Notice 2003-67

available for public inspection and copying.
DRAFTING INFORMATION
The principal author of this notice is
Marie Byrne of the Office of Associate
Chief Counsel (Corporate). For further
information regarding this notice, contact
Ms. Byrne at (202) 622–7750 (not a tollfree number).

The Jobs and Growth Tax
Relief Reconciliation Act of
2003—Information Reporting
for Payments in Lieu of
Dividends
Notice 2003–67
SECTION 1. PURPOSE
This notice provides guidance to brokers and individuals regarding provisions
in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the JGTRRA), Pub.
L. No. 108–27, 117 Stat. 752, that affect
information reporting for payments in lieu
of dividends (sometimes called “substitute
payments”). This notice announces that:
1. The Internal Revenue Service will
exercise its authority under section 6724(a)
of the Internal Revenue Code to waive
penalties under sections 6721 and 6722 for
information returns with respect to calendar year 2003 payments if a broker makes
a good faith effort to satisfy its information
reporting obligations in a way that is consistent with the statutory changes effected
by the JGTRRA.
2. The Service has revised the instructions to the 2003 Form 1099–MISC, “Miscellaneous Income,” to require brokers to
report payments in lieu of dividends to individuals in Box 8 of Form 1099–MISC.
3. The Service expects to revise Rev.
Proc. 2003–28, 2003–16 I.R.B. 759, to allow brokers to furnish composite substitute
payee statements for Forms 1099–DIV,
“Dividends and Distributions,” and Forms
1099–MISC, reporting payments in lieu
of dividends, as well as other information
returns.
4. If a payment in lieu of dividends
is reported as dividend income on a 2003

2003-40 I.R.B.

Form 1099–DIV, the taxpayer receiving
the form may treat the payment for tax purposes as a dividend, and not as a payment
in lieu of dividends, unless the taxpayer
knows, or has reason to know, of the actual character of the payment.
5. The Service expects to amend
section 1.6045–2 of the Income Tax Regulations to reflect the statutory changes
effected by the JGTRRA regarding payments in lieu of dividends. The Service expects to amend the regulations to provide
new rules for brokers to use to determine
which shares are loanable and to permit
brokers to use a new hierarchical method
to allocate transferred shares to new pools
of loanable shares. The amendments are
expected to be applicable to dividends
received on or after January 1, 2003.
SECTION 2. BACKGROUND
Effective for taxable years beginning
after December 31, 2002, and beginning
before January 1, 2009, section 302 of the
JGTRRA reduces the tax rate for “qualified dividends” paid to an individual shareholder to the same tax rate as capital gains.
The reduced tax rate does not apply to a
dividend on stock that is held (within the
meaning of section 246(c)) by the taxpayer
for 60 days or less of the 120-day period
that begins 60 days before the ex-dividend
date. The favorable tax rate is also denied to the extent that the taxpayer is under an obligation (whether pursuant to a
short sale or otherwise) to make related
payments with respect to positions in substantially similar or related property.
The legislative history states, however,
that “Payments in lieu of dividends are
not eligible for the lower rates.” H.R.
REP. NO. 108–94, 108th Cong., 1st Sess.
31 n.36 (2003). (The distinction between
payments made with respect to a financial
instrument by its issuer and payments
made by a third party who had borrowed
the instrument was already relevant even
before the JGTRRA for exempt interest
dividends, capital gain dividends, distributions treated as a return of capital, foreign
tax credit dividends, and dividends eligible
for the dividends received deduction, but
was generally not relevant for dividends
or in lieu of dividend payments received
by an individual. See section 1.6045–2(a),
(f)). In addition, the Conference Report
states:

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In the case of brokers and dealers who
engage in securities lending transactions, short sales, or other similar
transactions on behalf of their customers in the normal course of their
trade or business, the conferees intend
that the IRS will exercise its authority
under section 6724(a) to waive penalties where dealers and brokers attempt
in good faith to comply with the information reporting requirements under
sections 6042 and 6045, but are unable to reasonably comply because of
the period necessary to conform their
information reporting systems to the
retroactive rate reductions on qualified
dividends provided by the conference
agreement. In addition, the conferees
expect that individual taxpayers who
receive payments in lieu of dividends
from these transactions may treat the
payments as dividend income to the
extent that the payments are reported
to them as dividend income on their
Forms 1099–DIV received for calendar year 2003, unless they know or
have reason to know that the payments
are in fact payments in lieu of dividends rather than actual dividends. The
conferees expect that the Treasury Department will issue guidance as rapidly
as possible on information reporting
with respect to payments in lieu of
dividends made to individuals.
H.R. CONF. REP. NO. 108–126, 108th
Cong., 1st Sess. 42–43 (2003).
SECTION 3. WAIVER OF PENALTIES
UNDER SECTION 6724(a)
Section 6721 imposes a penalty if a
payor fails to file correct information returns with the Service, including returns
required under section 6042 (relating to
payment of dividends) and section 6045
(relating to returns of brokers). Section
6722 imposes a penalty if a payor fails
to furnish correct information statements
to payees, including statements required
under sections 6042 and 6045. Section
6724(a) authorizes the Service to waive the
section 6721 and 6722 penalties if the failure to comply is due to reasonable cause
and not to willful neglect.
If they have not already done so,
brokers as defined in section 6045 who
engage in securities lending transactions,
short sales, or other similar transactions

October 6, 2003

on behalf of their customers in the normal
course of the brokers’ trade or business
should immediately undertake action to
conform their information reporting systems to the JGTRRA. The Service expects
brokers to complete those efforts as soon
as reasonably possible for the calendar
year 2003 and, to the extent reasonably
possible, to comply with their reporting
responsibilities in a manner consistent
with the JGTRRA for payments in lieu of
dividends for the calendar year 2003.
The Service will exercise its authority under section 6724(a) to waive penalties if a broker shows that it made a good
faith attempt to comply with the information reporting requirements under sections 6042 and 6045 in a manner consistent with the JGTRRA for dividend payments made during calendar year 2003 but
could not reasonably do so because the
broker had inadequate time within which
to conform the broker’s information reporting systems to the JGTRRA. The Service will consider all relevant facts and circumstances in determining whether a broker acted in good faith in attempting to
comply with the information reporting requirements for dividend payments made
during calendar year 2003. For dividend
payments made during calendar year 2004,
however, except in extraordinary circumstances, the Service will consider brokers
to have had adequate time to conform their
information reporting systems to the new
law for payments in lieu of dividends.
SECTION 4. INSTRUCTIONS TO
FORM 1099–MISC AND REV. PROC.
2003–28
The Service has revised the Instructions to Form 1099–MISC for calendar
year 2003 for payments in lieu of dividends. The revised instructions direct
brokers to report payments in lieu of dividends in Box 8 of Form 1099–MISC
whether the recipient is a corporation, an
individual, or some other type of taxpayer.
In addition, the Service expects to revise
Rev. Proc. 2003–28 to allow brokers to
furnish composite substitute payee statements for Forms 1099–DIV and Forms
1099–MISC, reporting payments in lieu
of dividends, as well as other information
returns.

October 6, 2003

SECTION 5. PAYMENTS REPORTED
ON FORMS 1099–DIV FOR 2003
Some taxpayers may receive Forms
1099–DIV for calendar year 2003 that
erroneously characterize payments in lieu
of dividends as dividend income because
the brokers issuing the forms have not
yet modified their information reporting
systems to comply with the JGTRRA. A
taxpayer who receives payments in lieu
of dividends may treat the payments as
dividend income to the extent that the
payments are reported to the taxpayer as
dividend income on Form 1099–DIV for
calendar year 2003, unless the taxpayer
knows, or has reason to know, that the
payments are in fact payments in lieu of
dividends rather than actual dividends.
SECTION 6. AMENDMENT OF
REGULATION SECTION 1.6045–2
In general, section 1.6045–2 of the existing regulations, which was issued prior
to enactment of the JGTRRA, excludes
from the broker reporting requirements of
section 6045 payments in lieu of dividends
received by a broker on behalf of an individual. That is, these regulations generally require broker reporting only for payments in lieu of dividends received on behalf of corporations. The Service expects
to amend section 1.6045–2 to reflect the
differential tax treatment under JGTRRA
for dividends and payments in lieu of dividends, effective for dividends received on
or after January 1, 2003.
Under the existing regulations, brokers
must allocate transferred shares (that is,
shares giving rise to payments in lieu of
dividends) among: (1) shares of stock that
the broker has borrowed under a securities lending agreement with the customer
(borrowed shares); and (2) shares of stock
that are held by the broker on behalf of
customers who have authorized the broker
to loan their shares to third parties (loanable shares). Loanable shares also include
shares of the same class and issue held for
the broker’s own account. Under the existing regulations, transferred shares may
be allocated first to borrowed shares; then,
to the extent that the number of transferred
shares exceeds the number of borrowed
shares (or if the broker does not allocate the
transferred shares to the borrowed shares

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first), the broker must allocate the transferred shares between pools of loanable
shares.
.01 Loanable Shares Defined
The amendments to section 1.6045–2
are expected to clarify the present rule that
loanable shares do not include shares that
the broker by law is prevented from lending. Thus, loanable shares do not include
shares that the broker has not been given
permission to borrow or lend, shares that
the owner may not transfer (such as restricted stock), and shares that, although
held in a margin account, may not be borrowed because of Securities and Exchange
Commission restrictions on the value of
the shares that may be borrowed from the
account.
The Service also expects to amend the
existing regulations to provide new rules
regarding shares that are to be treated as
loanable shares. When amended, the regulations are expected to permit brokers to
exclude from loanable shares one or more
of the following categories of shares:
1.

All shares held for the broker’s own
account.

2.

All shares that would not be loanable
but for the fact that they are held in
a margin account pursuant to account
documentation authorizing the lending of shares.

3.

Shares that the owner has requested
the broker not to lend (even if the
owner had executed a written authorization to lend), provided that,
consistent with an established practice reflected in the broker’s books
and records, the broker complies with
the request.

4.

Shares which had been loaned, but,
with respect to which the owner exercised a right under the lending agreement to call back the shares within a
fixed period.

5.

Any other category of shares described in guidance issued by the
Service.
The regulations are expected to provide that, under the preceding paragraph,
shares in any of these five categories may

2003-40 I.R.B.

be treated as not loanable only if all of the
following requirements are satisfied:
a.

b.

At the time the broker designates the
share as not loanable, the share has
not, in fact, been loaned under an outstanding loan agreement;
The designation of a category of
shares as not being loanable is reflected in a written policy of the
broker that was placed in its books
and records on or before the time of
the stock loans to be affected by the
policy; and

c.

The policy is consistently applied for
both tax and nontax purposes to all
shares described in the category.
The Service invites comments on these
categories of shares and on the requirements that must be satisfied to treat the
shares as not loanable.
.02 Allocation and Selection of
Transferred Shares
Pending issuance of amendments to
section 1.6045–2, the rules of that section
continue to apply for recordkeeping for
payments in lieu of dividends and for
identifying which customers had their
shares transferred. A broker may continue to allocate transferred shares to
borrowed shares. In addition, if a broker uses the method of allocation and
selection of loanable shares specified in
paragraph (f)(2)(ii) of section 1.6045–2,
the amendments are expected to allow
the broker, starting in 2003, to make
the selection of the transferred shares
within the individual pool described in
section 1.6045–2(f)(2)(ii)(C) using the
methods of selection of transferred shares
used within the nonindividual pool as prescribed in section 1.6045–2(f)(2)(ii)(B).
The Service expects to amend the existing regulations to permit brokers to use a
new hierarchical method to allocate transferred shares. Under this new hierarchical method, a broker must allocate transferred shares first to shares that are borrowed under a securities lending agreement. Brokers must then allocate the remaining transferred shares to one or more
pools of shares held by tax-indifferent customers to the extent of loanable shares in

2003-40 I.R.B.

those pools. For this purpose, a tax-indifferent customer is a customer (for example, a tax-exempt entity) for whom the broker has reasonably determined that the tax
treatment of qualifying dividends and payments in lieu of dividends are the same.
These pools may also include shares held
by customers for whom the tax treatment
of dividends is more desirable than the tax
treatment of payments in lieu of dividends,
but who have specifically authorized that
the shares be included in a tax-indifferent-customer pool. After the broker has
exhausted all the loanable shares in the
tax-indifferent-customer pools, the broker
must allocate the transferred shares to a
single residual pool of all other loanable
shares. If only a portion of the loanable
shares held in any pool are transferred, the
broker must allocate the transferred shares
among customers in the pool using the
random lottery method provided in section 1.6045–2(f)(2)(ii)(B) of the existing
regulations. A broker may use some other
allocation method only with the consent
of the Service. See Rev. Proc. 2003–1,
2003–1 I.R.B. 1, for the procedures to request a letter ruling. The Service invites
comments on this hierarchical method as
well as other methods of allocating transferred shares (giving rise to payments in
lieu of dividends) among customers holding loanable shares. The amendments are
expected to allow brokers to use the allocation method described in this Section
6 for dividends received after January 1,
2003. The provisions applicable to foreign persons receiving substitute dividends
payments continue to apply (e.g., character
rules under section 1.871–7(b)(2)).
SECTION 7. EFFECTIVE DATE
This Notice is effective September 16,
2003.
SECTION 8. COMMENTS
The Service invites interested persons
to comment on the issues raised in this notice. Interested persons should send comments to:
CC:PA:LPD:PR (NOT–139295–03)
Room 5203
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

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Alternatively, comments may be hand delivered between the hours of 8:00 a.m. and
5:00 p.m. to:
CC:PA:LPD:PR (NOT–139295–03)
Courier’s Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224
Comments may also be transmitted electronically via the following e-mail address:
Notice.Comments@irscoun sel.treas.gov.
Please include “Notice 2003–67” in the
subject line of any electronic communications.
SECTION 9. PAPERWORK
REDUCTION ACT
The collection of information contained
in this notice has been reviewed and approved by the Office of Management and
Budget in accordance with the Paperwork
Reduction Act (44 U.S.C. 3507) under
control number 1545–1858.
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless the
collection of information displays a valid
OMB control number.
The recordkeeping requirement in this
notice is in Section 6. This information is
required for brokers to use the rules for determining loanable shares and to use the
rules for allocating transferred shares to
loanable shares. The collection of information is voluntary to obtain a benefit. The
likely respondents are businesses or other
for profit institutions.
The estimated total annual recordkeeping burden is 60,000 hours.
The estimated annual burden per
recordkeeper varies from 50 hours to 150
hours, depending on individual circumstances, with an estimated average of 100
hours.
The estimated number of recordkeepers
is 600.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally tax returns and tax return
information are confidential, as required
by 26 U.S.C. 6103.

October 6, 2003

SECTION 10. CONTACT
INFORMATION
The principal author of this notice is
Michael Hara of the Office of Associate

October 6, 2003

Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. Mr. Hara may be

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contacted at (202) 622–4910 (not a tollfree number).

2003-40 I.R.B.