under paragraph (c)(1)(ii) of this section, to determine its section 199 deduction for the taxable year, the shareholder aggregates its pro rata share of such items, to the extent they are not otherwise disallowed by the Code, with those items it incurs outside the S corporation (whether directly or indirectly) for purposes of allocating and apportioning deductions to DPGR and computing its QPAI.

(ii)*Determination at entity level* . The Secretary may, by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter), permit an S corporation to calculate a shareholder's share of QPAI and W-2 wages at the entity level, instead of allocating to the shareholder, in accordance with section 1366, the shareholder's pro rata share of S corporation items (including items of income, gain, loss, and deduction) and paragraph (e)(1) wages. If an S corporation does calculate QPAI at the entity level—

(A)Each shareholder is allocated its share of QPAI (subject to the limitations of paragraph (c)(2) of this section) and W-2 wages from the S corporation, which are combined with the shareholder's QPAI and W-2 wages from other sources, if any;

(B)For purposes of computing the shareholder's QPAI under §§ 1.199-1 through 1.199-8, a shareholder does not take into account the items from the S corporation (for example, a shareholder does not take into account items from the S corporation in determining whether a threshold or *de minimis* rule applies or in allocating and apportioning deductions) in calculating its QPAI from other sources;

(C)A shareholder generally does not recompute its share of QPAI from the S corporation using another method; however, the shareholder might have to adjust its share of QPAI from the S corporation to take into account certain disallowed losses or deductions, or the allowance of suspended losses or deductions; and

(D)A shareholder's share of QPAI from an S corporation may be less than zero.

(2)*Disallowed losses or deductions* . Except as provided by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter), losses or deductions of the S corporation are taken into account in computing the shareholder's QPAI for a taxable year only if, and to the extent that, the shareholder's pro rata share of the losses or deductions from all of the S corporation's activities is not disallowed by section 465, 469, or 1366(d), or any other provision of the Code. If only a portion of the shareholder's share of the losses or deductions from an S corporation is allowed for a taxable year, a proportionate share of those allowed losses or deductions that are allocated to the S corporation's qualified production activities, determined in a manner consistent with sections 465, 469, and 1366(d), and any other applicable provision of the Code, is taken into account in computing QPAI for that taxable year. To the extent that any of the disallowed losses or deductions are allowed in a later taxable year under section 465, 469, or 1366(d), or any other provision of the Code, the shareholder takes into account a proportionate share of those allowed losses or deductions that are allocated to the S corporation's qualified production activities in computing the shareholder's QPAI for that later taxable year. Losses or deductions of the S corporation that are disallowed for taxable years beginning on or before December 31, 2004, however, are not taken into account in a later taxable year for purposes of computing the shareholder's QPAI for that later taxable year, whether or not the losses or deductions are allowed for other purposes.

(3)*Shareholder's share of paragraph (e)(1) wages* . Under section 199(d)(1)(A)(iii), an S corporation shareholder's share of the paragraph (e)(1) wages of the S corporation for purposes of determining the shareholder's W-2 wage limitation equals the shareholder's allocable share of those wages. Except as provided by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)( *b* ) of this chapter), the S corporation must allocate the paragraph (e)(1) wages among the shareholders in the same manner it allocates wage expense among those shareholders. The shareholder then must add its share of the paragraph (e)(1) wages from the S corporation to the shareholder's paragraph (e)(1) wages from other sources, if any, and then must determine the portion of those total paragraph (e)(1) wages allocable to DPGR to compute the shareholder's W-2 wages. See § 1.199-2(e)(2) for the computation of W-2 wages and for the proper allocation of such wages to DPGR.

(4)*Transition rule for definition of W-2 wages and for W-2 wage limitation.* If an S corporation and any of its shareholders have different taxable years, only one of which begins after May 17, 2006, the definition of W-2 wages of the S corporation and the section 199(d)(1)(A)(iii) rule for determining a shareholder's share of wages from that S corporation is determined under the law applicable to S corporations based on the beginning date of the S corporation's taxable year. Thus, for example, for the short taxable year of an S corporation beginning after May 17, 2006, and ending in 2006, a shareholder's share of W-2 wages from the S corporation is determined under section 199(d)(1)(A)(iii) for taxable years beginning after May 17, 2006, even if that shareholder's taxable year began on or before May 17, 2006.

(d)*Grantor trusts.* To the extent that the grantor or another person is treated as owning all or part (the owned portion) of a trust under sections 671 through 679, such person (owner) computes its QPAI with respect to the owned portion of the trust as if that QPAI had been generated by activities performed directly by the owner. Similarly, for purposes of the W-2 wage limitation, the owner of the trust takes into account the owner's share of the paragraph (e)(1) wages of the trust that are attributable to the owned portion of the trust. The provisions of paragraph

(e)of this section do not apply to the owned portion of a trust.

(e)*Non-grantor trusts and estates* —(1) *Allocation of costs.* The trust or estate calculates each beneficiary's share (as well as the trust's or estate's own share, if any) of QPAI and W-2 wages from the trust or estate at the trust or estate level. The beneficiary of a trust or estate may not recompute its share of QPAI or W-2 wages from the trust or estate by using another method to reallocate the trust's or estate's qualified production costs or paragraph (e)(1) wages, or otherwise. Except as provided in paragraph

(d)of this section, the QPAI of a trust or estate must be computed by allocating expenses described in section 199(d)(5) in one of two ways, depending on the classification of those expenses under § 1.652(b)-3. Specifically, directly attributable expenses within the meaning of § 1.652(b)-3 are allocated pursuant to § 1.652(b)-3, and expenses not directly attributable within the meaning of § 1.652(b)-3 (other expenses) are allocated under the simplified deduction method of § 1.199-4(e) (unless the trust or estate does not qualify to use the simplified deduction method, in which case it must use the section 861 method of § 1.199-4(d) with respect to such other expenses). For this purpose, depletion and depreciation deductions described in section 642(e) and amortization deductions described in section 642(f) are treated as other expenses described in section 199(d)(5). Also for this purpose, the trust's or estate's share of other expenses from a lower-tier pass-thru entity is not directly attributable to any class of income (whether or not those other expenses are directly attributable to the aggregate pass-thru gross income as a class for purposes other than section 199). A trust or estate may not use the small business simplified overall method for computing its QPAI. See § 1.199-4(f)(5).

(2)*Allocation among trust or estate and beneficiaries* —(i) *In general.* The QPAI of a trust or estate (which will be less than zero if the CGS and deductions allocated and apportioned to DPGR exceed the trust's or estate's DPGR) and W-2 wages of a trust or estate are allocated to each beneficiary and to the trust or estate based on the relative proportion of the trust's or estate's distributable net income (DNI), as defined by section 643(a), for the taxable year that is distributed or required to be distributed to the beneficiary or is retained by the trust or estate. For this purpose, the trust or estate's DNI is determined with regard to the separate share rule of section 663(c), but without regard to section 199. To the extent that the trust or estate has no DNI for the taxable year, any QPAI and W-2 wages are allocated entirely to the trust or estate. A trust or estate is allowed the section 199 deduction in computing its taxable income to the extent that QPAI and W-2 wages are allocated to the trust or estate. A beneficiary of a trust or estate is allowed the section 199 deduction in computing its taxable income based on its share of QPAI and W-2 wages from the trust or estate, which are aggregated with the beneficiary's QPAI and W-2 wages from other sources, if any.

(ii)*Treatment of items from a trust or estate reporting qualified production activities income.* When, pursuant to this paragraph (e), a taxpayer must combine QPAI and W-2 wages from a trust or estate with the taxpayer's total QPAI and W-2 wages from other sources, the taxpayer, when applying §§ 1.199-1 through 1.199-8 to determine the taxpayer's total QPAI and W-2 wages from such other sources, does not take into account the items from such trust or estate. Thus, for example, a beneficiary of an estate that receives QPAI from the estate does not take into account the beneficiary's distributive share of the estate's gross receipts, gross income, or deductions when the beneficiary determines whether a threshold or *de minimis* rule applies or when the beneficiary allocates and apportions deductions in calculating its QPAI from other sources. Similarly, in determining the portion of the beneficiary's paragraph (e)(1) wages from other sources that is attributable to DPGR (thus, the W-2 wages from other sources), the beneficiary does not take into account DPGR and non-DPGR from the trust or estate.

(3)*Transition rule for definition of W-2 wages and for W-2 wage limitation.* The definition of W-2 wages of a trust or estate and the section 199(d)(1)(A)(iii) rule for determining the respective shares of wages from that trust or estate, and thus the beneficiary's share of W-2 wages from that trust or estate, is determined under the law applicable to pass-thru entities based on the beginning date of the taxable year of the trust or estate, regardless of the beginning date of the taxable year of the beneficiary.

(4)*Example.* The following example illustrates the application of this paragraph (e). Assume that the partnership, trust, and trust beneficiary all are calendar year taxpayers. The example reads as follows: Example.

(i)* Computation of DNI and inclusion and deduction amounts.

(A)Trust's distributive share of partnership items. * Trust, a complex trust, is a partner in PRS, a partnership that engages in activities that generate DPGR and non-DPGR. In 2010, PRS distributes $10,000 cash to Trust. PRS properly allocates (in the same manner as wage expense) paragraph (e)(1) wages of $3,000 to Trust. Trust's distributive share of PRS items, which are properly included in Trust's DNI, is as follows: Gross income attributable to DPGR ($15,000 DPGR−$5,000 CGS (including wage expense of $1,000)) $10,000 Gross income attributable to non-DPGR ($5,000 other gross receipts−$0 CGS) 5,000 Selling expenses attributable to DPGR (includes wage expense of $2,000) 3,000 Other expenses (includes wage expense of $1,000) 2,000

(B)*Trust's direct activities.* In addition to its cash distribution in 2010 from PRS, Trust directly has the following items which are properly included in Trust's DNI: Dividends $10,000 Tax-exempt interest 10,000 Rents from commercial real property operated by Trust as a business 10,000 Real estate taxes 1,000 Trustee commissions 3,000 State income and personal property taxes 5,000 Wage expense for rental business (direct paragraph (e)(1) wages) 2,000 Other business expenses 1,000

(C)*Allocation of deductions under § 1.652(b)-3.

(1)Directly attributable expenses.* In computing Trust's DNI for the taxable year, the distributive share of expenses of PRS are directly attributable under § 1.652(b)-3(a) to the distributive share of income of PRS. Accordingly, the $5,000 of CGS, $3,000 of selling expenses, and $2,000 of other expenses are subtracted from the gross receipts from PRS ($20,000), resulting in net income from PRS of $10,000. With respect to the Trust's direct expenses, $1,000 of the trustee commissions, the $1,000 of real estate taxes, and the $2,000 of wage expense are directly attributable under § 1.652(b)-3(a) to the rental income. ( *2* ) *Non-directly attributable expenses.* Under § 1.652(b)-3(b), the trustee must allocate a portion of the sum of the balance of the trustee commissions ($2,000), state income and personal property taxes ($5,000), and the other business expenses ($1,000) to the $10,000 of tax-exempt interest. The portion to be attributed to tax-exempt interest is $2,222 ($8,000 × ($10,000 tax exempt interest/$36,000 gross receipts net of direct expenses)), resulting in $7,778 ($10,000−$2,222) of net tax-exempt interest. Pursuant to its authority recognized under § 1.652(b)-3(b), the trustee allocates the entire amount of the remaining $5,778 of trustee commissions, state income and personal property taxes, and other business expenses to the $6,000 of net rental income, resulting in $222 ($6,000−$5,778) of net rental income.

(D)*Amounts included in taxable income.* For 2010, Trust has DNI of $28,000 (net dividend income of $10,000 + net PRS income of $10,000 + net rental income of $222 + net tax-exempt income of $7,778). Pursuant to Trust's governing instrument, Trustee distributes 50%, or $14,000, of that DNI to B, an individual who is a discretionary beneficiary of Trust. Assume that there are no separate shares under Trust, and no distributions are made to any other beneficiary that year. Consequently, with respect to the $14,000 distribution B receives from Trust, B properly includes in B's gross income $5,000 of income from PRS, $111 of rents, and $5,000 of dividends, and properly excludes from B's gross income $3,889 of tax-exempt interest. Trust includes $20,222 in its adjusted total income and deducts $10,111 under section 661(a) in computing its taxable income.

(ii)*Section 199 deduction.*

(A)*Simplified deduction method.* For purposes of computing the section 199 deduction for the taxable year, assume Trust qualifies for the simplified deduction method under § 1.199-4(e). The determination of Trust's QPAI under the simplified deduction method requires multiple steps to allocate costs. First, the Trust's expenses directly attributable to DPGR under § 1.652(b)-3(a) are subtracted from the Trust's DPGR. In this step, the directly attributable $5,000 of CGS and selling expenses of $3,000 are subtracted from the $15,000 of DPGR from PRS. Second, the Trust's expenses directly attributable under § 1.652(b)-3(a) to non-DPGR from a trade or business are subtracted from the Trust's trade or business non-DPGR. In this step, $4,000 of Trust expenses directly allocable to the real property rental activity ($1,000 of real estate taxes, $1,000 of Trustee commissions, and $2,000 of wages) are subtracted from the $10,000 of rental income. Third, Trust must identify the portion of its other expenses that is attributable to Trust's trade or business activities, if any, because expenses not attributable to trade or business activities are not taken into account in computing QPAI. In this step, in this example, the portion of the trustee commissions not directly attributable to the rental operation ($2,000) is directly attributable to non-trade or business activities. In addition, the state income and personal property taxes are not directly attributable under § 1.652(b)-3(a) to either trade or business or non-trade or business activities, so the portion of those taxes not attributable to either the PRS interests or the rental operation is not a trade or business expense and, thus, is not taken into account in computing QPAI. The portion of the state income and personal property taxes that is treated as an other trade or business expense is $3,000 ($5,000 × $30,000 total trade or business gross receipts/$50,000 total gross receipts). Fourth, Trust then allocates its other trade or business expenses (not directly attributable under § 1.652(b)-3(a)) between DPGR and non-DPGR on the basis of its total gross receipts from the conduct of a trade or business ($20,000 from PRS + $10,000 rental income). Thus, Trust combines its non-directly attributable (other) business expenses ($2,000 from PRS + $4,000 ($1,000 of other business expenses + $3,000 of income and property taxes allocated to a trade or business) from its own activities) and then apportions this total ($6,000) between DPGR and other receipts on the basis of Trust's total trade or business gross receipts ($6,000 of such expenses × $15,000 DPGR/$30,000 total trade or business gross receipts = $3,000). Thus, for purposes of computing Trust's and B's section 199 deduction, Trust's QPAI is $4,000 ($7,000 ($15,000 DPGR−$5,000 CGS−$3,000 selling expenses)−$3,000). Because the distribution of Trust's DNI to B equals one-half of Trust's DNI, Trust and B each has QPAI from PRS for purposes of the section 199 deduction of $2,000. B has $1,000 of QPAI from non-Trust activities that is added to the $2,000 QPAI from Trust for a total of $3,000 of QPAI.

(B)*W-2 wages.* For the 2010 taxable year, Trust chooses to use the wage expense safe harbor under § 1.199-2(e)(2)(ii) to determine its W-2 wages. For its taxable year ending December 31, 2010, Trust has $5,000 ($3,000 from PRS + $2,000 of Trust) of paragraph (e)(1) wages reported on 2010 Forms W-2. Trust's W-2 wages are $2,917, as shown in the following table: Wage expense included in CGS directly attributable to DPGR $1,000 Wage expense included in selling expense directly attributable to DPGR 2,000 Wage expense included in non-directly attributable deductions ($1,000 in wage expense × ($15,000 DPGR/$30,000 total trade or business gross receipts)) 500 Wage expense allocable to DPGR 3,500 W-2 wages (($3,500 of wage expense allocable to DPGR/$6,000 of total wage expense) × $5,000 in paragraph (e)(1) wages) $2,917

(C)*Section 199 deduction computation.

(1)B's computation.* B is eligible to use the small business simplified overall method. Assume that B has sufficient adjusted gross income so that the section 199 deduction is not limited under section 199(a)(1)(B). Because the $14,000 Trust distribution to B equals one-half of Trust's DNI, B has W-2 wages from Trust of $1,459 (50% × $2,917). B has W-2 wages of $100 from trade or business activities outside of Trust and attributable to DPGR (computed without regard to B's interest in Trust pursuant to § 1.199-2(e)) for a total of $1,559 of W-2 wages. B has $1,000 of QPAI from non-Trust activities that is added to the $2,000 QPAI from Trust for a total of $3,000 of QPAI. B's tentative deduction is $270 (.09 × $3,000), limited under the W-2 wage limitation to $780 (50% × $1,559 W-2 wages). Accordingly, B's section 199 deduction for 2010 is $270. ( *2* ) *Trust's computation.* Trust has sufficient adjusted gross income so that the section 199 deduction is not limited under section 199(a)(1)(B). Because the $14,000 Trust distribution to B equals one-half of Trust's DNI, Trust has W-2 wages of $1,459 (50% × $2,917). Trust's tentative deduction is $180 (.09 × $2,000 QPAI), limited under the W-2 wage limitation to $730 (50% × $1,459 W-2 wages). Accordingly, Trust's section 199 deduction for 2010 is $180.

(f)*Gain or loss from the disposition of an interest in a pass-thru entity.* DPGR generally does not include gain or loss recognized on the sale, exchange, or other disposition of an interest in a pass-thru entity. However, with respect to a partnership, if section 751(a) or

(b)applies, then gain or loss attributable to assets of the partnership giving rise to ordinary income under section 751(a) or (b), the sale, exchange, or other disposition of which would give rise to DPGR, is taken into account in computing the partner's section 199 deduction. Accordingly, to the extent that cash or property received by a partner in a sale or exchange of all or part of its partnership interest is attributable to unrealized receivables or inventory items within the meaning of section 751(c) or (d), respectively, and the sale or exchange of the unrealized receivable or inventory items would give rise to DPGR if sold, exchanged, or otherwise disposed of by the partnership, the cash or property received by the partner is taken into account by the partner in determining its DPGR for the taxable year. Likewise, to the extent that a distribution of property to a partner is treated under section 751(b) as a sale or exchange of property between the partnership and the distributee partner, and any property deemed sold or exchanged would give rise to DPGR if sold, exchanged, or otherwise disposed of by the partnership, the deemed sale or exchange of the property must be taken into account in determining the partnership's and distributee partner's DPGR to the extent not taken into account under the qualifying in-kind partnership rules. See §§ 1.751-1(b) and 1.199-3(i)(7).

(g)*No attribution of qualified activities.* Except as provided in § 1.199-3(i)(7) regarding qualifying in-kind partnerships and § 1.199-3(i)(8) regarding EAG partnerships, an owner of a pass-thru entity is not treated as conducting the qualified production activities of the pass-thru entity, and vice versa. This rule applies to all partnerships, including partnerships that have elected out of subchapter K under section 761(a). Accordingly, if a partnership manufactures QPP within the United States, or produces a qualified film or produces utilities in the United States, and distributes or leases, rents, licenses, sells, exchanges, or otherwise disposes of such property to a partner who then, without performing its own qualifying activity, leases, rents, licenses, sells, exchanges, or otherwise disposes of such property, then the partner's gross receipts from this latter lease, rental, license, sale, exchange, or other disposition are treated as non-DPGR. In addition, if a partner manufactures QPP within the United States, or produces a qualified film or produces utilities in the United States, and contributes or leases, rents, licenses, sells, exchanges, or otherwise disposes of such property to a partnership which then, without performing its own qualifying activity, leases, rents, licenses, sells, exchanges, or otherwise disposes of such property, then the partnership's gross receipts from this latter disposition are treated as non-DPGR. § 1.199-5T [Removed] **Par. 10.** Section 1.199-5T is removed. **Par. 11.** Section 1.199-7 is amended by revising paragraph (b)(4) to read as follows: § 1.199-7 Expanded affiliated groups.

(b)* * *

(4)*Losses used to reduce taxable income of expanded affiliated group* —(i) *In general.* The amount of an NOL sustained by any member of an EAG that is used in the year sustained in determining an EAG's taxable income limitation under section 199(a)(1)(B) is not treated as an NOL carryover or NOL carryback to any taxable year in determining the taxable income limitation under section 199(a)(1)(B). For purposes of this paragraph (b)(4), an NOL is considered to be used if it reduces an EAG's aggregate taxable income, regardless of whether the use of the NOL actually reduces the amount of the section 199 deduction that the EAG would otherwise derive. An NOL is not considered to be used to the extent that it reduces an EAG's aggregate taxable income to an amount less than zero. If more than one member of an EAG has an NOL used in the same taxable year to reduce the EAG's taxable income, the members' respective NOLs are deemed used in proportion to the amount of their NOLs.

(ii)*Examples.* The following examples illustrate the application of this paragraph (b)(4). For purposes of these examples, assume that all relevant parties have sufficient W-2 wages so that the section 199 deduction is not limited under section 199(b)(1). The examples read as follows: Example 1.

(i)*Facts.* Corporations A and B are the only two members of an EAG. A and B are both calendar year taxpayers, and they do not join in the filing of a consolidated Federal income tax return. Neither A nor B had taxable income or loss prior to 2010. In 2010, A has QPAI and taxable income of $1,000, and B has QPAI of $1,000 and an NOL of $1,500. In 2011, A has QPAI of $2,000 and taxable income of $1,000 and B has QPAI of $2,000 and taxable income prior to the NOL deduction allowed under section 172 of $2,000.

(ii)*Section 199 deduction for 2010.* In determining the EAG's section 199 deduction for 2010, A's $1,000 of QPAI and B's $1,000 of QPAI are aggregated, as are A's $1,000 of taxable income and B's $1,500 NOL. Thus, for 2010, the EAG has QPAI of $2,000 and taxable income of ($500). The EAG's section 199 deduction for 2010 is 9% of the lesser of its QPAI or its taxable income. Because the EAG has a taxable loss in 2010, the EAG's section 199 deduction is $0.

(iii)*Section 199 deduction for 2011.* In determining the EAG's section 199 deduction for 2011, A's $2,000 of QPAI and B's $2,000 of QPAI are aggregated, giving the EAG QPAI of $4,000. Also, $1,000 of B's NOL from 2010 was used in 2010 to reduce the EAG's taxable income to $0. The remaining $500 of B's 2010 NOL is not considered to have been used in 2010 because it reduced the EAG's taxable income below $0. Accordingly, for purposes of determining the EAG's taxable income limitation under section 199(a)(1)(B) in 2011, B is deemed to have only a $500 NOL carryover from 2010 to offset a portion of its 2011 taxable income. Thus, B's taxable income in 2011 is $1,500 which is aggregated with A's $1,000 of taxable income. The EAG's taxable income limitation in 2011 is $2,500. The EAG's section 199 deduction is 9% of the lesser of its QPAI of $4,000 or its taxable income of $2,500. Thus, the EAG's section 199 deduction in 2011 is 9% of $2,500, or $225. The results would be the same if neither A nor B had QPAI in 2010. Example 2. The facts are the same as in *Example 1* except that in 2010 B was not a member of the same EAG as A, but instead was a member of an EAG with Corporation X, which had QPAI and taxable income of $1,000 in 2010, and had neither taxable income nor loss in any other year. There were no other members of the EAG in 2010 besides B and X, and B and X did not file a consolidated Federal income tax return. As $1,000 of B's NOL was used in 2010 to reduce the B and X EAG's taxable income to $0, B is considered to have only a $500 NOL carryover from 2010 to offset a portion of its 2011 taxable income for purposes of the taxable income limitation under section 199(a)(1)(B), just as in *Example 1* . Accordingly, the results for the A and B EAG in 2011 are the same as in *Example 1* . Example 3. The facts are the same as in *Example 1* except that B is not a member of any EAG in 2011. Because $1,000 of B's NOL was used in 2010 to reduce the EAG's taxable income to $0, B is considered to have only a $500 NOL carryover from 2010 to offset a portion of its 2011 taxable income for purposes of the taxable income limitation under section 199(a)(1)(B), just as in *Example 1* . Thus, for purposes of determining B's taxable income limitation in 2011, B is considered to have taxable income of $1,500, and B has a section 199 deduction of 9% of $1,500, or $135. Example 4. Corporations A, B, and C are the only members of an EAG. A, B, and C are all calendar year taxpayers, and they do not join in the filing of a consolidated Federal income tax return. None of the EAG members (A, B, or C) had taxable income or loss prior to 2010. In 2010, A has QPAI of $2,000 and taxable income of $1,000, B has QPAI of $1,000 and an NOL of $1,000, and C has QPAI of $1,000 and an NOL of $3,000. In 2011, prior to the NOL deduction allowed under section 172, A and B each has taxable income of $200 and C has taxable income of $5,000. In determining the EAG's section 199 deduction for 2010, A's QPAI of $2,000, B's QPAI of $1,000, and C's QPAI of $1,000 are aggregated, as are A's taxable income of $1,000, B's NOL of $1,000, and C's NOL of $3,000. Thus, for 2010, the EAG has QPAI of $4,000 and taxable income of ($3,000). In determining the EAG's taxable income limitation under section 199(a)(1)(B) in 2011, $1,000 of B's and C's aggregate NOLs in 2010 of $4,000 are considered to have been used in 2010 to reduce the EAG's taxable income to $0, in proportion to their NOLs. Thus, $250 of B's NOL from 2010 ($1,000 × $1,000/$4,000) and $750 of C's NOL from 2010 ($1,000 × $3,000/$4,000) are deemed to have been used in 2010. The remaining $750 of B's NOL and the remaining $2,250 of C's NOL are not deemed to have been used because so doing would have reduced the EAG's taxable income in 2010 below $0. Accordingly, for purposes of determining the EAG's taxable income limitation in 2011, B is deemed to have a $750 NOL carryover from 2010 and C is deemed to have a $2,250 NOL carryover from 2010. Thus, for purposes of determining the EAG's taxable income limitation, B's taxable income in 2011 is $0 and C's taxable income in 2011 is $2,750, which are aggregated with A's $200 taxable income. B's unused NOL carryover from 2010 cannot be used to reduce either A's or C's 2011 taxable income. Thus, the EAG's taxable income limitation in 2011 is $2,950, A's taxable income of $200 plus B's taxable income of $0 plus C's taxable income of $2,750. § 1.199-7T [Removed] **Par. 12.** Section 1.199-7T is removed. **Par. 13.** Section 1.199-8 is amended by: 1. Removing the language “§ 1.199-9(j)” in paragraph (e)(1)(i) and adding the language “§§ 1.199-3(i)(8) and 1.199-9(j)” in its place. 2. Removing the language “§ 1.199-9(i)” in paragraph (e)(1)(i) and adding the language “§§ 1.199-3(i)(7) and 1.199-9(i)” in its place. 3. Removing the language “§ 1.199-9(i)” in paragraph (e)(1)(ii)(B) and adding the language “§ 1.199-3(i)(7) or § 1.199-9(i)” in its place. 4. Revising the last two sentences in paragraph (h). 5. Revising paragraphs (i)(5) and (i)(6). The revisions read as follows: § 1.199-8 Other rules.

(h)*Disallowed losses or deductions.* * * * For taxpayers that are partners in partnerships, see §§ 1.199-5(b)(2) and 1.199-9(b)(2). For taxpayers that are shareholders in S corporations, see §§ 1.199-5(c)(2) and 1.199(c)(2).

(i)* * *

(5)*Tax Increase Prevention and Reconciliation Act of 2005.* Sections 1.199-2(e)(2), 1.199-3(i)(7) and (8), and 1.199-5 are applicable for taxable years beginning on or after October 19, 2006. A taxpayer may apply §§ 1.199-2(e)(2), 1.199-3(i)(7) and (8), and 1.199-5 to taxable years beginning after May 17, 2006, and October 19, 2006, regardless of whether the taxpayer otherwise relied upon Notice 2005-14 (2005-1 CB 498) (see § 601.601(d)(2)(ii)( *b* ) of this chapter), the provisions of REG-105847-05 (2005-2 CB 987), or §§ 1.199-1 through 1.199-8.

(6)*Losses used to reduce taxable income of expanded affiliated group.* Section 1.199-7(b)(4) is applicable for taxable years beginning on or after February 15, 2008. For taxable years beginning on or after October 19, 2006, and before February 15, 2008, see § 1.199-7T(b)(4) (see 26 CFR part 1 revised as of April 1, 2007). § 1.199-8T [Removed] **Par. 14.** Section 1.199-8T is removed. **Par. 15.** Section 1.199-9 is amended by: 1. Revising paragraph (b)(1)(ii)(B). 2. Removing the language “paragraph

(b)of this section shall” from paragraph (b)(5) and adding the language “this paragraph (b)” in its place. 3. Revising paragraph (c)(1)(ii)(B). 4. Revising paragraph (e)(2)(i). 5. Removing the language “directly allocable costs” in the sixth sentence of *Example 4* in paragraph (j)(5) and adding the language “CGS” in its place. 6. Adding the language “finished dosage form” before the word “drug” each time it appears in the seventh, eighth, and ninth sentences in paragraph (j)(5) *Example 5*

(i)and in the second and third sentences in paragraph (j)(5) *Example 5* (ii). The revisions read as follows: § 1.199-9 Application of section 199 to pass-thru entities for taxable years beginning on or before May 17, 2006, the enactment date of the Tax Increase Prevention and Reconciliation Act of 2006.

(b)* * *

(1)* * *

(ii)* * *

(B)For purposes of computing the partner's QPAI under §§ 1.199-1 through 1.199-9, a partner does not take into account the items from the partnership (for example, a partner does not take into account items from the partnership in determining whether a threshold or de minimis rule applies or in allocating and apportioning deductions) in calculating its QPAI from other sources;

(c)* * *

(1)* * *

(ii)* * *

(B)For purposes of computing the shareholder's QPAI under §§ 1.199-1 through 1.199-9, a shareholder does not take into account the items from the S corporation (for example, a shareholder does not take into account items from the S corporation in determining whether a threshold or de minimis rule applies or in allocating and apportioning deductions) in calculating its QPAI from other sources;

(e)* * *

(2)* * *

(i)*In general.* The QPAI of a trust or estate (which will be less than zero if the CGS and deductions allocated and apportioned to DPGR exceed the trust's or estate's DPGR) and W-2 wages of a trust or estate are allocated to each beneficiary and to the trust or estate based on the relative proportion of the trust's or estate's distributable net income (DNI), as defined by section 643(a), for the taxable year that is distributed or required to be distributed to the beneficiary or is retained by the trust or estate. For this purpose, the trust or estate's DNI is determined with regard to the separate share rule of section 663(c), but without regard to section 199. To the extent that the trust or estate has no DNI for the taxable year, any QPAI and W-2 wages are allocated entirely to the trust or estate. A trust or estate is allowed the section 199 deduction in computing its taxable income to the extent that QPAI and W-2 wages are allocated to the trust or estate. A beneficiary of a trust or estate is allowed the section 199 deduction in computing its taxable income based on its share of QPAI and W-2 wages from the trust or estate, which (subject to the wage limitation as described in paragraph (e)(3) of this section) are aggregated with the beneficiary's QPAI and W-2 wages from other sources, if any. Linda E. Stiff, Deputy Commissioner for Services and Enforcement. Approved: February 1, 2008. Eric Solomon, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. E8-2761 Filed 2-14-08; 8:45 am] BILLING CODE 4830-01-P DEPARTMENT OF JUSTICE Office of the Attorney General 28 CFR Part 0 [A.G. Order No. [2949-2008]] Incentive Award Program Delegation AGENCY: Department of Justice. ACTION: Final rule. SUMMARY: This rule amends part 0 of title 28 of the Code of Federal Regulations to increase from $5,000 to $7,500 the dollar limit up to which certain component heads of the Department of Justice may approve incentive awards. The rule also makes minor revisions to the regulations to reflect organizational changes and updated terminology, and to provide for consistency with existing personnel delegations. DATES: This rule is effective February 15, 2008. FOR FURTHER INFORMATION CONTACT: Jeanarta C. McEachron, Justice Management Division, U.S. Department of Justice, 1331 Pennsylvania Ave., NW., Suite 1110, Washington, DC 20530; Telephone:

(202)514-3663. SUPPLEMENTARY INFORMATION: The Attorney General's authority under Department of Justice incentive award programs to approve honorary awards and cash awards up to a certain dollar amount has been delegated to the heads of certain Department components. Award amounts above the limit require Attorney General approval. The dollar limit of $5,000 was set more than 25 years ago. *See* 46 FR 52339-01, Oct. 27, 1981. The Department has decided to raise the dollar limit from $5,000 to $7,500 to provide the heads of components with greater flexibility to reward outstanding employees. In addition, the revised regulations reflect organizational changes within the Department and provide for consistency with existing delegations of personnel authority. Specifically, the Commissioner of Immigration and Naturalization has been deleted from the list of officials with approval authority, the Director of the Office of Justice Assistance, Research and Statistics has been replaced by the Assistant Attorney General for the Office of Justice Programs, and the Director of the Executive Office for U.S. Trustees and the Director of the Executive Office for Immigration Review have been added. The delegation also makes clear that it applies to personnel in General Schedule grades GS-1 through GS-15, administratively determined pay systems, and wage board positions, but it excludes all Schedule C positions. Finally, the term “Incentive Awards Plan” has been changed to “Incentive Award Program” for consistency with Office of Personnel Management regulations and Department orders. Administrative Procedure Act This rule is a rule of agency organization, procedure, and practice and is limited to matters of agency management and personnel. Therefore, this rule is exempt from the requirements of prior notice and comment and a 30-day delay in the effective date. *See* 5 U.S.C. 553(a)(2), (b)(3)(A). Regulatory Flexibility Act The Attorney General, in accordance with the Regulatory Flexibility Act, 5 U.S.C. 605(b), has reviewed this rule and, by approving it, certifies that it will not have a significant economic impact on a substantial number of small entities. Further, a Regulatory Flexibility Analysis was not required to be prepared for this final rule since the Department was not required to publish a general notice of proposed rulemaking for this matter. Executive Order 12866 This rule has been drafted and reviewed in accordance with Executive Order 12866, Regulatory Planning and Review, section 1(b), Principles of Regulation. This rule is limited to agency organization, management, and personnel as described by Executive Order 12866, section 3(d)(3), and therefore is not a “regulation” or “rule” as defined by that Executive Order. Accordingly, this action has not been reviewed by the Office of Management and Budget. Executive Order 12988 This regulation meets the applicable standards set forth in sections 3(a) and 3(b)(2) of Executive Order 12988, Civil Justice Reform. Executive Order 13132 This rule will not have substantial direct effects on the States, on the relationship between the national government and the States, or on distribution of power and responsibilities among the various levels of government. Therefore, in accordance with Executive Order 13132, Federalism, the Department has determined that this rule does not have sufficient federalism implications to warrant the preparation of a federalism summary impact statement. Unfunded Mandates Reform Act of 1995 This rule will not result in the expenditure by State, local and tribal governments, in the aggregate, or by the private sector of $100,000,000 or more in any one year, and it will not significantly or uniquely affect small governments. Therefore, no actions were deemed necessary under the provisions of the Unfunded Mandates Reform Act of 1995, 2 U.S.C. 1501 et seq. Congressional Review Act This action pertains to agency management, personnel and organization and does not substantially affect the rights or obligations of non-agency parties and, accordingly, is not a “rule” as that term is used by the Congressional Review Act (Subtitle E of the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA)). Therefore, the reporting requirement of 5 U.S.C. 801 does not apply. List of Subjects in 28 CFR Part 0 Authority delegations (Government agencies), Government employees, Organization and functions (Government agencies), Whistleblowing. Accordingly, for the reasons set forth in the preamble, part 0 of chapter I of title 28 of the Code of Federal Regulations is amended as follows: PART 0—ORGANIZATION OF THE DEPARTMENT OF JUSTICE 1. The authority citation for part 0 continues to read as follows: Authority: 5 U.S.C. 301; 28 U.S.C. 509, 510, 515-519. 2. In section 0.11, revise paragraph

(a)to read as follows: § 0.11 Incentive Awards Board.

(a)Consider and make recommendations to the Attorney General concerning honorary awards and cash awards in excess of $7,500 to be granted for suggestions, inventions, superior accomplishment, or other personal effort which contributes to the efficiency, economy, or other improvement of Government operations or achieves a significant reduction in paperwork. 3. Revise § 0.143 to read as follows: § 0.143 Incentive Award Program. The Director of the Federal Bureau of Investigation, the Director of the Bureau of Prisons, the Commissioner of Federal Prison Industries, the Administrator of the Drug Enforcement Administration, the Director of the Bureau of Alcohol, Tobacco, Firearms, and Explosives, the Assistant Attorney General for the Office of Justice Programs, the Director of the Executive Office for U.S. Attorneys, the Director of the Executive Office for U.S. Trustees, the Director of the Executive Office for Immigration Review, and the Director of the U.S. Marshals Service, as to their respective jurisdictions, and the Assistant Attorney General for Administration, as to all other organizational units of the Department, are authorized to exercise the power and authority vested in the Attorney General by law with respect to the administration of the Incentive Award Program and to approve honorary awards and cash awards under such program not in excess of $7,500 for personnel in General Schedule grades GS-1 through GS-15, administratively determined pay systems, and wage board positions, but excluding all Schedule C positions. Dated: February 8, 2008. Michael B. Mukasey, Attorney General. [FR Doc. E8-2952 Filed 2-14-08; 8:45 am] BILLING CODE 4410-19-P PENSION BENEFIT GUARANTY CORPORATION 29 CFR Parts 4022 and 4044 Benefits Payable in Terminated Single-Employer Plans; Allocation of Assets in Single-Employer Plans; Interest Assumptions for Valuing and Paying Benefits AGENCY: Pension Benefit Guaranty Corporation. ACTION: Final rule. SUMMARY: The Pension Benefit Guaranty Corporation's regulations on Benefits Payable in Terminated Single-Employer Plans and Allocation of Assets in Single-Employer Plans prescribe interest assumptions for valuing and paying benefits under terminating single-employer plans. This final rule amends the regulations to adopt interest assumptions for plans with valuation dates in March 2008. Interest assumptions are also published on the PBGC's Web site ( *http://www.pbgc.gov* ). DATES: Effective March 1, 2008. FOR FURTHER INFORMATION CONTACT: Catherine B. Klion, Manager, Regulatory and Policy Division, Legislative and Regulatory Department, Pension Benefit Guaranty Corporation, 1200 K Street, NW., Washington, DC 20005, 202-326-4024. (TTY/TDD users may call the Federal relay service toll-free at 1-800-877-8339 and ask to be connected to 202-326-4024.) SUPPLEMENTARY INFORMATION: The PBGC's regulations prescribe actuarial assumptions—including interest assumptions—for valuing and paying plan benefits of terminating single-employer plans covered by title IV of the Employee Retirement Income Security Act of 1974. The interest assumptions are intended to reflect current conditions in the financial and annuity markets. Three sets of interest assumptions are prescribed:

(1)A set for the valuation of benefits for allocation purposes under section 4044 (found in Appendix B to Part 4044),

(2)a set for the PBGC to use to determine whether a benefit is payable as a lump sum and to determine lump-sum amounts to be paid by the PBGC (found in Appendix B to Part 4022), and

(3)a set for private-sector pension practitioners to refer to if they wish to use lump-sum interest rates determined using the PBGC's historical methodology (found in Appendix C to Part 4022). This amendment

(1)adds to Appendix B to Part 4044 the interest assumptions for valuing benefits for allocation purposes in plans with valuation dates during March 2008,

(2)adds to Appendix B to Part 4022 the interest assumptions for the PBGC to use for its own lump-sum payments in plans with valuation dates during March 2008, and

(3)adds to Appendix C to Part 4022 the interest assumptions for private-sector pension practitioners to refer to if they wish to use lump-sum interest rates determined using the PBGC's historical methodology for valuation dates during March 2008. For valuation of benefits for allocation purposes, the interest assumptions that the PBGC will use (set forth in Appendix B to part 4044) will be 5.54 percent for the first 20 years following the valuation date and 4.61 percent thereafter. These interest assumptions represent an increase (from those in effect for February 2008) of 0.04 percent for the first 20 years following the valuation date and 0.04 percent for all years thereafter. The interest assumptions that the PBGC will use for its own lump-sum payments (set forth in Appendix B to part 4022) will be 3.00 percent for the period during which a benefit is in pay status and 4.00 percent during any years preceding the benefit's placement in pay status. These interest assumptions represent a decrease (from those in effect for February 2008) of 0.25% in the immediate annuity rate and are otherwise unchanged. For private-sector payments, the interest assumptions (set forth in Appendix C to part 4022) will be the same as those used by the PBGC for determining and paying lump sums (set forth in Appendix B to part 4022). The PBGC has determined that notice and public comment on this amendment are impracticable and contrary to the public interest. This finding is based on the need to determine and issue new interest assumptions promptly so that the assumptions can reflect current market conditions as accurately as possible. Because of the need to provide immediate guidance for the valuation and payment of benefits in plans with valuation dates during March 2008, the PBGC finds that good cause exists for making the assumptions set forth in this amendment effective less than 30 days after publication. The PBGC has determined that this action is not a “significant regulatory action” under the criteria set forth in Executive Order 12866. Because no general notice of proposed rulemaking is required for this amendment, the Regulatory Flexibility Act of 1980 does not apply. See 5 U.S.C. 601(2). List of Subjects 29 CFR Part 4022 Employee benefit plans, Pension insurance, Pensions, Reporting and recordkeeping requirements. 29 CFR Part 4044 Employee benefit plans, Pension insurance, Pensions. In consideration of the foregoing, 29 CFR parts 4022 and 4044 are amended as follows: PART 4022—BENEFITS PAYABLE IN TERMINATED SINGLE-EMPLOYER PLANS 1. The authority citation for part 4022 continues to read as follows: Authority: 29 U.S.C. 1302, 1322, 1322b, 1341(c)(3)(D), and 1344. 2. In Appendix B to Part 4022, Rate Set 173, as set forth below, is added to the table. Appendix B to Part 4022—Lump Sum Interest Rates For PBGC Payments Rate set For plans with a valuation date On or after Before Immediate annuity rate (percent) Deferred annuities (percent) i 1 i 2 i 3 n 1 n 2 * * * * * * * 173 03-1-08 04-1-08 3.00 4.00 4.00 4.00 7 8 3. In Appendix C to Part 4022, Rate Set 173, as set forth below, is added to the table. Appendix C to Part 4022—Lump Sum Interest Rates for Private-Sector Payments Rate set For plans with a valuation date On or after Before Immediate annuity rate (percent) Deferred annuities (percent) i 1 i 2 i 3 n 1 n 2 * * * * * * * 173 03-1-08 04-1-08 3.00 4.00 4.00 4.00 7 8 PART 4044—ALLOCATION OF ASSETS IN SINGLE-EMPLOYER PLANS 4. The authority citation for part 4044 continues to read as follows: Authority: 29 U.S.C. 1301(a), 1302(b)(3), 1341, 1344, 1362. 5. In Appendix B to Part 4044, a new entry for March 2008, as set forth below, is added to the table. Appendix B to Part 4044—Interest Rates Used to Value Benefits For valuation dates occurring in the month— The values of i t are: i t for t = i t for t = i t for t = * * * * * * * March 2008 .0554 1-20 .0461 >20 N/A N/A Issued in Washington, DC, on this 8th day of February 2008. Vincent K. Snowbarger, Deputy Director, Pension Benefit Guaranty Corporation. [FR Doc. E8-2947 Filed 2-14-08; 8:45 am] BILLING CODE 7709-01-P DEPARTMENT OF HOMELAND SECURITY Coast Guard 33 CFR Part 117 [Docket No. USCG-2008-0066 formerly CGD11-08-004] Drawbridge Operation Regulations; Sacramento River, Sacramento, CA AGENCY: Coast Guard, DHS. ACTION: Notice of temporary deviation from regulations. SUMMARY: The Commander, Eleventh Coast Guard District, has issued a temporary deviation from the regulation governing the operation of the Tower Drawbridge across the Sacramento River, mile 59.0, at Sacramento, CA. The deviation is necessary to allow the owner, California Department of Transportation (Caltrans), to conduct electrical maintenance. This deviation allows the bridge to remain in the closed-to-navigation position during the maintenance period. DATES: This deviation is effective from 6 a.m. on February 25, 2008, through 5 a.m. on February 29, 2008. ADDRESSES: Materials referred to in this document are available for inspection or copying at Commander (dpw), Eleventh Coast Guard District, Building 50-2, Coast Guard Island, Alameda, CA 94501-5100, between 8 a.m. and 4 p.m., Monday through Friday, except Federal holidays. The telephone number is

(510)437-3516. The Eleventh Coast Guard District maintains the public docket for this temporary deviation. FOR FURTHER INFORMATION CONTACT: David H. Sulouff, Chief, Bridge Section, Eleventh Coast Guard District, telephone

(510)437-3516. SUPPLEMENTARY INFORMATION: Caltrans requested a temporary change to the operation of the Tower Drawbridge, mile 59.0, over the Sacramento River, at Sacramento, CA. The Tower Drawbridge navigation span provides a vertical clearance of 30 feet above Mean High Water in the closed-to-navigation position. The draw opens on signal as required by 33 CFR 117.5. Navigation on the waterway is commercial and recreational. The drawspan will be secured in the closed-to-navigation position, from 6 a.m. on February 25, 2008 through 5 a.m. on February 29, 2008, to allow Caltrans to relocate the drawspan's electrical transformer and switchboard. This temporary deviation has been coordinated with waterway users. There are no scheduled river boat cruises or anticipated levee maintenance during this deviation period. No objections to the proposed temporary deviation were raised. Vessels that can transit the bridge, while in the closed-to-navigation position, may continue to do so at any time. In the event of an emergency the drawspan can be opened with 4 hours advance notice. In accordance with 33 CFR 117.35(e), the drawbridge must return to its regular operating schedule immediately at the end of the designated time period. This deviation from the operating regulations is authorized under 33 CFR 117.35. Dated: January 31, 2008. C.E. Bone, Rear Admiral, U.S. Coast Guard, Commander, Eleventh Coast Guard District. [FR Doc. E8-2857 Filed 2-14-08; 8:45 am] BILLING CODE 4910-15-P ENVIRONMENTAL PROTECTION AGENCY 40 CFR Part 52 [EPA-R01-OAR-2006-0641; A-1-FRL-8527-5] Approval and Promulgation of Air Quality Implementation Plans; Massachusetts; Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District AGENCY: Environmental Protection Agency (EPA). ACTION: Direct final rule. SUMMARY: EPA is approving a State Implementation Plan

(SIP)revision submitted by the State of Massachusetts. The SIP revision consists of technical revisions to Massachusetts regulation 310 CMR 7.38, “Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District.” The amendments better define the emissions monitoring techniques for various types of tunnel ventilation systems, and provide flexibility in emission monitoring requirements. This action is being taken in accordance with the Clean Air Act. DATES: This direct final rule will be effective April 15, 2008, unless EPA receives adverse comments by March 17, 2008. If adverse comments are received, EPA will publish a timely withdrawal of the direct final rule in the **Federal Register** informing the public that the rule will not take effect. ADDRESSES: Submit your comments, identified by Docket ID Number EPA-R01-OAR-2006-0641 by one of the following methods: 1. *http://www.regulations.gov:* Follow the on-line instructions for submitting comments. 2. *E-mail: arnold.anne@epa.gov* . 3. *Fax:*

(617)918-0047. 4. *Mail:* “Docket Identification Number EPA-R01-OAR-2006-0641,” Anne Arnold, U.S. Environmental Protection Agency, EPA New England Regional Office, One Congress Street, Suite 1100 (mail code CAQ), Boston, MA 02114-2023. 5. *Hand Delivery or Courier.* Deliver your comments to: Anne Arnold, Manager, Air Quality Planning Unit, Office of Ecosystem Protection, U.S. Environmental Protection Agency, EPA New England Regional Office, One Congress Street, 11th floor, (CAQ), Boston, MA 02114-2023. Such deliveries are only accepted during the Regional Office's normal hours of operation. The Regional Office's official hours of business are Monday through Friday, 8:30 to 4:30, excluding legal holidays. *Instructions:* Direct your comments to Docket ID No. EPA-R01-OAR-2006-0641. EPA's policy is that all comments received will be included in the public docket without change and may be made available online at *www.regulations.gov* , including any personal information provided, unless the comment includes information claimed to be Confidential Business Information

(CBI)or other information whose disclosure is restricted by statute. Do not submit through *www.regulations.gov* , or e-mail, information that you consider to be CBI or otherwise protected. The *www.regulations.gov* Web site is an “anonymous access” system, which means EPA will not know your identity or contact information unless you provide it in the body of your comment. If you send an e-mail comment directly to EPA without going through *www.regulations.gov* your e-mail address will be automatically captured and included as part of the comment that is placed in the public docket and made available on the Internet. If you submit an electronic comment, EPA recommends that you include your name and other contact information in the body of your comment and with any disk or CD-ROM you submit. If EPA cannot read your comment due to technical difficulties and cannot contact you for clarification, EPA may not be able to consider your comment. Electronic files should avoid the use of special characters, any form of encryption, and be free of any defects or viruses. *Docket:* All documents in the electronic docket are listed in the *www.regulations.gov* index. Although listed in the index, some information is not publicly available, i.e., CBI or other information whose disclosure is restricted by statute. Certain other material, such as copyrighted material, is not placed on the Internet and will be publicly available only in hard copy form. Publicly available docket materials are available either electronically in *www.regulations.gov* or in hard copy at Office of Ecosystem Protection, U.S. Environmental Protection Agency, EPA New England Regional Office, One Congress Street, Suite 1100, Boston, MA. EPA requests that if at all possible, you contact the contact listed in the FOR FURTHER INFORMATION CONTACT section to schedule your inspection. The Regional Office's official hours of business are Monday through Friday, 8:30 to 4:30, excluding legal holidays. In addition to the publicly available docket materials available for inspection electronically in the Federal Docket Management System at *www.regulations.gov* , and the hard copy available at the Regional Office, which are identified in the ADDRESSES section of this **Federal Register** , copies of the state submittal and EPA's technical support document are also available for public inspection during normal business hours, by appointment at the State Air Agency; Massachusetts Department of Environmental Protection, Bureau of Waste Prevention, One Winter Street, 8th Floor, Boston, MA 02108. FOR FURTHER INFORMATION CONTACT: Donald O. Cooke, Air Quality Unit, U.S. Environmental Protection Agency, EPA New England Regional Office, One Congress Street, Suite 1100 (CAQ), Boston, MA 02114-2023, telephone number

(617)918-1668, fax number

(617)918-0668, e-mail *cooke.donald@epa.gov* . SUPPLEMENTARY INFORMATION: Throughout this document whenever “we,” “us,” or “our” is used, we mean EPA. Organization of this document. The following outline is provided to aid in locating information in this preamble. I. Background and Purpose. II. Addition of Emissions Monitoring Techniques for Longitudinal Ventilation. III. New Requirement for an Air Emissions Monitoring Protocol. IV. Final Action V. Statutory and Executive Order Reviews I. Background and Purpose On July 12, 2006, the State of Massachusetts submitted a formal revision to its State Implementation Plan (SIP). The SIP revision consists of technical revisions to 310 CMR 7.38, “Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District.” The technical revisions apply to the emissions monitoring section of the regulation at 310 CMR 7.38(8)(a) and define the emission monitoring requirements for systems that use longitudinal ventilation, as well as add the requirement for an “Air Emissions Monitoring Protocol.” A new subsection 310 CMR 7.38(1)(b) requires any tunnel ventilation system subject to a Federal New Source Performance Standard or National Emission Standard for Hazardous Air Pollutants to operate in compliance with those standards. A new section, 310 CMR 7.38(10), “Removal of Air Pollution Control and Monitoring Equipment,” has been added to prohibit removal of air pollution control equipment, or monitoring equipment which has been installed in accordance with 310 CMR 7.38. In addition to the technical revisions, typographical errors are also being corrected in the existing regulation. The Certification of Tunnel Ventilation Systems in the Metropolitan Air Pollution Control District regulation, 310 CMR 7.38, was promulgated on January 18, 1991 and applies to the construction and operation of any tunnel ventilation system for highway projects constructed after January 1, 1991. On October 8, 1992, EPA approved 310 CMR 7.38 as a revision to the Massachusetts SIP (57 FR 46310). In the final rule, EPA agreed with Massachusetts Department of Environmental Protection (MA DEP) that tunnel ventilation systems are not stationary sources subject to Prevention of Significant Deterioration

(PSD)or to New Source Review

(NSR)permitting requirements of the Clean Air Act (CAA), nor to Massachusetts' Plan Approval and Emissions Limitations regulation for stationary sources, 310 CMR 7.02. The purpose of the Certification of Tunnel Ventilation Systems regulation is to require certification that tunnel ventilation systems for highway projects in the Metropolitan Boston Air Pollution Control District (defined in 310 CMR 7.00) meet certain air quality requirements, thereby protecting public health and the environment. The regulation requires an initial, “preconstruction” certification, an operation certification (required 12-15 months after a project becomes fully operational), and re-certification every five years. In accordance with 310 CMR 7.38(2), the proponent must certify that the project will not:

(a)Cause or exacerbate a violation of any National Ambient Air Quality Standard as set forth at 40 CFR part 50, or a Massachusetts Ambient Air Quality Standard as set forth at 310 CMR 6.00; or

(b)cause or exacerbate a violation of the MA DEP's one hour ambient NO 2 guideline of 320 μg/m 3 ; or

(c)result in an actual or projected increase in the total amount of non-methane hydrocarbons measured within the project area when compared with the no-build alternative. With this certification process approved as a SIP element, approval of individual certifications or conditions which require written approval by MA DEP will not require SIP revisions. This concept is included in the existing SIP-approved rule, and the recent revisions do not change this previously established process. II. Addition of Emissions Monitoring Techniques for Longitudinal Ventilation During the late 1980s when the CA/T Project was initially planning and designing the ventilation system, the only Federal Highway Administration

(FHWA)authorized tunnel ventilation system was the traditional “full transverse ventilation.” Therefore, when 310 CMR 7.38 was promulgated in 1991, the emissions monitoring requirements were based on full transverse ventilation technology. In 1995, FHWA issued a memorandum entitled “Mechanical Ventilation in Road Tunnels using Jet Fans” authorizing applicable projects to use longitudinal ventilation with jet fan technology. The availability of this additional ventilation technology was neither anticipated nor provided for in 310 CMR 7.38(8). Following the FHWA authorization memo, the Central Artery/Third Harbor Tunnel (CA/T) project studied the supplementary use of longitudinal ventilation at several exit ramps as a cost saving measure. The CA/T Project subsequently filed a Notice of Project Change, and implemented longitudinal ventilation at eight exit ramps. Although longitudinal ventilation was approved for use on the CA/T Project, the resulting emission impacts at the eight exit ramp portals cannot be monitored using 40 CFR part 60 Continuous Emissions Monitoring

(CEM)methods because those methods are designed to measure emissions from stacks, not exit ramp portals. The revised subsection 7.38(8)(a) specifically requires emissions monitoring and recording equipment in tunnel roadway exit portals that utilize longitudinal ventilation. The revisions to the Certification of Tunnel Ventilation Systems regulation contain a revised set of allowable techniques and emissions monitoring approaches that incorporate elements of 40 CFR part 58—Ambient Air Quality Surveillance, 40 CFR part 60—Standards of Performance for New Stationary Sources, 40 CFR part 75—Continuous Emission Monitoring, as well as statistical analysis, computer modeling, and innovative technologies. This “hybrid” approach to emission monitoring, which includes elements of ambient air quality monitoring and continuous emission monitoring, will provide more accurate monitoring of ambient emissions within the portal area environment which could not be conducted with the original stack monitoring approach under 40 CFR part 60, appendix B—Performance Specifications. III. New Requirement for an Air Emissions Monitoring Protocol MA DEP has also revised the emissions monitoring requirements at 310 CMR 7.38(8)(a) to require that any person who constructs and operates a tunnel ventilation system which is subject to the requirements of 310 CMR 7.38 shall, prior to commencing operation of the tunnel ventilation system or opening the project roadway for public use, develop and submit to the Department for review and approval an “Air Emissions Monitoring Protocol.” This subsection requires that all emissions monitoring and recording equipment be installed and operated in accordance with the approved protocol. Lastly, this subsection allows the “Air Emissions Monitoring Protocol” to be modified with prior written approval of the Department. This allows flexibility so that as technological advances occur in contaminant and emissions monitoring, MA DEP will be able to modify the monitoring procedures without necessarily having to complete a regulatory revision process. Therefore, the regulation allows affected projects to periodically modify or update their air emission monitoring protocol with written approval of MA DEP. IV. Final Action EPA has reviewed the revised rule and has found that it is consistent with requirements of the Clean Air Act. EPA is approving this rule because it will improve emission monitoring techniques, allowing the state greater flexibility to assess and quantify emissions, for the roadway tunnel ventilation systems in the Boston Metropolitan Air Control District. EPA is approving Massachusetts amendments to 310 CMR 7.38, entitled “Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District,” and incorporating this revised rule into the Massachusetts SIP. The EPA is publishing this action without prior proposal because the Agency views this as a noncontroversial amendment and anticipates no adverse comments. However, in the proposed rules section of this **Federal Register** publication, EPA is publishing a separate document that will serve as the proposal to approve the SIP revision should relevant adverse comments be filed. This rule will be effective April 15, 2008 without further notice unless the Agency receives relevant adverse comments by March 17, 2008. If the EPA receives such comments, then EPA will publish a notice withdrawing the final rule and informing the public that the rule will not take effect. All public comments received will then be addressed in a subsequent final rule based on the proposed rule. The EPA will not institute a second comment period on the proposed rule. All parties interested in commenting on the proposed rule should do so at this time. If no such comments are received, the public is advised that this rule will be effective on April 15, 2008 and no further action will be taken on the proposed rule. Please note that if EPA receives adverse comment on an amendment, paragraph, or section of this rule and if that provision may be severed from the remainder of the rule, EPA may adopt as final those provisions of the rule that are not the subject of an adverse comment. V. Statutory and Executive Order Reviews Under Executive Order 12866 (58 FR 51735, October 4, 1993), this action is not a “significant regulatory action” and therefore is not subject to review by the Office of Management and Budget. For this reason, this action is also not subject to Executive Order 13211, “Actions Concerning Regulations That Significantly Affect Energy Supply, Distribution, or Use” (66 FR 28355, May 22, 2001). This action merely approves state law as meeting Federal requirements and imposes no additional requirements beyond those imposed by state law. Accordingly, the Administrator certifies that this rule will not have a significant economic impact on a substantial number of small entities under the Regulatory Flexibility Act (5 U.S.C. 601 et seq.). Because this rule approves pre-existing requirements under state law and does not impose any additional enforceable duty beyond that required by state law, it does not contain any unfunded mandate or significantly or uniquely affect small governments, as described in the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4). This rule also does not have tribal implications because it will not have a substantial direct effect on one or more Indian tribes, on the relationship between the Federal Government and Indian tribes, or on the distribution of power and responsibilities between the Federal Government and Indian tribes, as specified by Executive Order 13175 (65 FR 67249, November 9, 2000). This action also does not have Federalism implications because it does not have substantial direct effects on the States, on the relationship between the national government and the States, or on the distribution of power and responsibilities among the various levels of government, as specified in Executive Order 13132 (64 FR 43255, August 10, 1999), because it merely approves a state rule implementing a Federal standard, and does not alter the relationship or the distribution of power and responsibilities established in the Clean Air Act. This rule also is not subject to Executive Order 13045 “Protection of Children from Environmental Health Risks and Safety Risks” (62 FR 19885, April 23, 1997), because it approves a state rule implementing a Federal standard. In reviewing SIP submissions, EPA's role is to approve state choices, provided that they meet the criteria of the Clean Air Act. In this context, in the absence of a prior existing requirement for the State to use voluntary consensus standards (VCS), EPA has no authority to disapprove a SIP submission for failure to use VCS. It would thus be inconsistent with applicable law for EPA, when it reviews a SIP submission, to use VCS in place of a SIP submission that otherwise satisfies the provisions of the Clean Air Act. Thus, the requirements of section 12(d) of the National Technology Transfer and Advancement Act of 1995 (15 U.S.C. 272 note) do not apply. This rule does not impose an information collection burden under the provisions of the Paperwork Reduction Act of 1995 (44 U.S.C. 3501 *et seq.* ) The Congressional Review Act, 5 U.S.C. 801 *et seq.* , as added by the Small Business Regulatory Enforcement Fairness Act of 1996, generally provides that before a rule may take effect, the agency promulgating the rule must submit a rule report, which includes a copy of the rule, to each House of the Congress and to the Comptroller General of the United States. EPA will submit a report containing this rule and other required information to the U.S. Senate, the U.S. House of Representatives, and the Comptroller General of the United States prior to publication of the rule in the **Federal Register** . A major rule cannot take effect until 60 days after it is published in the **Federal Register** . This action is not a “major rule” as defined by 5 U.S.C. 804(2). Under section 307(b)(1) of the Clean Air Act, petitions for judicial review of this action must be filed in the United States Court of Appeals for the appropriate circuit by April 15, 2008. Interested parties should comment in response to the proposed rule rather than petition for judicial review, unless the objection arises after the comment period allowed for in the proposal. Filing a petition for reconsideration by the Administrator of this final rule does not affect the finality of this rule for the purposes of judicial review nor does it extend the time within which a petition for judicial review may be filed, and shall not postpone the effectiveness of such rule or action. This action may not be challenged later in proceedings to enforce its requirements. (See section 307(b)(2).) List of Subjects in 40 CFR Part 52 Environmental protection, Air pollution control, Carbon monoxide, Incorporation by reference, Intergovernmental relations, Nitrogen dioxide, Ozone, Particulate matter, Reporting and recordkeeping requirements, Volatile organic compounds. Dated: February 1, 2008. Ira W. Leighton, Acting Regional Administrator, EPA New England. Part 52 of chapter I, title 40 of the Code of Federal Regulations is amended as follows: PART 52—[AMENDED] 1. The authority citation for part 52 continues to read as follows: Authority: 42 U.S.C. 7401 et seq. Subpart W—Massachusetts 2. Section 52.1120 is amended by adding paragraph (c)(134) to read as follows: § 52.1120 Identification of plan.

(c)* * *

(134)Revisions to the State Implementation Plan submitted by the Massachusetts Department of Environmental Protection on July 12, 2006.

(i)Incorporation by reference.

(A)Massachusetts Regulation 310 CMR 7.38, entitled “Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District,” effective in the Commonwealth of Massachusetts on December 30, 2005.

(B)Massachusetts Regulation Filing, dated December 13, 2005, amending 310 CMR 7.38 entitled “Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District.”

(ii)Additional materials.

(A)Letter from the Massachusetts Department of Environmental Protection dated July 12, 2006, submitting a revision to the Massachusetts State Implementation Plan. 3. In § 52.1167, Table 52.1167 is amended by adding two new citations to the existing entry for 310 CMR 7.38 to read as follows: § 52.1167 EPA-approved Massachusetts State regulations. Table 52.1167—EPA-Approved Massachusetts Regulations State citation Title/subject Date submitted by State Date approved by EPA **Federal Register** citation 52.1120(c) Comments/unapproved sections * * * * * * * 310 CMR 7.38 Tunnel vent certification regulation 7/12/06 2/15/08 [Insert **Federal Register** page number where the document begins] 134 Amendments to Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District. 7/12/06 2/15/08 [Insert **Federal Register** page number where the document begins] 134 Massachusetts Regulation Filing, dated December 13, 2005, substantiating December 30, 2005, State effective date for amended 310 CMR 7.38 “Certification of Tunnel Ventilation Systems in the Metropolitan Boston Air Pollution Control District.” * * * * * * * Notes: 1. This table lists regulations adopted as of 1972. It does not depict regulatory requirements which may have been part of the Federal SIP before this date. 2. The regulations are effective statewide unless stated otherwise in comments or title section. [FR Doc. E8-2745 Filed 2-14-08; 8:45 am] BILLING CODE 6560-50-P DEPARTMENT OF COMMERCE National Oceanic and Atmospheric Administration 50 CFR Part 679 [Docket No. 070213033-7033-01] RIN 0648-XF62 Fisheries of the Exclusive Economic Zone Off Alaska; Pacific Cod by Catcher Vessels Less Than 60 feet (18.3 m) LOA Using Jig or Hook-and-Line Gear in the Bogoslof Pacific Cod Exemption Area in the Bering Sea and Aleutian Islands Management Area AGENCY: National Marine Fisheries Service (NMFS), National Oceanic and Atmospheric Administration (NOAA), Commerce. ACTION: Temporary rule; closure. SUMMARY: NMFS is prohibiting directed fishing for Pacific cod by catcher vessels less than 60 feet (< 18.3 meters (m)) length overall

(LOA)using jig or hook-and-line gear in the Bogoslof Pacific cod exemption area of the Bering Sea and Aleutian Islands management area (BSAI). This action is necessary to prevent exceeding the limit of Pacific cod for catcher vessels < 60 ft (18.3 m) LOA using jig or hook-and-line gear in the Bogoslof Pacific cod exemption area in the BSAI. DATES: Effective 1200 hrs, Alaska local time (A.l.t.), February 12, 2008, through 2400 hrs, A.l.t., December 31, 2008. FOR FURTHER INFORMATION CONTACT: Jennifer Hogan, 907-586-7228. SUPPLEMENTARY INFORMATION: NMFS manages the groundfish fishery in the BSAI according to the Fishery Management Plan for Groundfish of the Bering Sea and Aleutian Islands Management Area

(FMP)prepared by the North Pacific Fishery Management Council under authority of the Magnuson-Stevens Fishery Conservation and Management Act. Regulations governing fishing by U.S. vessels in accordance with the FMP appear at subpart H of 50 CFR part 600 and 50 CFR part 679. In accordance with § 679.22(a)(7)(i)(C), the Administrator, Alaska Region, NMFS (Regional Administrator), has determined that 113 metric tons of Pacific cod have been caught by catcher vessels < 60 ft (18.3 m) LOA using jig or hook-and-line gear in the Bogoslof exemption area described at § 679.22(a)(7)(i)(C)( *1* ). Consequently, the Regional Administrator is prohibiting directed fishing for Pacific cod by catcher vessels < 60 ft (18.3 m) LOA using jig or hook-and-line gear in the Bogoslof Pacific cod exemption area. After the effective date of this closure the maximum retainable amounts at § 679.20(e) and

(f)apply at any time during a trip. Classification This action responds to the best available information recently obtained from the fishery. The Assistant Administrator for Fisheries, NOAA (AA), finds good cause to waive the requirement to provide prior notice and opportunity for public comment pursuant to the authority set forth at 5 U.S.C. 553(b)(B) as such requirement is impracticable and contrary to the public interest. This requirement is impracticable and contrary to the public interest as it would prevent NMFS from responding to the most recent fisheries data in a timely fashion and would delay the closure of Pacific cod by catcher vessels < 60 ft (18.3 m) LOA using jig or hook-and-line gear in the Bogoslof Pacific cod exemption area. NMFS was unable to publish a notice providing time for public comment because the most recent, relevant data only became available as of February 11, 2008. The AA also finds good cause to waive the 30-day delay in the effective date of this action under 5 U.S.C. 553(d)(3). This finding is based upon the reasons provided above for waiver of prior notice and opportunity for public comment. This action is required by § 679.22 and is exempt from review under Executive Order 12866. Authority: 16 U.S.C. 1801 *et seq.* Dated: February 11, 2008. Alan D. Risenhoover, Director, Office of Sustainable Fisheries, National Marine Fisheries Service. [FR Doc. 08-706 Filed 2-12-08; 2:08 pm]

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