The partnership agreement provides that upon the death of a partner, his estate is entitled to receive his share of profits of the partnership realized and remaining undistributed at the time of his death, and any guaranteed amounts payable in lieu of amounts earned while the decedent was a partner but not realized by the partnership at time of his death.

At the time of A's death, three rights existed with respect to his partnership interest as follows: (1) the right to undistributed amounts of his share of profits earned and realized by the partnership before calendar year 1964; (2) the right to undistributed amounts of his share of profits earned and realized by the partnership from the beginning of 1964 to the date of A's death; and (3) the right to guaranteed payments of designated amounts in lieu of amounts earned while the decedent was a partner but not realized by the partnership at the time of A's death.

Under the terms of his will, A bequeathed to each of five beneficiaries an equal portion of the right which he had at the date of his death to receive undistributed amounts of his share of the profits earned and realized by the partnership from the beginning of 1964 to the date of his death. He also bequeathed to those beneficiaries in equal shares any guaranteed amounts to which he had a right under the terms of the partnership agreement. Pursuant to the terms of the will, on December 1, 1964, the executor of the estate assigned to each beneficiary a one-fifth interest in these two rights.

The bequest to the five beneficiaries specifically excluded A's right to undistributed amounts of his share of profits earned and realized by the partnership before calendar year 1964.

The estate reports income on the cash receipts and disbursements method of accounting and uses a fiscal year accounting period ending February 28.

Section 706 (c) (1) of the Internal Revenue Code of 1954 provides the general rule that, except in the case of a termination of a partnership, the taxable year of a partnership shall not close as the result of the death of a partner.

Section 1.706-1 (c) (3) (i) of the Income Tax Regulations provides, in part, that when a partner dies, the partnership taxable year shall not close with respect to such partner prior to the end of the partnership taxable year.

Section 1.706-1 (c) (3) (ii) of the regulations provides, in part, that the last return of a decedent partner shall include only his share of partnership taxable income for any partnership taxable year or years ending within or with the last taxable year for such decedent partner. The distributive share of partnership taxable income for a partnership taxable year ending after the decedent's last taxable year is includible by his estate or other successor in interest in the return filed for the taxable year within or with which the taxable year of the partnership ends.

Section 1.706-1 (c) (3) (v) of the regulations provides that to the extent that any part of a distributive share of partnership income of the estate or other successor in interest of a deceased partner is attributable to the decedent for the period ending with the date of his death, such part of the distributive share is income in respect of the decedent under section 691 of the Code. Similarly section 1.753-1(b)

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of the regulations provides that when a partner dies, the entire portion of the distributive share which is attributable to the period ending with the date of his death and which is taxable to his estate or other successor is income in respect of a decedent under section 691 of the Code. Although section 691 of the Code and the regulations thereunder provide special rules for the reporting of income in respect of a decedent, those rules do not govern the time for reporting a deceased partner's distributive share of partnership income for the partnership's taxable year in which the decedent died. Instead, section 706 of the Code and the regulations thereunder are applicable, as provided in section 1.706-1 (c) of the regulations. Under section 1.706-1(c) (3) (ii) of the regulations a deceased partner's distributive share of partnership income for the partnership's taxable year in which the decedent died is includible in the gross income of the estate or other successor in interest in its taxable year within or with which the taxable year of the partnership ends, even though there may not have been a distribution by the partnership of the amounts involved.

A's estate became successor in interest upon his death and, as such, it became the owner of the partnership interest held by the decedent. As successor in interest and owner of the partnership interest, A's estate acquired the right to receive the payments specified in the partnership agreement. Since the estate did not assign to the five beneficiaries the right to receive undistributed amounts of his share of profits earned and realized by the partnership before 1964, the estate remained the successor in interest to the entire partnership interest of the decedent as of the end of the partnership taxable year ending December 31, 1964. Accordingly, the estate of the decedent is required to include in its gross income in its first taxable year, 50x dollars, the amount of the distributive share of partnership taxable income for the partnership taxable year ending December 31, 1964.

SECTION 708.-CONTINUATION OF PARTNERSHIP

26 CFR 1.708-1: Continuation of partnership.

Rev. Rul. 68-289

Where three partnerships merged, the terminating partnerships are treated as having contributed all of their assets and transferred their liabilities to the continuing partnership in exchange for interests in such partnership that are distributed to the respective partners of the terminating partnerships in liquidation of their interests. Basis of the partnership interests acquired in the resulting partnership is determined under section 732 (b) of the Internal Revenue Code of 1954.

Advice has been requested whether, under the circumstances described below, assets and liabilities of terminating partnerships, P1 and P2, are treated as having been distributed to the respective partners in liquidation and such assets and liabilities considered as subsequently recontributed by the respective partners to P3, the resulting partnership.

As of December 31, 1965, P1, P2, and P3 were limited partnerships engaged in the oil and gas business.

A and B, the only general partners, each owns a 20 percent interest in capital and profits of the three partnerships. The limited partners in Pi and P2 are also the limited partners in P3.

On January 1, 1966, in accordance with a written agreement, the three existing partnerships merged into one partnership with P3 contributing the greatest dollar value of assets.

In accordance with section 708(b) (2) (A) of the Internal Revenue Code of 1954 and section 1.708-1 (b) (2) (i) of the Income Tax Regulations, P3 is the resulting partnership and P1 and P2 are considered terminated.

Accordingly, P3 is the resulting partnership and P1 and P2 are treated as having contributed all of their respective assets and transferred their liabilities to P3 in exchange for a partnership interest. P1 and P2 are thereafter considered terminated and their respective partners are considered to have received in liquidation partnership interests in P3 with a basis to them as determined under section 732 (b) of the Code.

PART III.-DEFINITIONS

SECTION 761.-TERMS DEFINED

26 CFR 1.761-1: Terms defined.

Whether a venture formed by four electrical power corporations in which the participants own electrical generating units as tenants in common and each takes its share of the power generated and, through its own system, separately sells and distributes this power to its own customers is a partnership and, if so, may the participants in the venture elect to have the partnership excluded from the application of subchapter K, chapter 1, of the Code. See Rev. Rul. 68-344, page 569.

An organization which issues medical service contracts to groups or individuals and furnishes direct medical services to the subscribers by means of a salaried staff of doctors, nurses, and technicians is not an insurance company within the meaning of the Internal Revenue Code of 1954.

Advice has been requested whether an organization engaged in issuing medical service contracts under the circumstances described below qualifies as an insurance company within the meaning of the Internal Revenue Code of 1954.

An organization issues medical service contracts to various groups and individuals who prepay the contract price at fixed monthly rates. The organization furnishes a medical clinic staffed with salaried physicians, nurses, and technicians to provide a major portion of the medical services contracted for, which includes care for the injured or the sick as well as preventive care. When the clinic is unable to perform the medical services contracted for either because the injury or illness occurs in another geographical area or because a special type of treatment is required that the clinic is unable to provide, or because hospitalization is required, the organization pays the entire cost of such services.

The organization is under the jurisdiction of the insurance commissioner of the state in which it is organized, and is classified under state law as a health care service contractor. Under the law of that state, a health care service contractor is not deemed to be engaging in the insurance business and is not subject to the laws relating to insurance companies. However, the organization is obligated to include within its agreements provisions for reimbursements or indemnity of subscribers paying for services which the contractor is unable to perform. The agreements must be underwritten by an authorized insurance company, or guaranteed by an authorized surety, or guaranteed by a deposit of cash or securities of a designated amount. The financial operations of the organization disclose that a predominant portion of its expenses relates to the service feature and only a minor portion relates to the dollar indemnity feature.

For purposes of part I of subchapter L of the Code, section 1.8013(a) of the Income Tax Regulations defines an insurance company, in part, as follows:

(1) The term "insurance company" means a company whose primary and predominant business activity during the taxable year is the issuing of insurance or annuity contracts * *

The meaning of the term "insurance company" as defined in the regulations cited above is equally applicable to insurance companies other than life. See sections 1.831-1(a) and 1.831-3(a) of the regulations.

In terms of the definition in the regulations, a predominant activity of an organization qualifying as an insurance company must be the issuing of insurance contracts.

An insurance contract must involve the element of shifting or assuming the risk of loss of the insured and must, therefore, be a contract under which the insurer is liable for a loss suffered by its insured. See Jordan, Superintendent of Insurance v. Group Health Association, 107 F. 2d 239 (1939), and State ex rel. Fishback, Insurance Commissioner v. Universal Service Agency, 87 Wash. 413, 151 P. 768 (1915). With respect to the preventive phase of the medical service contract issued by the organization there is no hazard or peril insured against. With respect to the sick or disabled phase of the contract, although an element of risk exists, it is predominantly a normal business risk of an organization engaged in furnishing medical services on a fixed-price basis, rather than an insurance risk. As a result of illness or disablement, the contracting organization generally does not incur any expense other than that which it incurs in providing the medical services through a salaried staff of physicians, nurses, and technicians.

Since the essential element of an insurance contract is lacking, the medical service contract issued by the organization is not a contract of insurance. Therefore, the predominant business activity of the organization is not the issuance of insurance contracts.

Accordingly, the organization does not qualify as an insurance company within the meaning of the Code.

26 CFR 1.801-4: Life insurance reserves.

Rev. Rul. 68-185

An insurance company is engaged solely in the business of issuing life insurance through both direct writings and reinsurance insuring the lives of debtors of various credit institutions. Such institutions are the beneficiaries under the contracts. All of the contracts are of short duration. The company is required by law to maintain life insurance reserves. It computes its life insurance reserves by determining the average age of the borrowers and the average duration of the policies it issues and applies those averages to a recognized mortality table. The reserves so computed are maintained at assumed rates of interest. The above-described contracts are known as "credit life insurance contracts." Since the payment of the insurance money is contingent upon the loss of life of the debtor, the contract is recognized as a life insurance contract. A company engaged principally in the business of writing or reinsuring credit life contracts may qualify as a life insurance company, as defined in section 801 (a) of the Internal Revenue Code of 1954, provided its life insurance reserves (as defined in section 801(b) of the Code) comprise more than 50 percent of the total reserves.

Section 801(b) of the Code defines "life insurance reserves" as amounts which are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, and which are set aside to mature or liquidate future unaccrued claims arising from life insurance contracts involving, at the time with respect to which the reserve is computed, life contingencies. With certain exceptions not pertinent here, such reserves must be required by law.

Held, those reserves that are required by law to be maintained by the insurance company and that are determined by application of an average age and average duration against a recognized mortality and morbidity table qualify as life insurance reserves under section 801 (b) of the Code provided such averages are in accord with the actual ages of the insured members of the group and the actual durations of the policies issued.

Subpart B.-Investment Income

SECTION 804.-TAXABLE INVESTMENT INCOME

26 CFR 1.804-4: Investment yield of a life

insurance company.

Reduction of investment expenses by the amount of such expenses which are attributable to tax-exempt interest and dividends subject to dividends received deduction. See Rev. Rul. 68-103, page 324.